Building an impact-first social investment strategy

Building an impact-first social investment strategy: what we’ve learned

Insights Report 8 November 2021

Building an impact-first social investment strategy: what we’ve learned 2

Contents Executive Summary

3

Background 5 Our impact-first approach in practice

7

Insights 11

Consider impact first

11

Adding value beyond money

13

Accessibility and power dynamics

14

Challenging the status quo

16

Looking ahead

20

Glossary 22

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Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 3

Executive summary Social investment at Esmée Fairbairn Foundation was formalised in 2008.

Since then, we have been asking ourselves how we can play a supportive, yet challenging, role within the social investment market whilst also recognising that social investment is only one of the funding options for organisations on the ground.

At the heart of our thinking is our belief that the social outcome, the impact, should be the starting point.

In this report, we outline what our impact-first approach means in practice, and we share what we’ve learned, both the challenges and opportunities, from its evolution.

We hope this paper offers learning for new and existing investors, including foundations, for their own social investment practice.

Our impact-first approach in brief We start with the need and tailor our investment: adapting and selecting financial instruments that are most appropriate.

Social investment is embedded into our main funding support as another tool that we offer.

Co-design and learning are integral to our process.

S ocial investment is only one of the funding options for organisations on the ground.

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Contents

Executive Summary

Background

Our impact-first approach in practice

Our financial objective is to break-even across the portfolio with operating costs covered centrally.

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 4

Executive summary

Looking ahead

Quick insights Consider impact first • This requires a shift in mindset, ambition and bravery – with the needs of the investee, and their impact, placed ahead of the investor’s. Though more resource intensive, this can be mitigated by leaning on expertise within, and outside of, the organisation through working in partnership and prioritising activities.

Add value beyond money • Just as investees need to demonstrate a competitive advantage, so can investors; investors must bring greater value than money alone. Using sector knowledge from across the organisation, bringing in external expertise, and working well with co-investors are ways for investors to add value.

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Executive Summary

Challenge the status quo

Consider accessibility and power dynamics • Organisations seeking to address market and system failures can’t be solved with a one-size-fits-all approach, so why should social investment be any different? Co-design, a focus on simplicity, an openness to longer lead times to investments, and more supportive grant funding to help applicants new to social investment will improve accessibility and lead to a greater diversity of organisations benefiting from social investment.

• Good communication and a mutual understanding of expectations helps to create an equitable power dynamic.

Co-designing outcomes with more focus on what can be learned, plus removing unnecessary and unhelpful impact reporting requests, is also important.

Background

Our impact-first approach in practice

Insights

• Social investment often carries the stigma that it is not ‘real’ investing. Seen as an extension of grant making, it can be associated with misconceptions on risk, credibility and value. But social investment is not ‘investment-lite’. It is as challenging if not more - than ‘traditional’ investing because it adds the key dimension of impact to the traditional investment principles of risk and return..

• Understanding the needs of the investee and focusing on the impact – rather than following market norms – leads to more appropriate financial products.

• Similarly, blended capital a mix of public or philanthropic funds with private or repayable investment, has become synonymous with subsidised debt. A deep understanding of the applicant’s business model can lead to more appropriate placing of grant – particularly when it comes to funding research and development.

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Co-design and the use of developmental grant finance are cornerstones of Esmée’s social investment strategy, which have helped us to form closer partnerships with the investee. We expect to make more developmental grants to support innovation and emerging new models from a more diverse range of organisations.

Esmée will continue to play an active role in developing the social investment market, to consider how our practice can be applied to the emerging world of impact investing, and to explore how we can support and de-risk social investment for foundations wishing to learn.

We look forward to working with others to increase the amount of impact-first, appropriate, catalytic capital, which social purpose organisations tell investors they need.

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 5

Background The social investment market has come a long way since Gordon Brown launched the Social Investment Task Force in 2000.

The market’s evolution is excellently captured within Flip Finance’s report: ‘A snapshot of the UK social investment market 2020-2021’1.

Established as a wholesale social investor with a remit to build the market, Big Society Capital’s (BSC) £600m wholesale capital war chest has led to BSC becoming the dominant provider of finance to intermediary social investors. Although most of the wholesale capital in the market is provided by BSC, others, including foundations, also provide this form of finance. As such, foundations play an important role in the market. Foundations differ from other investors due to their non-profit status and tendency to be endowed with funds rather than needing to raise money.

Foundations have gone from investing in the development of the early social investment market pre-BSC to now being the primary provider of high risk ‘catalytic capital’. This capital often focuses on impact and innovation, but it is limited in availability.

