BIG SOCIETY CAPITAL’S INVESTMENT POLICY May 2013 1 CONTENTS INTRODUCTION ...................................................................................................................................... 3 1. BSC’s INVESTMENT OBJECTIVES ......................................................................................................... 4 1.1 SOCIAL IMPACT ............................................................................................................................ 4 1.2 CONTRIBUTION TO SOCIAL INVESTMENT MARKET DEVELOPMENT ............................................ 6 1.3 FINANCIAL RETURN ...................................................................................................................... 7 1.4 PORTFOLIO LEVEL OBJECTIVES AND DEALING WITH TENSIONS .................................................. 9 1.5 KEY INVESTMENT METRICS .................................................................................................. 10 2. BSC’s INVESTMENT RESTRICTIONS ................................................................................................... 11 2.1 LINE ELIGIBILITY .......................................................................................................................... 11 2.2 INTERMEDIARY STANDARDS ...................................................................................................... 12 2.3 MATCH FUNDING ....................................................................................................................... 13 2.4 MARKET FAILURE/ STATE AID COMPLIANCE .............................................................................. 13 3. BSC’s INVESTMENT PROCESS ........................................................................................................... 15 2 BSC INVESTMENT POLICY INTRODUCTION Every investment Big Society Capital (BSC) makes should contribute to our mission: to shape and grow a sustainable social investment market in the UK. For this to happen, we seek to combine three objectives in every investment: maximum social impact, a contribution to developing the social investment market, and a financial return. We seek to achieve the most appropriate mix of these three objectives subject to some conditions we must also adhere to, such as considering what counts as an eligible social sector organisation (SSO). This document sets out BSC’s investment policy in more detail. It is structured as follows: 1. BSC’s investment objectives 2. any conditions that BSC places on its investments 3. a summary of BSC’s investment process This document has several aims. We hope it will help potential applicants and the wider social investment market understand what we look for in our investments. Internally, we will use it to guide investment screening and questions during the due diligence process, and to provide a structure for BSC’s Investment Committee memos, discussion and post-­‐investment monitoring1. BSC’s Investment Policy is intended to be a ‘living’ document, and we will review it at least once a year. 1
As such, it is a major part of the response to the late 2012 review into how BSC integrates social impact in its investment process 3 1. BSC’s INVESTMENT OBJECTIVES BSC has three objectives that we seek to combine in every investment: 1. Social impact 2. Contribution to social investment market development 3. Financial return This section explains why we care about each objective and how we will assess it for each individual investment. It then discusses our objectives at a portfolio level, and considers the possible trade-­‐offs between the three objectives. It concludes with the key metrics we will track to know if we are meeting our objectives. 1.1 SOCIAL IMPACT Why does BSC care about social impact? We care because, ultimately, social investment is all about helping frontline SSOs increase their social impact by improving their access to appropriate and affordable finance. By an SSO we mean either a regulated body such as a charity, community interest company (CIC) or community benefit company, or a business that exists primarily to provide benefits for society2. By social impact we mean improved social outcomes such as those defined in the BSC Outcomes Matrix3 – for example improved educational attainment or health status, achieved for defined beneficiary groups, such as vulnerable children or deprived communities. We also care about social impact because we believe that evidence of sustainable social value from financial capital is key to unlocking the market. Investors choose to allocate their capital to social investment because they want their capital put to good use. They are investing in the promise of social change and want to see demonstrable evidence of social performance. BSC is a wholesaler and invests through social investment finance intermediaries (SIFIs). Decisions taken at SIFI level are an important determinant of the social impact generated by frontline SSOs. So we want to ensure that we understand and track social risk, social performance and mission congruency that have been triggered by our intervention all the way through the investment chain down to the front line. 2
The BSC Governance Agreement sets out the criteria we use to determine whether or not a business exists primarily to provide benefits for society. http://bigsocietycapitalblog.files.wordpress.com/2012/09/governance_agreement1.pdf 3
