Tag Archives: Pioneers Post

Ex-bankers in “social investment”: Disease or cure?

Before we talk about a “cure”,   let us first be clear on the disease.  I assume it is the fact that the economy has been run to profit-maximise, without any interest in societal ramifications – financial markets have supported this.  The full cost of this narrow-minded approach has been realised through the financial crisis and its aftermath.  We can spread the blame about if we wish and include governments, regulators and all of us as shareholders and consumers, but the main blame lies with bankers – it their actions were primarily responsible for the pain and suffering on an enormous scale.

Impact investing is about using these same financial markets, without which modern society cannot function, and take into account risk, financial return, and a third dimension: the social, ethical and environmental impact (we use social impact to mean all three) of investments.  At ClearlySo we speak about “3D investing”, where investors make conscious decisions  about these three dimensions and how they relate to each other – and this is becoming more popular by the day.

Who can help investors make these decisions, and explain to entrepreneurs how to seek the most attractive capital with which to expand? I am afraid it is the bankers – at least in part.  We do not have to forgive them for their role in the crisis, but they do have expertise in the financial markets on which we depend to improve our world.  Scientists and politicians built and delivered the atomic bombs that killed tens of thousands of Japanese and have unlimited destructive potential.  Should we absent them from disarmament negotiations because of their complicity?

Bankers understand how financial instruments work.  They know when debt or equity is appropriate for an entrepreneur, or a combination of the two.  They know how to build financial models, how relevant legal documents are structured, or who the likely investors are, and they can advise in negotiations.  We find it substantially easier to raise capital for clients when finance professionals (yes, ex-bankers) are involved.  Ex-bankers not only possess expertise, but also useful contacts, market awareness and speak the language of finance.  To refuse to access these skills because of past misdeeds would be counter-productive and harmful to the entrepreneurs generating impact.

Do bankers deserve the historically outlandish rewards for their skills as intermediaries?  Probably not.  Should we have deified them as some did before the crash?  Certainly not!  However, demonising them is not the answer. In my experience, no sector has a monopoly on saints or scallywags.  I have encountered highly moral senior bankers and scandalously corrupt leaders of charities.

As a society we believe individuals can redeem themselves.  We give prisoners a second chance – why not bankers?  (Note: I have a strong personal interest in this being the case, as an ex-banker myself!)

In immunology, it is not uncommon to inject the body with a bit of a disease in order for the body to develop useful antibodies.  Too much of the disease would be harmful, but what caused the disease can help foster a cure.  I think the same is true in finance.

First Published in Pioneers Post in August 2015.

Impact-oriented finance utilises innovation on many levels—how about bribery?

At ClearlySo we believe that the main difference between impact investing and the old way of thinking is that the old financial world existed in two dimensions (financial return and risk), whereas the new world exists in three.  Impact, measured from a social, ethical or environmental perspective is a third, often intentional, dimension to the prior two-dimensional world.

Frequently we consider the enterprises into which impact investment is being made and observe with utter amazement, how the entrepreneurs blend conventional enterprise models with beneficial societal outcomes doing well and doing good.  We are especially proud of organisations like Third Space Learning, which reduce the cost of maths tutoring while simultaneously helping educators in India receive decent wages, or Weedingtech, which sells a non-insecticide based device for weed control.

Business model innovation has also been a feature.  Consider the London Early Years Foundation, which runs high-quality nurseries where wealthier parents cross-subsidise those who are less wealthy.  Another illustration is the Ethical Property Company (EPC), which buys and lets commercial property to social change tenants, who receive far better terms than they would in more conventional premises.  EPC’s better terms means that void levels in its premises are substantially lower than in conventional office estates.

Impact-oriented finance has also seen innovation.  Consider the quasi-equity (QE) instrument we assisted HCT Group in raising in 2010.  As a charity, HCT could not offer shares, but required long term risk-oriented capital to finance growth. Impact investors took both conventional bonds and a QE instrument in a £4.2m fundraising.  Those taking the more risky QE instrument received returns that grew with the growth in HCT’s turnover (above a benchmark) – and generated 10+% returns.  Of course, it could have gone the other way and investors (including Bridges Ventures, Big Issue Invest, SIB Group and Rathbone Greenbank) might have received no interest, or even lost capital.

Of course the best known and most celebrated financial innovation concerns the much discussed Social Impact Bond (SIB).  SIBs link payments received by investors to the social outcomes made possible by the underlying investments.  They have initially received substantial subsidies to gain traction but are now taking off globally.  Their genius is not in the structures, which are costly, but in the notion that government should pay for cost-savings which stem from social innovation.  Payment-by-results contracts will certainly become a mainstay of government commissioning.

It is these types of innovation that must now come to the fore.  In such fiscally constrained times, the rule of “what works?” must predominate.  Ideological opposition is melting away and there should be no limit to what is now possible; blue sky thinking is essential.  It can involve enterprises, business models, financial instruments and even the very way we think about societal problems.