Though there is momentum and evidence behind the need for catalytic capital, such as flexible ‘equity-like’ finance2, the provision of such finance is relatively minuscule compared to the need, with many social investors leading with the financial product rather than the desired social outcome.

We’ll discuss some of the factors behind this in this report.

Catalytic capital Investment which accepts disproportionate risk and / or concessionary returns relative to other investments in order to generate positive impact, and to attract third party investment that would otherwise not be possible.

Equity-like finance (aka quasi-equity finance) A form of investment which shares some of the characteristics of equity investment without the sale of shares.

Wholesale capital (aka indirect investment) Funds invested into investment funds, to in turn invest directly into social purpose organisations.

1 Flip Finance (2021) A Snapshot of the UK Social Investment Market: 2000 to 2021 2 Shift (2020) Beyond Demand: the social sector’s need for patient, risk-bearing capital Home

Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 6

Background In 2017, social investment decision-making moved from a separate committee to our grant Approval Committees, which involves all Trustees on rotation. By incorporating it into our main funding practice, social investment could be better embedded into our support as one of the tools that we offer. It also helped to develop a greater knowledge of social investment among our Trustees.

How Esmée’s approach has evolved in the social investment marketplace

1997

2003

Dormant Bank and Building Society Accounts Act

Futurebuilders Launched

Esmée Fairbairn Foundation’s social investment activity began in 1997 with a number of trial investments.

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2008

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2012 Big Society Capital established

2014 Social Investment Tax Relief launched

Background

Our impact-first approach in practice

Access Foundation established

2018 Impact Management Project launched

In 2018, we shared learning from 10 years of social investment3, which informed our impact-first approach.

In 2008, we formalised our social investing. The funds are a separately managed allocation of our endowment.

Executive Summary

2017

In 2020, we launched a new organisational strategy and approach to social investment.

All future social investments now align to our impact goals.

2019 Impact Investing Institute established

2020

2021

In 2021, we approved a £10m allocation to impact investing, which is in addition to our £45m allocation to social investment

In 2019, we approved a grant to Shift Design for market research into the demand for ‘equity-like’ finance. The first phase of the research4 was published in June 2020.

3 Esmée Fairbairn Foundation (2018) Evolution not revolution: 10 years of social investment 4 Shift (2020) Beyond Demand: the social sector’s need for patient, risk-bearing capital

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 7

Our impact-first approach What do we mean by ‘impact-first’?

At Esmée, we start with the need, and tailor our investment: adapting and selecting financial instruments that are most appropriate.

We base appropriateness on the social and environmental outcomes, accounting for the social purpose organisation’s financial situation, affordability and the effect of the finance on the organisation’s operating dynamics.

This, we hope, recognises the need to start with understanding the issue to be solved before choosing an investment vehicle, whilst appreciating the importance of getting the investor / investee relationship right, and valuing flexibility.

The primary objective of our financial support is to provide the right type of finance, at the right time, to the right opportunities. Adopting this mentality means that impact is fully respected as a key consideration alongside the traditional dimensions of ‘risk’ and ‘return’. But impact is the central focus – not product or financial returns.

Social investment’s aim is to enable the creation of lifechanging impact whilst supporting the sustainability of the investee.

To achieve this, the focus needs to be on co-designing easily understood financial solutions with social purpose organisations and their users.

Our social investments now align to impact goals that contribute towards our three main aims: Our Natural World, A Fairer Future, Creative, Confident Communities; and to support Infrastructure and New Ideas.

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Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 8

Our impact-first approach

In practice Esmée Fairbairn Foundation has a £45m social investment facility and decision-making is incorporated into our main funding practice.

Decisions on social investments: • Up to £400k: Approvals Committee involving the Executive and Trustees on rotation, which meets every 6 weeks.

• Over £400k: Trustee Board, which meets 5 times a year.

5 Impact Management Project (2018) The Impact Classes of Investment Home

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Executive Summary

Our stated financial objective is to achieve a break-even position across the portfolio.

Although provisions and losses are accounted for within our social investment facility, operating costs are covered centrally rather than through social investment returns. This ensures all returns are recycled for the creation of impact. This also recognises that our social investment team is valuable to the rest of the organisation in the same way that our Funding Managers and Resources colleagues are essential to the success of our social investing.

Our internal Social Investment Policy Statement outlines our social investment objectives, provides guidance on asset allocation and concentration limits, and provides investment guidelines against which we assess social investments.

Our guidelines consist of 11 prompt questions covering: fit with strategic aims, the applicant’s model and risk.

Rather than being used as a scoring system, the guiding questions are used for broader reflection on alignment with our social investment approach.