The outcomes and beneficiaries that we ultimately target with our investment capital are defined in our Outcomes Matrix see www.bigsocietycapital.com/social-­‐impact . 4 What does significant social impact look like for BSC? We will assess how strong the social mission, set of governance arrangements, activities, impact performance and impact reporting are both at the SIFI level and in the way in which the SIFI manages its investments: A. Social mission -­‐ Strategy – How clearly is the SIFI’s social mission and strategy articulated and defined? Is the social mission embedded into the investment strategy and policy that it uses to invest in the front line? Is it reflected in eligibility criteria? -­‐ Context – To what extent does the SIFI understand the social issues, needs and policy landscape targeted in its mission? B. Governance -­‐ Mission lock – Are there ‘locks’ on the social mission, for example in the SIFI’s articles, policies or assets? Are there clear policies aligning profits and remuneration to long-­‐term social performance? -­‐ Board/ Investment Committee – Does the Board/Investment Committee have sufficient experience in the social sector and/or in the social investment market? -­‐ Exit – Is there a clear policy on how social value is preserved beyond the term of the invested capital? Is the proposed exit plan likely to happen? C. Activities -­‐ Business model – To what extent will the SIFI ensure social impact and revenue generation are linked, and that mission fulfilment is integral to financial success and vice-­‐versa? -­‐ Track record – To what extent does the SIFI have experience and a track record of delivering successful social outcomes, either through its investments or via direct activities? -­‐ Management – To what degree does the management team have a propensity (commitment and passion) and the capability (relevant skills and experience) to successfully deliver social outcomes? -­‐ Accessibility – To what extent would the investment facilitate products and services that are inclusive, accessible and affordable to hardest-­‐to-­‐reach groups? D. Impact performance -­‐ Depth of impact – To what extent is the SIFI aiming to achieve outcomes that will make a fundamental difference to people’s lives? -­‐ Breadth of impact – How many people’s lives is the SIFI aiming to change, or how extensive is the change the SIFI is trying to make? In some circumstances, we may also look at the location of impact, for example making sure investments are targeted in areas of high deprivation. -­‐ Innovation – Will the SIFI deliver any systemic impact, for example local economic growth, knowledge sharing, disruptive models for social change, advocacy or innovation? If so, how much? -­‐ Organisational development – To what extent will the SIFI build frontline capability (including systems)? E. Impact measurement -­‐ Planning and targeting – Does the SIFI have a well-­‐designed impact planning and measurement protocol and process based on best practice for screening, selecting, assessing and investing? 5 Are targets and goals realistic and linked to the social mission? Are appropriate indicators selected? -­‐ Monitoring and reporting – How strong are the SIFI’s systems for monitoring and reporting the social impact of its portfolio and of its own impact? -­‐ Auditing – Has the SIFI arranged for a third party or arm’s-­‐length operative to perform independent auditing and verification of social impact reporting claims? -­‐ Learning –To what extent is the SIFI likely to improve performance and future strategy by learning from its impact measurement? The BSC Social Impact Tests and Thresholds sets out the criteria we use to assess the social impact of an investment. 1.2 CONTRIBUTION TO SOCIAL INVESTMENT MARKET DEVELOPMENT Why does BSC care about contribution to market development? Every investment we make must contribute to the development of the UK social investment market. This is the core of our mission. Market development is not only about achieving a positive social impact and/or positive financial return4. Market development means understanding how each prospective BSC investment helps strengthen a component of the social investment market, and how each investment contributes to a larger, more sustainable and diverse market. For example, certain investments will help to attract new types of investors, which is extremely important if the long-­‐term pool of social investment capital is to be broadened. Other investments will be particularly relevant to the front line, for example by providing a new product or type of capital that had previously been in limited supply or entirely unavailable. Other investments will strengthen the intermediaries on which BSC is so dependent to build a diverse and more expert market. Some investments will do a number of these things simultaneously or excel in a particular area – and these are the best investments from a market development perspective. What does a significant contribution to market development look like to BSC? We will assess the extent to which any investment will contribute to developing the supply of social investment capital, the intermediary level of the market, and the demand for capital: A. Supply of social investment capital -­‐
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Amount of capital – To what extent would the proposal significantly leverage additional capital into the sector? BSC seeks 1:1 matching of its own capital with a longer-­‐term aspiration of a 4:1 match. Source of capital – To what extent does the proposal attract new types of investors? We are particularly interested in proposals that help to pull in or build a new investor class. This might be via a new social investment product with appeal to new investors or a distribution mechanism. 4