Consider one such thought experiment:

What if we had bribed Iraqi citizens or its leaders to depose Saddam Hussein instead of using weaponry to defeat him?  The estimated official cost to the US of the war is around $815 billion (subsequent estimates by the Congressional Budget Office and the Nobel Laureate Joseph Stiglitz suggest the full impact was between $2-3 trillion).  This amounts to $24k for every single Iraqi (or $120k at $3 trillion!), in comparison with GDP per person of $6,863 per annum. This excludes the military cost to other nations and does not consider the extraordinary damage and suffering of the Iraqi people. One might argue that the cost of war is never known until after the fact, which is true; however, on 16 March 2003 Dick Cheney was asked on national television about the approaching war and he estimated that it would cost $100 billion.  Just this was equivalent to $3,852 per person at the time when GDP per person was $1,373 in Iraq. By using that money to persuade Iraqis, war could have been averted and costs in a purely economic sense (not even taking into account the damage, destruction and death caused) would have been sharply reduced.

If just the UK had used its far lower cost for the Afghan War of £37 billion to bribe Afghanis, or even their leaders, to do the things we wanted, this would have amounted to £1,600 per person, well above the current level of GDP per person of £436. Again this does not take into account the military costs to other combatants, including the USA ($686bn), or the devastation of Afghanistan.  When the figures are so compelling there must be a strong moral argument to consider such an innovation even if one might be a bit queasy about some of the underlying issues and despite the obvious technical and tactical issues involved.

The above is not to argue for Western imperialism or our right to impose “our” geopolitical preferences on others.  But from our own (selfish) perspective, we might have: a) had a better chance of achieving our goals, and b) saved a fortune, with this approach.  Furthermore, not to have gone to war would have avoided unspeakable suffering on the part of Iraqis and saved thousands of lives.

There are precedents for bringing behavioural persuasion into the public realm.  The “nudge” unit, established by the Coalition Government, did precisely this.  Here too, there was concern about the “nanny state”, but again in these times it is unwise to disregard any aspect of innovation.

We see cases of “bribes” being used to achieve social outcomes every day.  On 8 June 2015 the Independent reported on the Peacemaker Fellowship, which could also be described as targeted bribes to those most likely to commit offences not to shoot people.  This programme, operating in Richmond, California, follows on from similar programmes in Boston and Chicago.

I accept that there have to be limits, and important moral issues need addressing, but these are incredibly challenging times, and our failure to face up to these questions involves an active moral choice as well, even if we pretend to ignore it.  Opting to go to war because one finds bribery morally dubious is a very tricky argument to make.

We are just at the beginning of what we can do when we use financial innovation for positive outcomes.  I intend only to challenge a few shibboleths and get some creative juices flowing – as always, I look forward to further discussions.

First published by Pioneers Post in June 2015.

Are there really too many VCs in Impact Investment?

For years I have heard those involved in impact investment moan about the extent to which experienced VCs are “taking over”, bringing values which will destroy the very essence of the movement.  As someone who spent the better part of ten years as a conventional VC, perhaps I am being a little sensitive and taking this criticism too personally, but recent developments have brought me to reflect on the reality of this situation and its consequences.

One of ClearlySo’s Non-Executive Directors (NXD), Tim Farazmand, has just stepped down as Chair of the British Venture Capital Association (BVCA).  Tim made impact a central pillar of his tenure at the BVCA and has been interested in this sector since I first met him around 2000.  Significantly, Tim’s first new role since stepping down from his post at the BVCA is as NXD of the Ethical Property Company, a leading enterprise generating substantial social impact and a pioneer in using UK investors to raise tradable share capital. One imagines that there may have been quite a few options for such a person – the fact that he chose a values-led business is very significant.

This migration of VCs into impact investing is a well-trodden path.  An old friend, Stephen Dawson, was one of the founders (together with Nat Sloane) of Impetus (now Impetus PEF), the venture philanthropy investor. Antony Ross is a sector heavyweight with Bridges Ventures, and was previously at 3i.  Another 3i alumnus is John Kingston, the driving force behind CAF Venturesome, an early pioneer in impact investment.  Doug Miller, who used to raise money as a placement agent in private equity went on to found the European Venture Philanthropy Association.

Of course, the best known ex-VC in the field is Ronnie Cohen, a previous chair of BVCA and also Chair of the original Social Investment Task Force (SITF), as well as the founder of several impact firms including Bridges Ventures and Social Finance. Ronnie has been a leading advocate for the sector, the first Chair of Big Society Capital and was most recently Chair of the G8 SITF.  His influence within UK governments of all colours and with decision makers across the western world has been an important factor in UK pre-eminence in this space.

Some may not approve of the influence of these ex-VCs, but it is worth exploring why such individuals gravitate towards this field and what they are able to contribute.  Firstly, VCs understand, better than most, the ability of capital to effect transformation – they do this for a living.  Successful VCs understand how to grow entrepreneurial businesses and in many cases these are highly disruptive.  Their experience in generating growth can be useful in scaling organisations with the potential for sizable social impact.  VCs also are very experienced in raising capital.  They are forced to do this from time to time when they raise new funds – but any successful VC also knows that companies, especially the successful ones, require many rounds of funding before they achieve exit.  They are therefore resourceful when it comes to finding co-investors and other partners to work with during the life cycle of a business.