Background

Our impact-first approach in practice

Insights

How we assess risk As part of due diligence, we complete a risk matrix which gives us a view on whether the investment is low, medium or high risk based on a series of criteria across organisation, proposition and investment. This includes integration of the Impact Management Project’s Impact Classes Tool5. The risk matrix is repeated annually, unless significant changes to the investment occur, in which case the matrix is completed more frequently.

In addition, we co-design outcomes with the investee during the due diligence process to articulate the desired impact and investment outcomes. Rather than being used to grade performance, outcomes are used to prompt learning which we apply to future investments. Learning questions include: have we used the right form of capital to enable the change we had mutually hoped to see, are we taking enough / too much risk, how can we better support our portfolio?

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 9

Our impact-first approach

Improving our practice We constantly ask ourselves questions to improve our practice: are we building trusted, balanced relationships with our investees, are we providing enough flexibility and retaining simplicity, is our capital far enough reaching?

We’ve highlighted three...

1

Could we better capitalise organisations?

Hubbub UK

At the heart of an impact-first approach is providing the most appropriate form of finance to enable the desired impact, within a structure which is most likely to further investee sustainability.

We need to consider whether our finance offer is forward looking enough. This means learning from developments in the private sector and abroad, deepening our, and others’ understanding; one example being the growth of impact-linked finance6. This extends beyond our own practice to think about how we can support others to do likewise in a bid to develop the market.

In July 2020, we made a £250,000 impact-linked investment into Hubbub – who develop creative campaigns to inspire a greener living – to run a Climate Emergency Campaign in Manchester. The investment’s goal is to incentivise the scaling up of this campaign by reducing the loan’s interest rate (from 4% to 2%) on adoption by another Local Authority.

Esmée and Hubbub co-designed the instrument, recognising they share a common impact goal: changing public environmental behaviour and spreading best practice.

This deal was shortlisted for UK Social Enterprise Deal of the Year 2021.

6 Investing for Good (2021) A review of impact-linked finance: does incentivising impact work?

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Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

2021 Shortlisted for UK Social Enterprise Deal of the Year

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 10

Our impact-first approach Resonance repayable grant facility

2

How can we most effectively use developmental grants?

As social investment is only one tool within the toolbox, the use of grant alongside social investment is likely.

Convention suggests that blending grant funding alongside investment to create cheaper debt typically yields more sustainable business models.

We take a different approach.

Dissecting the applicant’s business model helps to understand which elements of the business can sustain repayable finance and which cannot. Yet those elements which cannot sustain repayable finance may have the potential to increase the organisation’s sustainability and impact.

In July 2018, we made a repayable grant facility available to Resonance – a South West England based social investment intermediary – to build on an existing repayable grant made in March 2014 for product development.

3

Drawdowns of up to £75,000 are used as match funding to fund product development. If a product comes to market, we are repaid from management fees raised.

How should we consider pipeline development, disbursements and the impact on accessibility?

Disbursement targets are rife among social investors. Often due to pressures to recoup investment returns to cover operating costs or to repay their investors within an agreed term. These wholesaler repayment terms also heavily influence investor product offering. Psychologically, disbursing finance can demonstrate activity. However, it also throws up moral and operational challenges.

Over £700,000 has been drawn down and resulted in three successfully launched funds: the National Homeless Property Fund, Real Lettings Property Fund² and the South West Social Investment Tax Relief Fund. In total, these funds have unlocked around £140 million of investor capital for social enterprises from nearly 100 different investors.

Do disbursement targets drive irresponsible investing to hit shortterm targets which may have repercussions for the investee and the investor’s future default rates?

Disbursement targets are particularly relevant when considering accessibility.

Often organisations led by communities experiencing racial inequity face barriers to social investment because they may not have ‘oven-ready’ propositions which fit investment criteria, and instead may require development support. This runs counter to the push for fast lead : approval conversions and targets favouring speed over thought.

This understanding encourages the use of restricted purpose grants to fund targeted investee research and development rather than simply providing cheaper debt through blended capital.

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Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 11

Insights Consider impact first If the primary objective of a social investment is how to best capitalise a social purpose organisation, we put the needs of the investee, and their impact, first.

Land Purchase Facility

An impact-first approach is a mindset available to every investor Whilst it’s true that flexible, wholesale finance with a low cost of capital - or better yet, employing their own funds for social investing - gives investors greater control, an impact-first mindset is available to every type of investor.

If wholesale investors then also have a desire to evolve with the market, the provision of patient, lower cost wholesale finance could follow, creating self-perpetuating market improvements.