Although we do of course recognise that if BSC’s investments fail to demonstrate either a social impact and/or a financial return, they will not be demonstrating the innate characteristics of social investment, and therefore will not help to develop the market either. 6 B. Intermediation -­‐
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SIFI sustainability – To what extent does the proposal contribute to a stronger SIFI landscape that helps access or provides finance for SSOs? We are particularly interested in proposals from new SIFI entrants that are credible and financially sustainable in a parallel asset class, and/or proposals that move existing SIFIs towards a sustainable model. Type of intermediation – To what extent does the proposal create or strengthen a valuable intermediation function in the social investment market? We are particularly interested in absent but critical pieces of market infrastructure that help to link the supply and demand for capital and/or reduce transaction costs. We are also interested in intermediaries that can be accessed as widely as possible by all target SSOs. C. Demand for social investment capital -­‐
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Diversity and reach – To what extent does the proposal channel social investment to previously unreached SSOs? Strong proposals might target an underserved sector or geography and/or have an innovative deal origination strategy. Frontline impact – To what extent does the proposal establish or improve access to a useful financial product and/or help prove, improve or scale good social business models? What denotes a ‘useful’ product will change as the market evolves. Currently, products that are particularly valued are those with a small minimum ticket size, that provide relatively patient or long-­‐term capital and risk or unsecured capital, and that get to the front line quickly. 1.3 FINANCIAL RETURN Why does BSC care about a financial return? We aim to balance our mandate to develop the social investment market and create positive social outcomes with the need to generate long-­‐term financial returns. We ourselves need to ensure that we are sustainable as an organisation and that our capital is preserved. Our investments will be diversified across a number of dimensions (see next section 1.4). If BSC achieves a long-­‐term financial return, it will help to prove the financial case for social investment and help to attract mainstream capital into the market. The nature of BSC’s proposed investment activity is high risk and not currently undertaken by mainstream financial services. Some of the target organisations will have no operating track record. Furthermore, under its 2012 State Aid exemption application, BSC can only operate in areas where market failure has been identified. Our focus will be to position SIFIs for growth and future investment, helping to develop the social investment market. What does a good financial return look like? BSC will assess an investment’s legal and capital structure, the investee organisation and its business plan, and the proposed financial model: A. Business and capital structure -­‐
Legal structure – Is the proposed legal structure appropriate and consistent with the business plan? Does it allow for future capital growth and provide effective governance? Is the autonomy of the business protected and consistent with its ownership structure? 7 -­‐
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Size – Is the proposed size of BSC’s investment appropriate and efficient in relation to operating costs, legal structure, regulatory considerations and suitability? Capital structure – In a tiered capital structure, is BSC’s proposed risk and return profile appropriate, for example are higher risks associated with the subordinated tranches compensated by a higher financial return? Costs and compensation – Is there complete transparency around fees/cost structure? We want to ensure SIFIs can deploy invested capital effectively without excessive leakages in the form of commissions, fees, remuneration etc. Exit – Is there is a realistic chance of exit within our timeframes? B. Organisation and business plan -­‐
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Business plan and link to investment – Does the business plan show a legitimate need for the proposed volume of investment capital? Does it explain clearly how it will be used to boost sustainable business operations? Market context – To what extent does the business plan seem feasible when looked at in the context of the market as a whole, competition in the market, the history of the company (or relative individual track record if appropriate), and with the anticipated injection of investment capital? We will centre our analysis on the evidence provided to support all projections and ensure these are consistent with the financial projections also provided. Track record – If relevant, is there a track record of fundraising and investment performance, and/or audited accounts if the proposal is from an operating intermediary? What is the quality of the management team and/or board? If the organisation has been operational for a shorter time, or it is a start-­‐up, we will look to support any proposal with as many references of individuals and analysis of prior roles as possible. Scale – To what extent does the SIFI have large enough assets (or assets under management in the case of a fund manager), or grow in a way that will both achieve its objectives and provide stability? C. Financial model -­‐
