One of the biggest challenges faced by social enterprises is the lack of funding opportunities. A conventional business can use its business plan and balance sheet to offer different combinations of risk and return and attract investors. However, social enterprises find it difficult to do the same. In this article, we will look at Quasi Equity Debt and Social Impact Bonds as the two innovative financial vehicles that social enterprises use.
Quasi Equity Debt
In order to overcome the hurdle of the lack of funding opportunities, many social organizations have developed financial vehicles which combine the properties of debt as well as equity. If the structure of an enterprise is as a non-profit, it cannot get equity capital. This is where a Quasi Equity Debt security is useful. A Quasi Equity Debt security is technically a form of debt. However, its returns are indexed against the financial performance of the enterprise.
The holder of the security has no direct claim on the ownership and governance of the enterprise. Further, the terms and conditions of the loan provide the management incentives to operate the enterprise efficiently. Social investors purchase these securities. The Quasi Equity Debt securities make it possible for social enterprises to offer banks and other lenders a competitive investment opportunity.
Example of Quasi Equity Debt
The Bridges Social Entrepreneurship Fund is one of the many social funds of Bridges Ventures – a UK-based investment company. This fund has around £12 million available for investment in social enterprises. For example, it loaned £1 million to HCT – a company which uses surpluses from its commercial London buses, school buses, and Park & Ride services to provide community transportation for people who are unable to use the conventional public transport. This loan has a Quasi Equity Debt feature:
The fund takes a percentage of the revenues and shares some of the risks and gains of the business. By tying up the loan to the revenue line, HCT has a strong incentive to manage the business efficiently. Usually, covenants on such loans are added to avoid the mission drifting away from social goals.
Social Impact Bonds
The Social Impact Bonds help the government fund infrastructure and services costs. This is important especially during cuts in the public budgets and stressful municipal markets. The Social Impact Bonds were launched in 2010 in the UK. Further, these bonds were sold to private investors who received returns only if the public project succeeded. For example, if a rehabilitation program reduces the rate of recidivism among newly released prisoners, then the investors receive returns. Therefore, investors have an opportunity to take calculated risks for profits.
The government pays the investors a fixed return for any verifiable results. Since these bonds shift the risk of failure of the program from the taxpayers to the investors, they can potentially transform the discussions about expanding social services. All across the world, governments are developing bonds to fund interventions targeting homelessness, early childhood education, and other similar social issues.
How it affects social enterprise financing?
These developments are opening new horizons for social enterprises in financing. If this continues, then soon, social enterprises will have more financing options than conventional businesses too! Most of us donate some money for charity. However, if you were to think of all these donations as investments and imagine a comprehensive legal structure to regulate them, then you have a completely new class of investors.
For example, an organization delivering social returns could obtain seed capital without providing the donors with any claim on its assets. Further, the equity capital with a residual claim on assets and the debt capital with a prior claim on assets and cash flow can augment the seed capital. Imagine the growth of possibilities for social enterprises if this market develops.
Interestingly, apart from social enterprises, conventional financial markets gain from this as well. Since these bonds broaden the range of asset classes, investors have more options to diversify their investment portfolios. They can earn returns from a completely new set of products and customer groups and also in different countries.
Solved Question for You
Q1. What is a Quasi Equity Debt Security?
If the structure of an enterprise is as a non-profit, it cannot get equity capital. This is where a Quasi Equity Debt security is useful. A Quasi Equity Debt security is technically a form of debt. However, its returns are indexed against the financial performance of the enterprise.