Consequently, we could see a new dawn of thoughtfully designed, appropriate funds, which take an impact-first mindset, and support organisations led by those with lived experience of the challenges faced.

The determining factors for being impact-first are mindset, ambition and bravery. A shift in mindset will result in a wider variety of financial products on offer from investors and greater demand from social purpose organisations. In turn, greater familiarity with a diverse range of products would drive down transaction time and costs.

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Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Our £10m Land Purchase Facility, first established in 2008, is used to purchase land of high current or potential conservation value. Once purchased we lease the land to our partner conservation organisations (the RSPB, the Wildlife Trusts and the Woodland Trust) with the option for them to buy in two years’ time at the price Esmée paid for it plus a small interest charge, with all returns recycled back into the facility. This gives the organisation a window to fundraise.

As of November 2021, the facility has approved £21.7m of investment into 35 pieces of land and been 100% successful in transferring ownership to our partner organisations.

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 12

Insights Consider impact first

Committing to additional resource requirements and a different way of considering spend Taking an impact-first approach, in which financial products are tailored to the needs of the applicant, is more resource intensive for investors.

There is a perceived trade-off between overheads and investment capital: that more money spent on staff means less available to invest, and vice-versa. At Esmée, our 2.6 FTE social investment team cover a portfolio of over 85 investments and an allocation of £45m. We use our resource efficiently and lean on expertise within, and outside of, Esmée through partnership working. We think this counters the notion that only a large team can deliver an impact-first approach.

There is also a perception that an investor should be as lean as possible whilst distributing as much money as possible.

At Esmée, our focus on impact-first structuring means we may invest less than other investors as a result. On average over the last 5 years, we’ve made 16 investments per annum.

Yet this additional investment into resourcing means that we have space for thought; value over volume. This also builds stronger investee relationships, which we believe ultimately results in more successful investments.

Think for the Future In February 2020 we invested £540,000 into Think for the Future – an organisation improving behaviour and preventing exclusions for young people – to enable their purchase of an education hub in the Midlands. We worked with Think for the Future to invest when mainstream banks, and others, turned them down. Interest at 2% is charged for the first 3 years of the investment before an increase to 5% thereafter. The deal, structured alongside Think for the Future, is designed to enhance the organisation’s sustainability and in doing so getting the organisation into a strong position to attract affordable and appropriate mainstream refinancing before the interest rate increase.

Efficiency of resource, leaning on expertise within, and outside of, the organisation through partnership working, and prioritisation of activities, can enable an organisation to adopt whichever investment strategy they see fit.

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Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 13

Insights Adding value beyond money The Rivers Trust

Add value beyond money Do we, as investors, give enough thought to our offer to investees: the value we provide, and how to best work as investor groups?

Adding value through expertise There is more social investment available than ever before7 and the provision of ‘technical assistance’ is now commonplace (our support of Big Issue Invest’s ‘Beyond the Cheque Initiative’8 which seeks to measure the efficacy of technical assistance is testament to that).

Just as investees need to demonstrate a competitive advantage, so must investors; investors can bring greater value than money alone.

As a social investment team – and as a funder – we acknowledge that we can never be experts in every impact area. We need to use the expertise provided by our impact specialist Funding Managers, and, where appropriate, bring in external expertise.

In January 2019 we approved a co-designed £1.8m bridging loan facility with The Rivers Trust – a charity that acts as an umbrella organisation to 60 member Trusts – to plug cashflow gaps created by Defra’s Water Environment Grant (WEG). The WEG uses money it receives from the European Union to fund river and wetland restoration in the UK; the WEG pays funds in arrears.

Our facility provides upfront funding to Trusts to enable delivery of these projects with our repayments received from WEG payments.

Member Trusts apply to The Rivers Trust, who, with our input, approve applications. Member Trusts are charged interest on an escalating annual basis (starting at 0%) alongside a small upfront fee to cover The Rivers Trusts’ administrative costs.

Working with co-investors There is a need to share resource among investors who adopt the same resource-intensive impact-first approach.

By sharing the load pre-investment (deal leading, due diligence and legals) and post-investment (rotational observer seats, commonly agreed investee financial and impact reporting) the strain and cost on one investor is reduced.

A genuine investor partnership, with the intention for an equitably risk-shared investment, aids shared learning and will ultimately result in wider provision of appropriate social investment.

As Esmée has a dedicated social investment team, we may need to lead on structuring in the hope that others follow. Equally, others may be better placed to lead than we are on other occasions.

The focus must be on identifying and working to our strengths.

