Risky business?

A donation is a financial risk. How do you know that you are trading your money for social impact?  Will donated funds be used effectively, and efficiently?

To mitigate against this risk, donors may take the view that they can track where and how their money has been used by restricting funding to particular projects; others may only give to those charities or causes they feel they know well.

But there is another way: invest with the expectation that funds will be repaid. The very concept may seem bizarre to many donors – how could this be possible, without diluting social impact? 

To answer this question, first we have to answer why charities might need such funding. Charities are not-for-profit businesses.  In many ways, charities face the same financial needs as businesses and require not only income (in the form of grants, donations or trading), but also capital.  Capital can be needed to bridge the gaps between grants, weather stormy times when income dips or invest in development.

Historically, capital need has not been well articulated. It has certainly been poorly served. Typically, charities have low reserve bases, finding it difficult to generate surpluses.  They have often struggled to access capital from banks and may shy away from asking donors to step in to cover these needs – they don’t want to alienate donors by asking them to invest in areas that, at first glance, appear removed from the cause (however false that perception may be).

Yet capital is vital. We have witnessed in recent months businesses with solid income streams folding for want of access to capital. Capital can, of course, be provided in the form of grants. Grant funding is the lifeblood of the sector and will continue to be so. But grants and donations are in short supply, an issue which will worsen for some during the recession. Furthermore, grants might not always be the most appropriate use of funds.

Social investment complements grant and trading income. Take the following examples:

Underwriting enables organisations to proceed with plans before 100% of funding is raised. Charities can then take advantage of a better property price, cheaper building contracts, or a great new hire. Underwriting can galvanise fundraising – once a project is underway, charities may find it easier to raise the remainder. But if funds aren’t raised in time to meet costs, then the social investor is there to bridge the gap.

Bridging finance tides charities over where income is delayed or uncertain. Rather than stopping or scaling back, negatively impacting social impact, charities can use bridging finance to continue activities, at minimal cost.

Where future income streams are more uncertain, but where the risk is worth taking for the potential social impact, equity-like investment may be needed. ‘Quasi-equity’ is a hybrid between debt finance (which may be too onerous) and equity (not possible as charities can rarely offer share capital), and is typically used when a charity has a product or service it can sell. The investor can be repaid from future revenues through a royalty payment, but stands to gain nothing if the organisation does not achieve expected revenues.

These types of investment work alongside grants and other support to improve efficiency and effectiveness. Venturesome has invested in some 200 charities, ensuring the survival of some and enabling the growth of others, while recycling 95% of the capital committed to date. We’ve advised hundreds more on the right type of funding for their particular financial need. Awareness is growing among charities of this type of financial support, and among donors – rather than placing funds on deposit and realising minimal financial returns, why not make your money work to realise social impact?

Emilie Goodall joined Venturesome as an Investment Manager in 2007, having previously worked as a Research Analyst at the charity New Philanthropy Capital (NPC). She holds an MA in French and Philosophy from Oxford University. www.venturesome.org.