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.
In the UK, the Commission on Unclaimed Assets (CUA) and the Social Investment Task Force forcefully argued for the creation of a “social investment bank,” capitalized from the pool of unclaimed assets languishing for more than fifteen years in bank accounts and building societies. Now provisionally named the Big Society Bank, this initiative has strong backing from the Coalition Government.
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.
Some argue that the social sector’s problem is that it is significantly under-resourced. Others argue that the insufficiency of resources is in part a consequence of the sector’s reliance upon philanthropy — from foundations and from individual donors — that can be unpredictable. Both critiques may be correct: the social sector has a problem in accessing capital, often because of a lack of a reliable revenue stream, and, as a consequence, it is inefficient, especially in respect of building sustainable organizations, securing funding and utilizing assets to support large-scale activity.
Recent moves to make the social sector more efficient, by focusing on improvements to the management of both the donors and the recipients of grants, are an important development. The Bill & Melinda Gates Foundation applies rigorous criteria to the assessment of the performance of organizations in receipt of its grant funding. Michael Dell’s philanthropic work is similarly rigorous. Their goal, according to Harvard professors Robert Kaplan and Allen Grossman, is, essentially, “to find and fund the Microsofts and Dells of the non-profit sector.”
In fact, such moves are more necessary than ever, as deficit-ridden governments seek to pass greater responsibility onto the shoulders of the social sector. An example of this is the UK Coalition Government’s strategic objective to foster the “Big Society.” In essence, the Big Society agenda seeks to pass a significant portion of responsibility for social cohesion back to the community via the voluntary sector, and, at the same time, to confer greater legitimacy upon such community work and to provide incentives and support for it. However, the social sector as currently constituted is unlikely to be able to address the scale of the social need; or, to put it another way, to meet the scale of the social challenge.
Say it with philanthropy
- Matthew Bishop and Michael Green are the authors of “Philanthrocapitalism: How the Rich Can Save the World.” They blog regularly at Philanthrocapitalism. Their views are their own. -
Bankers keep telling us how sorry they are for getting the world into the current economic mess, but the public doesn’t seem to want to accept their apology. To show they mean it, the rich need to discover philanthrocapitalism and start to give back to society – for their sakes and ours.
Reckless financiers are public enemy number one and everyone seems to be enjoying the schadenfreude of watching them squirm in front of Congressional and Parliamentary inquisitions. Cathartic as these spectacles may be, it doesn’t seem that the bankers are going to be let off the hook that easily.
Bonuses are already under scrutiny. But more swingeing, and damaging, action is being called for. How long will it be before public bloodlust demands convictions and jail time? Will governments be able to resist draconian regulation of the financial sector that will choke off financial intermediation and risk taking, and thus hobble the economic recovery?
It’s not just the bankers who are in the frame. The financial meltdown is adding fuel to the pre-existing fire of deep resentment of CEOs of big corporations and the rich in general who amassed such a large share of the benefits of the boom time. This is an ugly time to be rich and a perilous period for capitalism as a system.
As our economies worsen, poverty and social unrest will rise. Charities and nonprofits, which will be on the front line in meeting those needs, are being hit by a triple whammy of declining revenue, as private donors cut back their giving, scarcer public funds, and rising demand for their services.
The rich need to move swiftly and decisively to fill the charity funding gap: to show contrition and demonstrate that they are good members of society rather than a bunch of speculators and hucksters. That’s why, at the World Economic Forum in Davos earlier in the year, we called on the CEOs of the Fortune 500 and FTSE 100 companies to give a year’s salary to good causes. Other wealthy individuals should join them.
Mr. Matthew Bishop, isn’t it a condescending view of the world?
Let’s see it this way: what would you think if you got robbed at gun point, shot at, but luckily escape death, then get taken to the hospital and then realize your doctor is the guy that robbed and shot you?
It’s like arms dealers setting up charities for victims of exploding mines.
Like the guy who lays you off to save his hide now serving you a hot steamy bowl at the soup kitchen, out of his kind heart and selflessness – not to mention a duty as a rich man to tend to the needy and the lesser well-off.
Comparatively speaking of course.
We at Santa Clara University’s Center for Science, Technology, and Society believe that changing investment rules may accelerate impact capital, and importantly the benefit delivered by social entrepreneurs receiving the funds. We also believe that a critical element will be what we term “horizontal capital aggregation” – syndicating funding partners by aligning key objectives among different capital investment structures.
In fact, we are releasing a new report through our work with the Aspen Network of Development Entrepreneurs (ANDE) that shows why impact capital investors face far greater challenges in creating efficient investment ecosystems than traditional VCs. Among the challenges: due diligence is conducted remotely; syndicates are assembled globally but impact measured locally; and the majority of impact investments still come from wealthy individuals or family foundations — not the corporate or professional money that supports the U.S. VC machine. Our report seeks to identify where opportunities exist to create consistent sources of capital flows to these socially-minded businesses, so they won’t have to scramble for new money at each stage of development. We hope this will catalyze exponentially better chances of success and therefore greater impact to the base-of-pyramid communities, creating nuclei for economic growth and systemic alleviation of poverty. The full report can be found here.
Thane Kreiner, Ph.D., executive director of the Center for Science, Technology, and Society at Santa Clara University. http://www.scu.edu/socialbenefit/index.c fm