7 Big Society Capital (2020) Size of the UK social impact investment market 8 Big Issue Invest (2020) Beyond the Cheque Initiative Literature Review Home

Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 14

Insights Accessibility and power dynamics Fair By Design

Consider accessibility and power dynamics

Addressing accessibility and market failure

We shouldn’t underestimate the difficulties faced by social purpose organisations seeking to address market and system failures.

Often organisations are seeking to address market failures which can’t be solved with a one-sizefits-all approach, so why should social investment be any different?

Most of Esmée’s investments have come from our networks. On average over the last five years, 74% of the applications for investment received have been unsuccessful.

It’s clear we need to look at diversity and accessibility as an organisation. Investment principles, partnerships and adaptations to risk tolerance have also taken on greater significance.

This is a challenge shared by others in the sector, and best practice is emerging.

Fair by Design, research – such as that undertaken by The Young Foundation9 – and Ada Venture’s underrepresented scouting community10 offer exemplars for

9 The Young Foundation (2020) Nothing About Us Without Us 10 Ada Ventures Scout Community 11 Diversity, Equity and Inclusion

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Executive Summary

us, and others, to learn from. At Esmée, we’ve made a start to change this: through a whole organisation approach to diversity, equity and inclusion (DEI); and our Involving Young People Collective12 – which brings young people into our work; and opening our Funding Plus support programme13 to social investment pre-applicants. But we know there is more that we can do.

More partnership working, wider input and greater clarity of selection criteria should enhance accessibility and save applicants’ time. Since making changes, our successful application rate has increased to over 55% within the last 12 months.

We believe co-design, a focus on simplicity, an openness to longer lead times to investments and more supportive grant funding to help applicants new to social investment lends itself to greater diversity.

Fair by Design is a UK based fund launched in 2017 which focuses on tackling the poverty premium. The fund invests in technology businesses that address market failure, correct inequalities and drive cost savings for low-income households.

The Fair by Design fund is managed by Ascension Ventures – a pre-seed / seed venture capital firm – and works with several partners to collaborate on interlinked elements of the programme, and overseen by a Steering Group. This includes a campaign run by Barrow Cadbury Trust which seeks to influence policymakers, regulators, and companies to ensure fairer markets for low-income consumers. The fund also features a panel of experts with lived experience of the poverty premium who support and influence investment decisions as part of the due diligence process, and work with portfolio organisations post-investment; this is delivered alongside Toynbee Hall – a charitable institution that works to address the causes and impacts of poverty.

12 Esmée Fairbairn Foundation Involving Young People Collective 13 Esmée Fairbairn Foundation Funding Plus

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 15

Insights Accessibility and power dynamics

Create Equity Fund Create Equity Fund is a proposed fund for Black, Asian and Minority Ethnic (BAME) artists and creative entrepreneurs led by Kevin Osborne, founder of MeWe360 - established to find and test new approaches to supporting BAME creative talent.

The fund is one part of a wider programme-in-development led by Create Equity to tackle the racially unequal UK arts funding system in which only 2.6% of arts funding goes to BAME-led organisations, a figure which should be closer to 14% if funding were distributed proportionally.

We, alongside other peer funders, have supported the ongoing development of Create Equity Fund with close engagement and grant funding of £200,000 since January 2021.

Creating an equitable power dynamic

Understanding impact through co-designed outcomes

The relationship between investor and investee is fraught with imbalance; it’s difficult to be a financial investor and a partner. We’ve noticed a trend for investors to dictate to the investee the information they need, regardless of its use to the investee.

Impact measurement is hard. For social purpose organisations working on complex issues, success is not usually defined by houses built, job numbers or exam results.

Often, social investment is a small part of the total support organisations receive.

Attempting to define and attribute impact to an investment is neither easy nor helpful.

In the same way in which co-investors need to think about how they work together to share cost and resource, the same level of attention should be given to investees.

Communication and a mutual understanding of expectations is crucial.

Agreeing common financial and impact reporting with co-investors has an obvious benefit to the investee as they can report on one set of requests.

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Executive Summary

Background

Our impact-first approach in practice

Insights

For Esmée, what’s important is the learning we take from each investment and how we use that learning to refine our approach and make better decisions.

Our new approach to assessing impact and capturing learning builds upon the creation of co-designed outcomes – ensuring aligned impact objectives between investor and investee.

Consider impact first

Adding value beyond money

Accessibility and power dynamics

In addition to supporting the reduction of power imbalances and misalignment, this practice also lends itself to new forms of investment such as impact-linked finance.

We code these co-designed outcomes by outcome type: • ‘Social outcome’ (social / environmental impact created by the investee).

• ‘Organisational outcome’ (impact on the resilience of the organisation working in social / environmental change).

• ‘Market outcome’ (wider and structural impact on the market).