I believe that these are skills that are invaluable for the sorts of enterprises we work with, those that generate substantial social impact.  Others somehow feel that the influence of such thinking and experience will “damage the sector” or “destroy its soul”.  Frankly, I find this baffling.  We need people who understand rapid growth and have experience in achieving it.  We need people who understand how to galvanise capital.  And we really need people who understand disruption, which is the essence of what this is all about.  I think that any attempt to stem the flow of VCs into impact investment will actually harm the growth of the sector and will ultimately constrain the flow of funds into impact investment and thereby bring about less impact.  Encouraging trade bodies like the BVCA to get involved is enormously useful, particularly when one considers the scale of today’s societal problems.

There are still those who maintain that VCs undermine “the sector” and the purity of its purpose. I do not believe that any single person can define for others how the field should operate and what constitutes purity, or have a unique insight into its soul.  Each of us contributes our skills, our experience, our views and our influence – and sometimes our capital.  If there are those who feel a less financially-oriented marketplace, with a greater orientation towards impact is more desirable, there is ample opportunity to bring this about. There is also a great irony; the field was created by many of these same VCs whose views are deemed to threaten its future.  The debate continues …

First published in Pioneers Post in April 2015.

All Government Contracts Should Go to Companies Focused on Social Impact

The title is overstated, but there are strong arguments why most contracts ought to be awarded preferentially to bidders who operate primarily for social impact (PSIs).  Jon Cruddas, who is helping write Labour’s Election Manifesto, is to make this point in an upcoming book, reported on by The Telegraph entitled ‘The Common Good in an Age of Austerity’.  This position is based on a hard-edged, practical position that puts taxpayers first.

Governments have a depressingly poor track record in negotiating with purely for profit companies (PFPs).  The Private Finance Initiative (PFI), which brought commercial capital into public services, has been widely judged a disaster, with profit transferred to the private sector, but risk retained by the state.  From aircraft carriers to databases government negotiators have failed to impress.

The most recent scandal involved £16.6bn of bids for alternative energy provision.  Recently, the Guardian quoted Margaret Hodge, Chair of the Public Accounts Committee, in saying, “Yet again, the consumer has been left to pick up the bill for poorly conceived and managed contracts”.  This is similar to a previous report by this committee which was highly critical of G4S, Atos, Serco and Capita.  Serco and G4S were also the subject of an investigation by the Serious Fraud Office.

But let’s not unfairly demonise PFPs.  They have a legal responsibility to act in shareholders’ interests and to maximise profits. In negotiating with governments, PFPs structure contracts to their advantage – they have no legal obligation to act otherwise. We shouldn’t be surprised by this – it’s perverse to expect otherwise! It’s even more perverse that despite this PFPs are awarded nearly all contracts.

Why not award most contracts to PSIs?  Their raison d’etre is about social impact – and their constitutional documents reinforce this. Their approach is not about maximising profit, but about charging fairly and looking after beneficiaries.  Often they are innovative in their approach and genuinely care about the outcomes they achieve—their key stakeholders are beneficiaries, not shareholders.

If contracts with PSIs were priced too low, the taxpayer would get good value for money and PSIs gain painful lessons.  If too high, then PSI’s extra surpluses grow enabling more social impact – again the taxpayer wins.  Given this win-win “game” it’s astonishing PSIs don’t win all contracts.

One issue is scale.  There is no denying that private sector providers are larger.  Commissioners must be able to establish that PSIs can do the work – but this should be the only test. Instead, civil servants put in place pointless hurdles that have the effect of eliminating PSIs from the competition.

This was evident in the MoJ’s recent initiative-turned-fiasco “Transforming Rehabilitation”.  PSIs were told they could play a large role in the programme and the impact investment sector, led by Big Society Capital, helped some PSI-led consortia to qualify despite the unfairly tilted playing field.  Some well-run and large PSIs were involved such as Catch 22, Turning Point and Changing Lives.   In the end, all the contracts are led by PFPs, although some PSI “bid candy” also featured.  This was cynical and Chris Grayling and the MoJ were rightly excoriated by Antony Hilton.

A key issue was the need for parent company guarantees to ensure contract fulfilment, and the sums involved (£13-£74 million) meant few PSIs qualified.  But let’s unpack this criteria.  The parent companies that offered such guarantees are lowly rated – in each case far lower than RBS before the crisis began, leading to a state rescue.  How good a “guarantee” is this really? And SEUK research on PSIs found they are actually less likely to go under than private firms over the past 30 years.  People tend to value what PSIs do and work to rescue them if they encounter difficulties – would G4S be protected in a similar way if it encountered difficulties?

The lobbying efforts of large companies help put in place criteria that made bid processes complex which they then have an advantage in winning.  Don’t taxpayers’ interests demand we take the benefits PSIs offer into account? The Social Value Act was meant to help ensure this—it doesn’t.

Government ministers and civil servants are either lazy, illogical or excessively influenced by business, not to weight these factors more heavily in favour of PSIs—let us hope it is laziness, which can be most easily addressed.

First published on Pioneers Post in February 2015.