First-loss, frontline gains

Adrian Brown wrote a thought-provoking piece on the role of first-loss capital in social impact bonds. He noted, rightly, that it’s not the hammer to hit all nails and, when used inappropriately, skews incentives and its objectives. However, it is our belief that first-loss capital can be structured in social investing in a way that does align incentives correctly, and therefore have the catalytic effect it is intended to.  In short, not all first-loss capital is the same.

There is a world of social finance beyond social impact bonds. In speaking to many charities and social enterprises across the country – and at the Social Investment Business we have worked with over 1,000 organisations in the last 12 years – a recurring theme has been the request for simple finance. Typically, this translates to straightforward loans, usually unsecured. 

The question we have been asking is how do we get more finance to frontline organisations? We believe first-loss capital has a role to play. 

High street banks have historically provided some of this debt to charities and social enterprises, but the vast majority of that has been long-term, secured lending. This does not reflect the demand from the sector, and there remains a large group of charities and social enterprises that are unbanked, but are far from unbankable. Given this, the question we have been asking is how do we get more simple finance to these great organisations? 

We believe first-loss capital has a role to play. Adrian rightly talks about the alignment of incentives that is frequently missing in first-loss structures. We couldn’t agree more. Without aligning all the participants, you do risk philanthropy being seen as ‘soft’ and the others being seen as ‘serious'. But it need not always be that way. 

In the coming weeks, Social and Sustainable Capital (SASC) will announce a new fund in which SIB Foundation is providing first-loss capital structured as a 'repayable grant'.

We will be providing other investors with first-loss protection, but importantly not subsidising their returns. We have achieved this by requiring SIB Foundation’s investment to be repaid in full before other investors in the fund can make a positive financial return. By structuring the fund in this way, SIB catalyses a larger pool of funds for frontline organisations, creating the potential for far greater social impact, without creating ‘skewed incentives’ within the fund.

Incentives truly are key. The benefit of structuring it this way has been twofold. First, all of the participants (philanthropic investor, socially-motivated investor, commercial investor) fulfil their objectives on each of risk, financial return and social impact. Second, and moreover, all of this structuring (and financial jargon!) can be in the background so that, in the foreground, we can offer straightforward loans to charities and social enterprises, which they are demanding of us.  

On a broader point, the role of philanthropy and grant 'subsidy' for our sector is critical and mustn’t be dismissed entirely, as I’m certain Adrian agrees. As well as this new fund, we focus on the role of grants for investment readiness work through Big Potential, funded by the BIG Lottery Fund, and the Investment and Contract Readiness Fund, from the Office for Civil Society. With both of these, we provide grants to charities and social enterprises to buy dedicated business support from a range of providers, helping them to take on investment. This is another important way for philanthropy/grants to be involved in social investing, which need not be soft; but, rather, play a catalytic role to prime the pump of the sector and enable more capital to flow to frontline organisations, which we are collectively criticised for not adequately doing. 

Therefore, we believe that correctly structured first-loss capital, that aligns incentives, does have a role to play in social investing and can be the right hammer to strike down the right nail. 

Vinay Nair is the Director of Business Development at the Social Investment Business Foundation and at its partner organisation, Social and Sustainable Capital. 

Photo by Brian Wolfe