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Financial model – To what extent does the SIFI have a well thought-­‐out financial model, including detailed figures indicating cash flows, profits and expenses, and balance sheet? Ideally, the model will include activity and changes anticipated over the next five years as a minimum. Investments with terms of more than five years will be expected to include forecasting within their model to the end of the investment term. Repayments – To what extent do the business plan and financial model evidence an explicit and well-­‐structured repayment plan in the case of loan capital? Cost of capital – We will look at the financial model presented and work with the applicant to determine what capital is appropriate and affordable given the model. We will then judge whether the model delivers an acceptable risk/return against our three objectives as articulated in section 1. D. Financial risk -­‐
To what extent is there a clear understanding of the key risks inherent in the business model and financial plan and of the proposed mitigating strategies? We will want to understand how our 8 capital will be protected in the event of the investee organisation entering into financial difficulties, including default proceedings if relevant. The financial risk assessment includes any wider impact of economic risks, as well as the dependence on government policy or contracts and on donations or grant funding. All other things being equal, we also will expect greater financial risk to be compensated with a higher projected financial return. 1.4 PORTFOLIO LEVEL OBJECTIVES AND DEALING WITH TENSIONS The very best investments will make a strong contribution to all three objectives. BSC may occasionally find such investments (see diagram below left), in which case it should be a relatively easy decision to approve the investment. We may also find investments that are weak in all three objectives, in which case the investment should be rejected (see right hand side diagram below). An investment with weak contribution An investment with strong contribution to B
SC’s o
bjectives
to BSC’s objectives
Market development Market development contribution
contribution
Strong
Strong
Weak Weak Strong
Strong
Strong
Strong
Social impact Financial Social impact Financial performance
performance performance
performance (risk-­‐adjusted)
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In practice, however, most investments will feature a tension between the three objectives, which will need to be considered carefully by BSC’s Investment Committee. For 2013, our priority is to understand better the nature of these tensions and use this learning to drive our investment strategy in the future. Balancing these three objectives for any given investment will depend in part on what the rest of the wider BSC portfolio looks like. We will consider an investment’s relative strengths and weaknesses across the three objectives and the needs of the market that we serve. In addition, we want to build an investment portfolio that is diversified across: -­‐
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type of capital (for example, debt, equity, long/short-­‐term, secured/unsecured) geography social sectors/outcome areas as identified in the BSC Outcomes Matrix 9 In time, BSC will develop two ‘floor’ standards of portfolio performance: -­‐
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The social performance of our portfolio should not fall below a target impact for each of the social outcome areas outlined in the BSC Outcomes Matrix. We are working with the sector to develop portfolio tools for social impact performance metrics based on target outcomes, beneficiaries and allocated capital. Over the long term, the blended financial performance of our portfolio should: first, protect our capital by covering our operating costs and covering impairments, provisions and write-­‐offs; second, and then meet our obligations under the Subscription Agreement with our bank shareholders to generate a small positive return. 1.5 KEY INVESTMENT METRICS Across social impact, market development and financial return, there are some key metrics that will help us assess investments and, when monitoring investments, help us understand whether we are achieving our objectives. These key metrics are set-­‐out in the table below. Some metrics are particular to a single objective, others span all three. Some are particular to portfolio or individual level, others apply to both. Metric Expected and actual impact by outcomes, beneficiaries and geography Absolute and percentage of investments by i) types of capital ii) outcome areas/social sector iii) beneficiaries iv) geography v) intermediary type SIFIs in £ and number, cumulative total and incremental within a period Frontline organisations impacted, in £ and by number Amount of capital drawn down by frontline SSOs against approved Investment Committee memorandum commitments in £ and as % of total commitments Average lag period between commitment, drawdown to intermediary, and drawdown to frontline Leverage on BSC capital in £ and % Source and type (charitable, individual, institutional) of co-­‐investor by £ and % Portfolio size in amount and number of investments – in principle, closed and drawn down Expected and actual return on investment BSC profitability and capital adequacy Portfolio (P) or Individual (I) level Social impact Market development Financial return P/I Y P Y Y Y P Y Y P Y Y P/I Y Y P/I Y P/I Y P/I Y P Y P/I I Y Y