Toby Johnson
21 January 2015

Background and hints for implementation - finance

Issues in financing social enterprises

1. Social enterprises are a wise investment

Public investment in social enterprises represents not an expense but a saving, as they typically generate a very positive social return on investment. On top of the economic value added they create, they also lead to significant savings in unemployment and social benefits, law enforcement and health budget. They are also on average less risky than conventional businesses.

2. There is finance gap

A study carried out for the Polish ESF department showed that about half of Poland’s 2,500 non-governmental organisations (with turnovers above €2,500), co-operatives and social enterprises have held back on investments because they could not raise funds – the average gap being €27,000. However they are averse to borrowing – it is only the top 10% of larger, older organisations that take out loans. At the same time financial institutions are not interested in this sector. Banks and clients live in two separate worlds – there is a market failure. The investment that has not happened totals somewhere between €12m and €160m.

3. Design a package of services

It is often repeated that “everyone prefers grants”, but for the best rate of success, different types of finance and consultancy support should always be combined. Certainly for most associations opening up an enterprise activity, grant finance is necessary in the start-up phase. However long-term reliance on grants can be self-deluding.

Taking a loan demands hard-headed thinking and discipline in researching, compiling and then implementing a business plan. This different mindset is crucial to business success.

4. The Structural Funds can support a range of different financial instruments

  • Start-up grants

The Czech Republic used the ESF and ERDF to launch two parallel grant schemes for start-up social enterprises.

There are several lessons to be learnt. The two separate schemes had the same eligibility criteria for social enterprises but had different rules, and their coordination worked for only part of the implementation period and gradually dissolved. It was difficult to maintain the coordinated process when the schemes were administered by different managing authorities. The business plans were evaluated alongside the grant application but the official evaluation criteria were the same for the whole operational programme and did not fit the needs of social enterprises. It was difficult to manage one entrepreneurial grant scheme in the operational programme that was very different from the rest of the programme, and not everything fitted in the administration as needed.

Despite these teething troubles, the scheme went on to allocate €20m of grants to 157 enterprises, which has resulted in the creation of 827 jobs at an average cost of €22,000. For 2014-2020 an enlarged scheme is on the stocks.

  • Loans

The Polish financial institution TISE was originally set up in 1991, and in 2008 was taken over by the French co-operative bank Crédit Coopératif. It manages €32m in assets, and has loans outstanding to 320 social enterprises in Poland, Hungary, Romania, Slovakia and Slovenia.

It has won all five of the regional tenders to administer a €6m pilot loan fund for social enterprises being set up by the public Bank Gospodarstwa Krajowego (BGK) Its targets are to make 250 loans by 2015, to deliver 4,000 hours of advice, and thus to create over 50 jobs. The maximum loan is of €25,000. Things are going well: so far, it has made 115 loans, and used up 40% of its fund.

There are interesting possibility for international co-operation between TISE and social finance organisations in neighbouring countries.

CoopEst is a fund for the development of co-operatives in central and eastern Europe, which was created in 2006 and has €40m in assets. Supported by the EIF, it makes long-term loans and currently has 40 borrowers in 10 countries – many of them in microfinance. For many of CoopEst's clients, grants and loans are complementary: their equity comes from grants, and their working capital from loans.

  • Working capital

Lombardy is running a unique and innovative JEREMIE ESF scheme, which matches ESF funds with private capital to make loans to co-operative members, which they invest in the shares of their co-operative, thus building up their working capital. The scheme has invested €31m in 7,800 people (4,000 of whom are disadvantaged) belonging to 507 co-operatives.

5. Programming the Structural Funds

An example of this multi-strand financial package is to be found in Poland’s ESF and ERDF operational programmes for the 2014-20 period. They resolve the finance gap revealed by the research study. The menu of tools is:

For start-ups:

grants + supplementary loans (ESF)

For businesses over 1 year old:

loans (ESF)

For investments with a high social impact:

grants (ERDF) – e.g. up to €375,000 over 7 years at 2.75% interest

For job creation:

a hybrid instrument – e.g. a loan of €7,500 over 4 years per job created

The scheme will be nationally managed, but with regional intermediaries which can offer high-quality advice. Guarantees and equity investment will also be considered.

6. There are new sources of finance

  • Pension savings

The newly-introduced French scheme of épargne salariale solidaire, under which pension funds that invest between 5% and 10% of their assets in the social economy can brand themselves as solidarity funds. This scheme effortlessly raises €160m a year.

