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Equity-Like Capital for Social Ventures

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Equity-Like Capital for Social Ventures Equity-like capital for social ventures Contents Introduction 3 Executive Summary 5 Project overview 6 The Market of Social Ventures 8 The Equity-like capital gap 19 Proposed social fund structure 30 Investor types for social fund 51 Implications for policy 57 Appendix 1: List of interviewees 62 Appendix 2: Source documents and further reading 65 Appendix 3: Background on Bridges Community Ventures 66 This exploratory study was completed in July-September 2004 with a grant from the Phoenix Fund. Author: Laura Howard Editor: Michele Giddens For more details, please contact: Michele Giddens ([email protected]) Bridges Community Ventures 1 Craven Hill London W2 3EN 020 72625566 2 Introduction Purpose of this study Bridges Community Ventures (BCV) has undertaken this exploratory study to investigate whether there is a need for a new kind of equity-like capital to support the growth of social ventures and whether there is an investment model that could create more substantial and sustainable flows of investment into social ventures and complement existing sources of funding like donations and loans. About Bridges Community Ventures BCV is the UK’s first community development venture capital company, established to invest in ambitious businesses in the most under-invested parts of England (www.bridgesventures.com). BCV invests in ambitious businesses that are located in and economically linked to deprived areas in England. To be eligible to be considered for an investment a business must meet the following 3 criteria: - Location - Based in the most deprived 25% of areas in England. - SME - Independently owned with fewer than 250 employees and an annual turnover not exceeding £25M - Economic Links - Connected with the local economy by employment, market or supply chain BCV looks for businesses with the following attributes: - Clear business objectives - Strong management team - Compelling business proposition - The potential to deliver attractive returns Deal parameters: - Stage - Bridges Community Ventures is a generalist investor, investing in a range of industry sectors and stages. - Sector- All sectors considered with emphasis on manufacturing, services, media, retail and leisure - Deal size- From £150k - £2 m in terms of our portion of a transaction Why BCV undertook this study In its first year of operations, BCV came across a significant number of socially-motivated companies who applied for investment but could not be financed using the venture capital funds currently under management. Approximately 10% (c. 40 applicants) of BCV’s deal flow in the first year came from businesses that had an overriding social goal to their work. There was no obvious place to refer these deals. Rather than continuing to turn them away, BCV has decided to engage in this research to examine alternatives to provide funding for these important ventures. 3 Why couldn’t BCV finance these businesses from existing funds? The investment model BCV and uses is a traditional venture capital approach in which we buy shares in companies for a period of 3-5 years, during which time we work with the companies to grow the businesses and make them more valuable. At the end of this time, we do not typically get repaid by the companies but instead sell our shares by floating the company or by selling it onto someone else. This model is not appropriate for social ventures, where the social mission is core to the business and so, even if the business is profit-making, it is not profit-maximising. The financial returns from such businesses are often lower than their mainstream private sector equivalents and they usually are not comfortable aiming to sell onto another business or issuing shares on an ordinary exchange because the social mission may be compromised by the new owners’ desire to maximize profits. This means that the exit route used by venture capital funds, (including community development venture capital) is not available. As a result, if BCV tried to invest in social ventures, it would usually have to seek a return through repayment of capital from the company and that would be at rates of return that would be burdensome and possibly detract from the social mission. Methodology BCV completed over 40 interviews as part of this study and held a consultation roundtable to gather comments from experts and practitioners in the sector. We also conducted desk research and telephone interviews with practitioners in the USA. Thank you Bridges Community Ventures would like to express its thanks to all who kindly allowed us to interview them in the production of this report. A list of interviewees is available in Appendix 1. Presentation of findings The bulk of this report is based around a working presentation which was used with interviewees and at the consultation roundtable. We have added further explanatory comments and sources in the notes below each slide. The animated PowerPoint version of this presentation is also available by emailing [email protected]. 4 Executive Summary Momentum is growing in the social enterprise sector. Patient Capital1 funds have been set up and are making their first investments. In 2003, seven social enterprises ranked among the Inner City 1002. A new social enterprise centre has been set up at the Said school of business in Oxford. The Global Entrepreneurship Monitor (GEM) Project has started tracking social entrepreneurship. The Government is launching a new legal form for social enterprises (the Community Interest Company). Several in-depth pieces of work on aspects of social enterprise have been completed or are close to completion. On the investor side there is also momentum. There has been increasing interest in SRI3 and ethical investment. Investors have bought ethical shares in companies like Café Direct and the Ethical Property Company. The new Community Interest Tax Relief accounts offered by Charity Bank and Triodos bank have been heavily subscribed. However, there is still a disconnect between social investors and social ventures. A large proportion of social enterprises still cite lack of availability of external finance as one of the main barriers they face to expanding trading revenue4. As well as facing difficulty attracting funds, social ventures also frequently need support in the complex balancing act they perform in trying to deliver both social and financial value. BCV undertook this research project to explore whether there was an opportunity to learn lessons from the venture capital sector to work on this issue. We believe we have identified an opportunity to bring social investors and social ventures together. Establishing a social venture fund would support social ventures by using innovative equity-like financing instruments to avoid the problems that some social enterprises face when issuing pure equity. It would also help them build their social ventures by providing business building support tailored to the specific challenges that social ventures face. Finally, it would make the space more visible and accessible to social investors whilst delivering a return to that makes the fund sustainable and able to attract more funds in future. We see this as an important first step in establishing a new social investment asset class for investors. Our recommendation is that a pilot social venture capital fund should be established to demonstrate that there is sufficient market demand and that social ventures can be sustainable. This will have both a social purpose and an educational purpose that will bring more social ventures into the space and provide comfort to investors that promised returns will be delivered. 1 For a definition of Patient Capital see page 25 2 The Inner City 100 is a yearly business index and research initiative which locates and celebrates the 100 fastest-growing inner city enterprises in the UK. 3 SRI = Socially Responsible Investment 4 32% of social enterprises cited lack of available external finance as a barrier to expanding trading activity – Bank of England report on financing social enterprises 2003 5 Outline Project overview The Market of Social Ventures The Equity-like Capital Gap Proposed Social Fund Structure Investor Types for Social Fund Implications for policy Appendices List of interviewees Source Documents and further reading 6 Project Overview Purpose: • Bridges Community Ventures is undertaking an exploratory study to understand the need for a new kind of equity-like capital to support the growth of social ventures Key questions: Market of Social • What are the types of social ventures that could be supported with Ventures equity-like capital? How large is the market of these ventures? Equity-like capital • What sources of capital are currently available to social ventures? gap Is there currently a need for additional types of risk capital? Equity-like capital • If so, what are the vehicles that could best provide this risk vehicles capital? How would these vehicles be structured? Investor • What type of investors would invest in this capital and what is the proposition investor proposition? Implications for • What are the actions that government or other players should be policy taking to promote the growth of the social venture sector? Bridges Community Ventures (BCV) has undertaken this exploratory study to investigate whether there is a need for a new kind of equity-like capital to support the growth of social ventures and whether there is an investment model that could create more substantial and sustainable flows of investment into social
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