Y Y 10 2. BSC’s INVESTMENT RESTRICTIONS As well as the three objectives that we analyse in every investment, there are also some absolute restrictions which BSC will impose on each investment. These restrictions also help ensure each investment contributes towards BSC’s mission of building a sustainable social investment market. The main investment conditions BSC will impose are: -­‐ frontline eligibility -­‐ intermediary standards -­‐ match funding -­‐ market failure test 2.1 LINE ELIGIBILITY The 2008 Dormant Bank and Building Society Accounts Act defines a ‘social investment wholesaler’ under Section 18(1)(2) as a body that “exists to assist or enable other bodies to give financial or other support to third sector organisations”, and that a third sector organisation is one that “exists wholly or mainly to provide benefits to society or the environment”. All BSC investments are required to confirm with the Act. Therefore, we have to be clear on which organisations qualify under the Act. We consider all regulated forms of SSOs to be fully eligible, by which we mean registered charities, CICs, and community benefit companies. We also consider for-­‐
profit companies to be eligible where they meet the terms of our Governance Agreement5. The main terms of this agreement are that companies: -­‐
Have objects set out in their constitutional documents which are primarily concerned with the provision of benefits to society. -­‐ Have a policy in relation to the distribution of profit after tax that ensures surpluses are principally used to achieve social objectives. Practically this means that the pay-­‐out of cumulative profit after tax to shareholders will be capped at 50% over time, and therefore ensures that any surpluses generated over time will be mainly: o reinvested in the business; o applied in advancement of their social objects; or o distributed or donated to other social sector organisations. -­‐ Have a constitutional or contractual lock on their social objects, dividend and surplus distribution policy, and ensure the disposal of assets is compatible with the social objects embedded in their constitutional documents. -­‐ Are able to demonstrate that the remuneration of their officers and employees, including salaries, benefits and all forms of distribution or other participation: 5
The full Governance Agreement is available on our website: http://bigsocietycapitalblog.files.wordpress.com/2012/09/governance_agreement1.pdf 11 is reasonable and proportionate relative to market practice for SSOs generally; is disclosed in a manner consistent with the Statement of Recommended Practice for accounting by charities; and o bases any incentive pay on social returns as well as financial returns. Make best efforts to preserve the social purpose or social mission of the SSO in the event of a change of ownership or control. Regarding the social impact they must: o articulate, measure and report their social impact; o have a stated commitment to a particular social outcome(s) that is based on inclusivity, affordability and accessibility for beneficiaries; o measure and report social metrics; and o be open to independent social audit. o
o
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We ask every SIFI to sign a compliance form, at the point of drawing down investment from BSC, confirming that any investment into for-­‐profit companies conforms to BSC’s Governance Agreement. 2.2 INTERMEDIARY STANDARDS As detailed in section 2.1 above, BSC is a social investment wholesaler, defined by the Dormant Bank and Building Society Accounts Act 2008 (Section 18) as: “a body that exists to assist or enable other bodies to give financial or other support to third sector organisations; ‘third sector organisation’ means an organisation that exists wholly or mainly to provide benefits for society or the environment.” We interpret the ‘other bodies’ to be social investment financing intermediaries (SIFIs). We think of SIFIs as organisations that provide facilitates or structure financial investments for SSOs and/or provide investment-­‐focused business support to SSOs. In more detail, SIFIs can: -­‐
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raise investment for funds that provide loans or invest equity in the social sector; manage funds on behalf of others; design and structure financial instruments that, for example, enable SSOs to deliver public services under payment-­‐by-­‐results contracts; provide platforms and exchanges that directly connect investors and SSOs; and support SSOs to develop their business models and skills so that they can take on new types of investment. In line with BSC’s mission and the spirit of the Act, we have some minimum standards that we want SIFIs to meet if they are to receive BSC investment. In outlining these standards, it is helpful to distinguish between two types of legal entity that can together comprise a SIFI. First, there is always a ‘management company’ that performs the sorts of investment and support activities listed above. Second, there can often be a separate legal ‘vehicle’ that holds investment capital, for example as a fund. 12 Management companies that either directly receive BSC capital onto their own balance sheet and/or manage vehicles receiving BSC capital should: -­‐
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be Financial Conduct Authority authorized, if carrying out regulated activities; have a high degree of transparency around the remuneration of officers and employees; ensure they have a good understanding of State Aid requirements and to put procedures in place to deal with them; and handle post-­‐execution monitoring arrangements. -­‐