We then review progress against these outcomes annually, with no penalty for lack of progress, but rather an understanding that business plans evolve and that the outcomes set, or finance employed, may have been inappropriate. We can reflect and improve because of this learning.

Collectively the progress against outcomes and the financial performance of the investment enables us to reflect, learn and improve upon the structuring and use of our funding.

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 16

Insights Challenge the status quo

Challenge the status quo Social investment has gone from a niche, misunderstood topic to one which is widely discussed and has seen the UK established as a global leader, and with it, creating a status quo.

How can we support the social investment market to evolve?

Internal challenges with getting started Trustees can be those most willing to explore social investment, yet challenges related to extensive costs and risks involved in establishing in-house social investment departments create barriers.

A typical entry route to begin social investing is through fund investments, yet these carry – sometimes high – management fees and are limited in their ability to offer direct learning exposure to wannabe social investors.

There can be Trustee reticence due to uncertainty and misunderstanding of what social investment entails.

Social investment often carries the stigma that it is not ‘real’ investing and is instead an extension of grant making which may bring with it misconceptions on risk, credibility and value.

Despite the concept of social investment now more widely known, the practice is still relatively nascent. The addition of ‘impact investing’ and ‘environmental, social, governance’ (ESG) investing, with terms used interchangeably, has created confusion, preventing, rather than supporting, understanding. The ‘Spectrum of Capital14’ has sought to clarify distinction.

The only way that social investment can be taken seriously, and understood as a concept, is to continue to build the evidence-base demonstrating that impact alongside financial returns (even if concessionary) is realistic. Our 2.0% return across 93 exited* social investments is testament to the financial viability of social investment.

Financial-only

Responsible

2.0% return

Unsuccessful financial exit: 26% Successful financial exit: 74%

Sustainable

Impact

Impact-only

Delivering competitive financial returns Mitigating Environmental, Social and Governance (ESG) risks Pursuing Environmental, Social and Governance opportunities Focusing on measurable high-impact solutions and addresses system failures.

*As at November 2021 **‘Spectrum of Capital’

**

14 Bridges Fund Management (2013) Bridges Spectrum of Capital Home

Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 17

Insights Challenge the status quo Fair for You

Rather than being ‘investment-lite’, social investment is as, if not more, challenging than ‘traditional’ investing.

Whereas traditional investing rests on the principles of risk and return, social investment has the added dimension of considering impact.

Market initiatives and emerging collaborative activities (referenced later) provide alternative entry points to those wishing to explore social investment.

Importantly these enable potential investors to make informed decisions about whether pursuing social investment is right for them prior to investing in the necessary in-house resource.

Challenging market norms Like many others, we have been guilty of following market norms and transferring financial practice and products from the private sector and expecting that they will be appropriate within the social sphere without amendment. This was evident in some of the early social investments we made which were relatively inflexible – often ‘standard’ amortizing debt.

In hindsight, this resulted in some inappropriately capitalised social purpose organisations. This was particularly true with some of our affordable credit provider investments.

We increased our attention and resource on deal structuring and focused on impact, not product. Our active portfolio now comprises less than 8% of capital in standard and inflexible debt products.

In July 2020, we finalised an investment into Fair for You – the affordable credit provider (and a Community Interest Company limited by guarantee) alongside six other investors15, in the form of a Perpetual Bond.

A Perpetual Bond is a form of permanent capital which falls firmly into the category of ‘equitylike’ investment. And depending on how it is structured, it can also be accounted for as partially or fully equity on the investee’s balance sheet.

Our initial £500,000 investments into Fair for You, made in 2015 and 2016, were in the form of standard fixed term amortizing debt carrying 6% interest. It became clear that this was inappropriate which eventually led to our restructuring into the Perpetual Bond. The Bond pays interest linked to impact performance (ranging from 3% to 10%), with capital repayments made at the discretion of Fair for You.

Through experience and by restructuring some previously made investments, we’ve understood the importance of investor / investee co-working to fully appreciate the applicant’s business model, impact objectives and financial needs.

This deal has been extensively covered in an Esmée learning paper16 published in September 2020.

15 P ioneers Post (2020) Affordable credit CIC Fair for You secures £7.5m in first-time quasi equity deal 16 E smée Fairbairn Foundation (2020) Perpetual Bonds: an answer to equity-like social investment?

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Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 18

Insights Challenge the status quo RefuAid

Best use of blended capital Blended capital has become synonymous with subsidised debt. Some market data suggests that this is supportive in creating more sustainable business models due to having a smaller level of debt to service.

However, this is only one ‘use case’.

