Government-backed blended finance solutions key for social impact investment growth, report

A report aimed at UK policymakers argues that grants, guarantees and tax relief need to be combined to maximise benefits and grow the social impact investment market

A new UK government-commissioned report from two impact investment institutions calls on the government to use the subsidy tools at its disposal in a more coordinated way to support social enterprises. 

UK social impact investor Big Society Capital (BSC) and industry body the Impact Investing Institute (III) looked at the effectiveness of the three main tools at the government’s disposal – grants, guarantees and tax relief. The report, Bridging Capital into Communities: A Practical Guide for Policy Makers , was commissioned and funded by the government’s Department for Digital, Culture, Media and Sport.  

“Government is a key actor in encouraging the social impact investment market to develop, so we wanted to dig deeper into the tools that it has been using and analyse their effectiveness in growing the social impact investment market,” Tessa Godley, policy and strategy manager at BSC who is one of the report’s main authors, told Impact Investor.  

The report looks at the advantages and disadvantages of each of the three policy levers with the aim of enabling government to better understand how they’ve been used to date and become better informed when developing policy. 

It concludes that while there are strengths and weaknesses to each subsidy tool, none provides a complete solution. It says the UK government needs to “use them simultaneously to allow their different strengths and weaknesses to complement and compensate for each other” to achieve the widest possible range of goals. 

One way of doing this, which has proved effective, has been the blending of guarantees and grants alongside other investment capital, which has facilitated the allocation of smaller loans than would otherwise have been possible.  

The value of guarantees to support fragile small businesses was brought out in the COVID pandemic. That sparked a number of new government guarantee schemes that led to an increase in the volume of guaranteed loans to £70bn issued to 1.5m firms.

These new schemes, such as the Recovery Loan Scheme (RLS), are regarded as improvements on pre-pandemic schemes. They have been well received by social enterprises and charities and are actively used by social impact investors in their work, according to the report.   

The power of blended structures 

But combining guarantees, loans and grants is an even more effective mix in terms of reaching the broadest spread of social enterprises.   

“Guarantee instruments are very effective at enabling lending to happen, which wouldn’t otherwise, and mobilise capital into investment funds. But what you tend to find is that a standard loan product that doesn’t offer the flexibility that a grant enables,” Godley said. 

For example, the Recovery Loan Fund, which is backed by the government’s RLS guarantee, also offers grants as part of its remit to support charities and social enterprises to build stronger and fairer communities to expand its reach. By adding grants to guarantees, the fund has been able to bring down its minimum loan size to £50,000 from £100,000 for social enterprises and charities led by black and minority ethnicities. 

Similarly, the Access Growth Fund, managed by BSC’s sister organisation  Access – The Foundation for Social Investment, has used the combination of a grant from the National Lottery Community Fund and investment capital from BSC to make more than 600 investments in the social enterprise sector since 2016 with an average deal size of £67,000. AGF supported organisations with, on average, half the turnover and one-eighth of the assets of those who normally attract social impact investment, according to the report. 

Room for further action 

However, the report concludes that, despite the benefits, there are currently too few blended finance structures and products to fully realise the potential of the tool, with the level of blended finance flows restricted by the limited availability of public or philanthropic grants. 

“Considering blended finance is overcoming persistent market failure, a significant and enabling opportunity for the social impact investment sector is a long-term, reliable source of grant to mount blended structures and products. This would support sustained market development and also help to attract other grant funders and investors,” the report says. 

The UK is one of the few countries in the world that has introduced specific tax relief for social impact investment, such as the Social Investment Tax Relief (SITR), which incentivises individuals to invest in social enterprises and charities. But the report says there is still room for more effective deployment. 

“A tax relief for social enterprises should be the ideal fit – scalable, adaptable, avoiding dependency on subsidy and encouraging risk-taking, but SITR as currently designed constrains that potential. Enabling social enterprises and charities to use the relief to, for example, develop properties, and simplifying terms around investment subsidiaries and ownership restrictions, would enable better uptake of the relief,” it says. 

There is also uncertainty over how long tax relief schemes will be in place, making planning for investors in social enterprises difficult. The SITR is currently only guaranteed to be available until April 2023, for example. 

US approach 

While other countries may be able to learn lessons from the UK on the government’s role in stimulating the social impact investment sector, the report also looked at where the UK could learn from elsewhere.  

Godley notes that in the US, the charitable foundation sector plays a significant role using grants to provide first loss capital intended to leverage more and new capital to address social problems – a practice that is less common in the UK. The report also highlights the effectiveness of the US government’s deployment of guarantees to build the Community Development Finance Institution (CDFI) sector. This allows eligible CDFIs to raise bonds of $100m or more with a 100% federal guarantee. CDFIs are local non-profit lenders providing debt finance to businesses and individuals using a relationship-based approach. 

It is too early to say how the UK government’s social sector strategy will change under new Prime Minister Liz Truss, but Godley said the report provided evidence that the tools to support the sector were readily available.   

“One of the key takeaways from the report is that government really has the power to grow the social investment market through the policy levers of grants, guarantees and tax relief. We have a decade or more showing that it works, so if the government really wants to grow the market, it can,” she said.