The Great Debate

Impact capital is the new venture capital (Part II)

By Sir Ronald Cohen
The views expressed are his own.

The first part of this essay laid out the rationale for impact investing, whereby investors can simultaneously create social impact and achieve financial returns. How can we bring it about? First, we need an enabling environment. In the 1970s and 1980s, the venture capital community argued successfully for changes in taxation and the regulation of financial institutions to foster investment in venture funds. Governments were lobbied to improve the climate for start-up and early-stage ventures. Markets to raise equity and trade stocks in pre-profit companies were introduced in the US (Nasdaq in 1970) and in the UK (USM in 1979). Rates of direct, personal taxation were reduced. And, in 1978, amendments to the USA’s ERISA legislation were specifically designed to foster venture investment by U.S. corporate pension funds. Such liberalizing measures were adopted first in the USA, which, as it turned out, reaped most of the benefit of the high-tech revolution, largely funded through venture capital.

Social enterprise and impact investment need similar rule-changes to foster investment in mission-driven ventures that deliver social returns in combination with financial returns. We need tax incentives, as well as several rule changes: in the permitted scope of activities by charitable foundations; in the role of banks in low-income areas;  and in the rules governing institutional investment. In particular, the restrictions on investment by charitable foundations and financial institutions need to be adapted to enable the inclusion of social investment. For example, regulatory encouragement for pension funds is needed, so that social investments are included within the definition of prudent investment.

The Social Investment Task Force, which examined these issues in the UK over the period from  2000 to 2010, recommended the creation of a system to support social investment. Its specific proposals included the introduction of Community Investment Tax Relief, fashioned after the U.S.’s New Markets Tax Credits; the formation of community development venture funds to take a long-term view of equity investment in poorer, underinvested areas; greater disclosure of the lending practices of banks in low-income areas to encourage best practices, following the U.S. lead; greater latitude and encouragement for charitable trusts and foundations to invest in community development initiatives; and the strengthening of the community development finance industry through the creation of a professional association.

These recommendations were taken up by the Labour Government and the decade witnessed the emergence or development of many social enterprises, including Charity Bank, CAF Venturesome, Big Issue Invest, Breakthrough, Investing for Good, CAN, Impetus Trust, Bridges Ventures, Social Finance and Social Investment Business. We need to continue this momentum in the UK and elsewhere by focusing on building the enabling environment to support impact investing.

Next, there needs to be a wholesaler to channel capital into the social sector, which has, to date, been disconnected almost completely from capital markets and so has suffered from inefficiency in funding and capital formation. Social returns do not attract capital in the way that financial returns do. An organization is required to act as a financial engine for the social sector, attracting capital by blending social returns with financial returns and tax incentives.

Impact capital is the new venture capital (Part I)

By Sir Ronald Cohen
The views expressed are his own.

Broadly speaking, capitalism does not deal with its social consequences. Even as communities grow richer on average, so the gap between the “haves” and the “have-nots” increases. For example, since the mid-1970s, both the USA and UK have actually become less equal rather than more equal. In the long post-war boom many governments did make significant headway in ameliorating the consequences of social inequality. This can be seen in levels of investment in areas such as health and in critical performance measures such as life expectancy. Nevertheless, governments, despite their best efforts and even in the best of times, have not been able to resolve all social problems.

Commentators on one side of the political spectrum attribute this failure to the lack of resources available to the state and to the state’s reluctance or inability to act appropriately. Commentators on the other side attribute government’s shortcomings to the inherent inefficiency of the state itself. The truth is that the political process, which focuses on short-term gains, does not favor long-term, preventative investment of the type required to address major social problems.

The social sector, which is also called the voluntary, non-profit or third sector, has done its best, with the support of philanthropic donations and government, to address the social problems that fall through the gaps in government provision.