Examples of organisations wanting to develop new revenue streams and business activities whilst operating within a revenue generative model being unable to access grant finance are common.

Often these organisations need to take repayable funding, repaid via the revenue generating part of the organisation, to enable research and development activities.

This can create a greater burden on the revenue generating activities to subsidise research and development, creating a distraction. Social purpose organisations need resource to develop new areas of activity, which may offer the greatest potential to advance the organisation’s impact and sustainability.

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Executive Summary

Applying blended finance following deep understanding of the applicant’s business model can lead to more appropriate placing of grant to fund research and development, whilst also applying repayable finance to organisational activities which are seeking growth, rather than conception.

This may mean pre-investment developmental grant funding, or the provision of grant alongside repayable finance as part of the same transaction.

Undoubtedly more resource intensive, this alternative view highlights the fact that one-size-fits-all approaches rarely yield success, particularly when working with often under-resourced social purpose organisations.

Background

Our impact-first approach in practice

Insights

In July 2020, we finalised a £255,000 blended revolving facility into RefuAid – who support refugees with language tuition, access to Higher Education and an ‘Equal Access Loan’ scheme: interestfree loans enabling requalification.

The investment, made alongside Barrow Cadbury Trust, was co-designed with RefuAid. The structure built on learning from Joseph Rowntree Foundation and Comic Relief’s previous investments into RefuAid which were non-recyclable. £200,000 of the investment is designated for on-lending through Equal Access Loans. Esmée’s investment can be on-lent, returned and recycled for four years, with repayment at 0% interest over the final two. Alongside the investment, a £55,000 Esmée grant enabled RefuAid to launch a recruitment service to place those they support. This supports RefuAid’s sustainability; up to that point the organisation had been reliant on philanthropy and interest-free loans.

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 19

Insights Challenge the status quo

The role of foundations in social investment With the vast amount of wholesale finance coming from a limited number of sources and the smaller supply of impact-first finance, there is a question as to whether risk is being adequately shared within the market. Are social purpose organisations and a handful of social investors taking too much of the burden of risk?

For a foundation social investor, investment money may come from its endowment, but it is not grant funding.

A foundation’s money is as valuable as that of any other investor, though a lower cost of capital does enable foundation social investors to take greater risk and be more flexible.

The provision of ‘sacrificial first-loss, last-out’ capital to funds, or indefinite forbearance or forgiveness to investees, is unlikely to lead to a sustainable long-term model and is likely to be detrimental to the market’s long-term health.

Every investor has tough choices to make and stay true to their strategy. Despite having greater flexibility than many others, Esmée still has a financial target – of break-even – across our portfolio.

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Executive Summary

Therefore, foundations must negotiate the middle ground between being a commercial investor and being too ‘soft-touch’; a difficult line to tread.

At Esmée, we hope that clear, consistent decision-making helps applicants understand our position. We are also looking to work with, and influence, others with a view to increasing the supply of appropriate finance in future.

A Foundation’s money may come from own endowments rather than from external investors, however, this does not mean it is less valuable than any other investor’s money; greater control of funds does not mean less value.

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 20

Looking ahead Is the narrative around pipeline evolving?

Narrowing Esmée’s focus on our organisational impact goals has meant that our ‘investable pool’ has reduced.

Interestingly, early indications show that this has not had an effect on the volume or value of our investments. Instead, there is a longer lag time in converting pipeline opportunities into approved social investments.

More time invested during the pipeline development process means more involvement, co-design and thought is given to the appropriateness of investment structure and a greater partnership being formed rather than a transactional relationship.

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Executive Summary

How will we talk about impact?

We’ve found that we’re more likely to invest if we’re involved in the process before the ask is fully formed. With this comes the recognition that there is a larger need for social investment related developmental grant funding (we saw a 144% increase in social investment related grants from 2019 to 2020). This type of grant is innovative and helps reduce barriers to social investment. Not only does this support our impact-first approach, it also aids our thinking and work on diversity, equity and inclusion.

Our work in this space is evolving.

We will learn from the development of our co-designed outcomes practice and will share what we find. This work, and that of impact measurement within the market, is still young and social investments are long-term.

Co-design and the use of developmental grant finance are cornerstones of our social investment strategy.

It is important to allow time for new models to prove themselves and resist the temptation to jump to conclusions too early.

We expect to see the continued growth of developmental grants as part of staged innovation funding to support emerging new models from a more diverse range of social purpose organisations.

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 21

Looking ahead The Wyre Rivers Trust

How can we encourage greater collaboration?

There is undoubtedly a need to support, and accelerate, the development of others who wish to enter social investment – and more urgently the environmental investment space – due to its lack of historic infrastructure funding which has seen it lag.