  • Gearing up local ethical funds

A good case of the public sector gearing up a local fund comes from Göteborg in Sweden, which is the first use of the REVES Financial Programme. Here the existing Mikrofonden Väst scheme is to receive an unprecedented €1.1m injection from the city council. The REVES approach links local energy with external expertise from other regions of Europe.

  • Mutual funds

In some – but not all – countries, mature social enterprises are perfectly capable of financing their own expansion. Italy’s movement has established several mutual funds to do this. One of them is Coopfond, set up in 1992 by the country’s largest co-op federation, Legacoop. For fundraising, it relies on a legally mandated 3% share of profits which all co-ops must pay.

As the Lega has 11,000 members with a combined turnover of €55 bn, this brings in €21m a year. The fund currently stands at €430m. It invests equity and loans in new and expanding co-operatives as a form of ‘external solidarity’. Over the last two decades it has invested €420m in 537 co-operatives, which have created 800 jobs. Coopfond is more flexible than public funds, and can also make small grants.

Crédal, a co-operative of 2,000 members that operates a €25m fund in Wallonia and Brussels, makes 1,000 loans a year, of several different types – 80% social economy and 20% microfinance.

  • Social impact bonds

Social impact bonds (SIBs) are mechanisms which bring new sources of finance to bear on social problems, by offering them a share of the saving which the public sector will make through a successful innovation. They transfer the risk to the private sector, as they pay out only if certain carefully-defined targets are met. They typically use voluntary organisations and social enterprises are typically involved as the principal deliverers of the innovation. They are being used to address problems such as homelessness, care and reoffending, where large public savings stand to be made.

For example the world’s first SIB, at Peterborough Prison in the UK, has seen a number of funds investing £5m (€6m) in a consortium of voluntary organisations, who aim to reduce the number of prisoners who reoffend. If they succeed in cutting reoffending by 7.5%, then the investors will be paid a return which could go as high as 13% a year. Over the five-year term of the bond, this would mean they make an 84% gain. The government calculates that it would save much more than this by having to look after fewer prisoners.

With several dozen SIBs now under way in several countries, they are still in the experimental phase. They can only be used under certain circumstances: where there is good enough data over a long enough period to understand the problem and the options for innovation, and to track the impacts accurately; and where the partners trust each other.

7. Impact measurement

The idea of measuring impact arouses doubts and suspicions, particularly among social enterprise which fear it as an imposition which is not required of conventional firms. To some extent it has been discredited by the experience of the SROI (social return on investment) tool, which many feel to be over-elaborate and heavy on consultancy time. However impact measurement is the necessary counterpart to preferential treatment by government. For use by EaSI and EuSEFs, the GECES working group on impact measurement is proposing a workable, proportionate and flexible system, based on indicators that are chosen by the enterprise to reflect its own objectives.

1.1.Hints on implementation in 2014-20

Public funding has played a major role in the creation and development of social enterprises. However the historical model of tackling social issues mainly using public budgets is in crisis. Every entrepreneur who wants to develop their activity has inevitably to consider new financial options – either philanthropic resources or refundable ones. This makes the discussion whether social enterprises should choose loans or subsidies pointless. What matters is to prepare social enterprises for this revolution of thinking. Today’s paradigm is to build up the market structure and support the creation of a complete ‘funding chain’ for social enterprises.

The role of the Structural Funds is nevertheless crucial, as they can support different financial tools. Their programmes should combine loans, grants and business support, using the leverage effect of the matching offer:

  • Grants: These make sense when they have a leverage effect on financing, or when they are used for very specific focus (innovative activities, new markets, research and development) that needs to gain visibility and requires ‘patient’ capital approach. This mainly applies to new enterprises;
  • Loans: Repayable public money is a good way to teach social enterprises what an investment is and prepare them to achieve business sustainability. It can also help to convince external private investors to enter this new market by showing to them the good track record and low default risk of these clients. When the resource is delivered through an intermediary, the amount under management can play a role in stabilising the intermediary business model;
  • Local matching funds: Building local financial institutions or local agreements able to match funds from different sources – from the social economy sector, EU funds and municipal budgets – is an approach to be spread widely. The ESF should be used to support intermediate organisations a strategic partners;

The establishment of funds should be accompanied by capacity building for all stakeholders: managing authorities, local authorities, financial institutions and intermediaries, social enterprises.