Vehicles receiving investment capital from BSC should: -­‐
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have a social mission and a governance structure that embodies and protects this mission; pay fee levels and structures that are reasonable in relation to the cost of operations, providing for a sustainable business but without excessive profitability; make any incentive pay, such as carry, on an assessment of social returns as well as financial returns; not use non UK-­‐domiciled structures for the purposes of avoiding UK tax; ensure standard BSC investor protections with regard to deployment of capital; and ensure transparency on all fees and expenses incurred and charged to the investors in the vehicle. 2.3 MATCH FUNDING BSC aims to build the social investment market through leveraging in additional capital into the sector alongside its commitments. We look for investments into investment intermediaries to be matched on a 1:1 basis; over the long-­‐term we have an aspiration of a 4:1 match. Furthermore, we will consider: -­‐
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Type of match – Our preference is like-­‐for-­‐like match, although we will retain flexibility and can consider investment into a tiered structure where appropriate. Timing of match – We will consider making commitments that allow a SIFI a period of time in which to raise matched funding, but our investment will not typically close until a match is available. Investments into operating SIFIs/asset managers – For direct investments into a SIFI, we will ideally look for a match but will not always require any co-­‐investment. This is in recognition that BSC has been established to provide the risk capital required to build organisations at this early stage of market development. 2.4 MARKET FAILURE/ STATE AID COMPLIANCE 13 BSC uses publicly directed money (up to £400m from dormant bank accounts) to address a market failure, that is the inability of SSOs to access capital on similar terms to similar commercial organisations. As such, BSC’s £400m capitalisation from dormant account money counts as State Aid, and is to be used subject to the State Aid clearance given by the European Commission in December 2011. This clearance applies at two levels: first, BSC investment into SIFIs; second, SIFI investment into the front line. At a SIFI level: -­‐
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BSC’s State Aid clearance notification states: “as part of the investment process, BSC will require evidence from SIFIs and funds that they are unable to access the finance they are requesting from elsewhere”. A practical investment test or restriction – We will evaluate carefully whether market failure is evident and should only invest if the deal or target fund size cannot be completed without our involvement. In assessing whether the finance requested can be accessed elsewhere, our State Aid clearance suggests BSC can take into consideration qualitative criteria such as liquidity of the investment, the business plan/business model, expected risk adjusted returns, social impact, and percentage of profit reinvested,6 as these can all be reasons why traditional providers of investment capital can decide not to invest. At the level of SIFI investment into frontline organisations, we will work with SIFIs to ensure that they have a good understanding of their own State Aid requirements and that they have adequate procedures in place to deal with them. 6
EC State Aid clearance notification: http://ec.europa.eu/eu_law/state_aids/comp-­‐2011/sa33683-­‐2011n.pdf 14 3. BSC’s INVESTMENT PROCESS We aim to make our investment process highly rigorous, yet accessible to proposals from a variety of organisations. We can also work with some organisations ahead of the formal investment process to help them understand what work needs to be done to develop their early stage ideas and get their applications ready to put to investors. From that initial contact through to post-­‐investment monitoring, we work iteratively with each potential investee to tailor the process to their project. A summary of the different potential stages of the investment process is given in the table below: •
•
Enquiries Organisations can visit our website for information about who is eligible and how it works. www.bigsocietycapital.com/seeking-­‐investment Ideas co-­‐development programme We invite some organisations to a workshop where we help them to develop their idea and prepare for the formal application process. Organisations can contact us at [email protected] with their ideas. 1. Expressions of interest Organisations fill out a short online form, which we use to screen proposals for eligibility. http://www.bigsocietycapital.com/expression-­‐
interest. This marks the start of the formal application process 2. Application Organisations that have submitted an Expression of Interest and are screened as eligible are asked submit a standard application form with detailed business social impact plans. 3. Due diligence and Investment Committee (IC) We meet with applicant’s management team and analyse their business plan, financial model and social strategy and plan. Each investment comes to BSC’s Investment Committee at least twice. 4. Execution After an in-­‐principle commitment, we will work with the investee to complete all the investment documents. 5. Post transaction monitoring and reporting We monitor each investment against the agreed financial and social impact targets. 15