Risk capital

Since 2000, there has been increasing interest in exploring new ways of providing support to charities, other than grants or donations. Interest is fuelled by a desire to ensure that funds are used as efficiently as possible in the pursuit of social returns.

The Social Investment Task Force Report that year highlighted opportunities to use a range of financial mechanisms that were commonplace in the private sector, yet were almost unknown in the charitable sector.

Since then, the emerging social investment market is beginning to offer charities a range of funding, spanning a spectrum of risk profiles, where risk is defined as the chance that money will be repaid (see Figure 1).

What is risk capital investment?

In the risk capital model¹, funders see their money 'recycled' several times, rather than given away once, furthering the social impact of their giving. That is, funds are committed to a charity, and then repaid to the funder, usually with interest. These funds are then reinvested, hence the term 'recycled'.

For the charity such tools can be cost-effective, as interest is only charged on money that is drawn down. Underwriting, for example, is commonly used to reduce the level of financial risk to charities, allowing charities to proceed with their plans in the confidence that they could draw down funds should they need to. Risk capital funds may therefore form part of an organisation's overall financial risk management strategy. Further benefit to the charity comes from the mix of finance, advice and access to the wider social investment network that many risk capital funds provide.

Risk capital funds tend to assume higher financial risk than would a conventional bank lender, for whom, in the absence of security, the charity or project could be assessed as too risky or to have too high an appraisal and monitoring cost. Whilst risk capital funds do not necessarily expect a higher financial return for this increased risk, they expect and monitor social returns on their investments. The total return is therefore made up of both financial and social elements.

Demand for Risk Financing

Risk capital funds support charities that find it difficult to raise funds from more traditional sources, such as grants or bank borrowing. This may be because the application falls outside of traditional grant-makers' criteria, is not project specific, has too great a commercial characteristic or because competition for funding in the sector is intense.

Awareness of the potential role of risk capital is growing, and there is greater willingness amongst trustees to consider such finance in a charitable organisation. Charity trustees, who are obliged to consider the management of risk in their organisations, are beginning to see risk capital as an appropriate element of the financing mix of their organisations.

Supply of Risk Capital

Risk capital mechanisms are being explored and supplied by individual donors, trusts and foundations and central government. Support can be given directly, although intermediaries offering the opportunity to invest in risk capital funds are increasingly seen as an efficient route to market for those seeking to maximise the use and social impact of their money.

Intermediaries include Venturesome, Bridges Community Ventures and the Triodos Opportunities Fund, while several banks, including specialists such as Charity Bank, also provide lending support to charities.

Involvement of individual philanthropists

As the sector grows, individual philanthropists are increasingly taking an investment approach to their charitable giving. By investing in the intermediary risk capital market, philanthropic investors benefit from:

• Efficiency: Investors can see their charitable money recycled several times, in contrast to one-off donations.
• Access and research: Investors benefit from a route to market, and particularly to small, entrepreneurial charities that they may otherwise miss. This access is backed up by due diligence and screening by a trusted source.
• Engagement: Some funds may offer investors opportunities to engage in different ways, from the simple commitment of funds to the opportunity to visit charities, select investments and provide on-going mentoring support.
• Strategic impact: Funders taking an investment approach are helping to build the emerging social investment market and have benefited from the mutual learning of their peer group.

 Recommended resources

• Venturesome is an £8m fund (2008) supported by a mixture of individuals, corporate investors, trusts and foundations. Venturesome uses investment mechanisms such as underwriting, unsecured loans and equity-like instruments to support charities, charitable enterprises and other businesses with a social purpose.  
• Ventures">Bridges Community Ventures is a venture capital fund investing in ambitious for-profit businesses in deprived areas in England. In 2002, the UK Government committed £20m to its first fund, matched by £20m of private investment. Bridges raised a further £75m from the private sector for its second fund in 2007. 
• Bank">Charity Bank takes deposits in order to create a source of affordable loans and to provide related support services for the charitable sector.
• Triodos Opportunities Fund provides investment funding for growing social entreprises. 

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1 The risk capital model offers social investors an opportunity to combine financial with social returns. As with any investment decision, we advise you to consult an investment professional in evaluating your options.