The question is how.

The Association for Charitable Foundations and therein, the Social Impact Investors Group (SIIG), are examples of cross sector collaborative and supportive initiatives which exist. Yet reticence from organisations wishing to enter social and environmental investing remains due to many of the challenges outlined previously.

As well as being active contributors to market initiatives like the SIIG, we are exploring how we can support and de-risk social – and particularly environmental – investing for foundations wishing to learn. This is a key element of our strategic road map.

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Executive Summary

After receiving its first grant in November 2019, The Wyre Rivers Trust – one of the four pilot projects funded – secured social investment totalling £850,000 in September 2021; we played a key role in structuring the deal and are the lead investor. This project uses Natural Flood Management (NFM) with the aim to reduce the severity of flooding in Churchtown – a village in Lancashire which has suffered from significant flooding. Private buyers, including water utility companies and insurers, are paying for the benefits created by the NFM interventions with their payments contingent on the efficacy of the interventions, measured by predetermined performance metrics.

With payments made in arrears, our investment is used to fund upfront installation costs. The deal incentivises improvements to biodiversity, with interest rates reducing from 6% to 5% based on performance against biodiversity metrics.

Our partnership with Defra and the Environment Agency was a success. Four new environmental models received over £500,000 of research and developmental grant with all making strides towards pioneering new revenue-based environmental models. This collaborative pilot enabled the sharing of skills between government and established organisations and can provide a template for other similar relationships.

Defra and Environment Agency collaboration In 2019, we formed a collaborative pilot with the Environment Agency and the Department for Environment, Food and Rural Affairs (Defra) to support environmental projects in creating funding models which could be replicated by other projects up and down the country.

This pioneering project is the first in the UK to use NFM and attract private buyers to pay for environmental outcomes.

We made over £500,000 of research and developmental grant funding (split equally between the three partners) to four projects that are delivering environmental improvement, helping them to develop business plans and identify additional revenue sources to complement ongoing public sector support.

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 22

Glossary Amortizing debt Principal and interest of the loan are paid in periodic, fixed payments.

Blended capital The mix of public or philanthropic funds with private or repayable investment through a common deal.

Catalytic capital Investment which accepts disproportionate risk and / or concessionary returns relative to other investments in order to generate positive impact, and to attract third party investment that would otherwise not be possible.

Cost of capital Required rate of return for an investor.

Direct investment Funds invested directly into social purpose organisations.

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Disbursements The payment of money from a fund.

Forbearance Refraining from enforcing something which is due (eg a debt).

Due diligence Process of collecting and analysing information before making a decision or conducting a transaction.

Forgiveness Partial or full cancellation of the borrower’s outstanding loan balance.

Equity-like finance (aka quasi-equity finance) A form of investment which shares some of the characteristics of equity investment without the sale of shares.

Environmental, Social, Governance (ESG) investing Investing that prioritises financial returns alongside a company’s impact on the environment, its stakeholders, and the planet.

First-loss capital An investment which creates a partial loss protection guarantee for other investors.

Executive Summary

Background

Impact-linked finance Linking financial rewards to the achievements of positive social outcomes.

Impact investing Investments with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return.

Impact Management Project A global community of practitioners who share best practice and seek to accelerate wider adoption of impact measurement and management.

Our impact-first approach in practice

Insights

Intermediary social investor (aka Social Investment Finance Intermediary (SIFI)) Organisations that provide, facilitate or structure financial investments for social purpose organisations.

Investable pool The number of social purpose organisations in which an investor can invest.

Natural Flood Management The use of nature and natural processes to reduce the risk of flooding and coastal erosion.

Principal The amount borrowed.

Spectrum of Capital An attempt to map out the broad range of risk and return strategies that exist within sustainable investing.

Technical assistance (aka non-financial support) – support provided to a social purpose organisation, either pre or post investment, to further the social purpose organisation’s development.

Author Ben Smith Head of Social Investment, Esmée Fairbairn Foundation

*Disclaimer The contents of this paper is not legal advice, investment advice, accountancy advice or any other professional advice.

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Wholesale capital (aka indirect investment) – funds invested into investment funds, to in turn invest directly into social purpose organisations.

Social purpose organisation Non-profits, charities, co-operatives, social enterprises, and for-profit organisations with a social mission.

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary

Building an impact-first social investment strategy: what we’ve learned 23

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Contents

Executive Summary

Background

Our impact-first approach in practice

Insights

Consider impact first

Adding value beyond money

Accessibility and power dynamics

Challenging the status quo

Looking ahead

Glossary