Beats | February 9, 2016

Arts, Dementia and Social Enterprise: Lessons from the UK’s Blended Finance Initiatives

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As governments around the world look for more efficient ways to finance critical social services, the UK government is engaging the private sector to fund the arts, research into treatments for dementia, incubation of new social enterprises and other initiatives.

fullstackImpactAlpha recently spoke with Edward Evans, a senior policy advisor in the UK Cabinet Office’s Social Investment and Finance team, to gain insight into the use of “blended finance” to leverage limited public funds to catalyze private capital and resources to address pressing social issues.

The UK is recognized as having one of the world’s most developed social economies. A vibrant social sector is benefiting from increasing capital flows following the launch of the world’s first social investment wholesaler, Big Society Capital, and the introduction of the social investment tax relief.

The UK benefits from direct government intervention to strengthen and grow the market. In the past 18 months, the UK Cabinet Office conducted extensive research on blended finance structures that have worked around the globe along with analysis of the UK’s domestic market. In the process, the UK government has taken on an active approach in facilitating investment vehicles where appropriate and working with a range of investors – from purely commercially-minded, to organizations solely focused on impact.

[blockquote author=”Iain Duncan Smith, UK Department of Work and Pensions” pull=”pullleft”]To my mind, social investment stands to make perhaps the single most significant difference to how we fund and deliver social services in years to come.[/blockquote]

Evans compared blended finance market in the UK to the development of the market for Social Impact Bonds, or SIBs, another offshoot of social finance. A little while ago SIBs were a new idea without much precedent. As evidence began to trickle out of their effectiveness, SIBs started attracting more attention from investors and the market for the social finance tool has been growing. The same is now happening with blended finance  – it’s a fairly new concept that is gaining credibility as more investment vehicles are rolled out.

Here are a few lessons the UK Cabinet Office has learned so far:

  • Be robust.It is critical to understand the rationale behind creating an investment vehicle – what is the issue that is being addressed? Is a fund the most appropriate intervention? Is there demand for and supply of investment capital?
  • Be flexible. The best solutions might not be the easiest ones and may take considerable time and effort to get off the ground. The government’s support can accelerate the usually lengthy process of establishing a fund.
  • Leverage other stakeholders’ expertise. For example, the UK Government worked with J.P. Morgan to develop the Dementia Discovery Fund. The firm provided financial advice to the government and support through its knowledge and experience of the healthcare industry to help identify private sector investment partners.
  • Have an entrepreneurial attitude. Blended finance structures present new ways of doing things and require a considerable amount of experimentation to reach an optimal solution for all parties involved.

Evans explained that there are two major stages in the Cabinet Office’s evaluation of whether a blended finance model would be suitable.

Investment proposition

The first step is a market research effort to identify the strong investment proposition needed for blended finance to work. Can the organizations in a given sector create social impact at scale and repay investment? What is the demand for capital and what kind of capital infusion (debt or equity) would be appropriate given a business model? What is the risk/return profile of the investment? Is it suitable for commercial investors or impact first investors?

For example, market research suggested there is an investment demand of £28 million from arts-based organizations in the UK. To test the waters, in March 2015, the Cabinet Office worked with the Department for Culture, Media and Sport to help launch the £7 million Arts Impact Fund, bringing together public, private and charitable investment to support arts organizations that are seeking growth capital and can generate both social and financial returns. It’s the first fund of its kind to look at the social, artistic and financial returns from arts organizations and has the potential to be used as a model for social investment in other sectors of the UK economy.

The Arts Impact Fund is a £7 million pilot investment vehicle that seeks to support the growth of arts organizations in the UK. The Fund was established by Arts Council England, Nesta, Bank of America Merrill Lynch, Esmée Fairbairn Foundation and Calouste Gulbenkian Foundation. The selected organizations can receive unsecured loans ranging from £150,000 to £600,000, repayable over a period of 3-5 years at interest rates of between 4 and 7 percent.

The Arts Impact Fund is seeking to build a market for social finance in the arts by, first, establishing demand among arts organizations by showing that they can improve their sustainability through social investment and, second, developing a sustainable fund model with default rates and returns that allow for follow-on investment.

In some sectors a short program of tailored support can help increase the number of organizations that are investment ready. The Cabinet Office recently announced the establishment of a second round of the Impact Readiness Fund, or IRF, with £1.5 million in funding. The IRF will provide grants ranging from £25,000 to £100,000 to help social enterprises build systems and skills, increase their social impact, and attract social investment or win public and private contracts.

The first IRF round of funding totaling £2 million was launched in October 2014 and supported 51 social enterprises. As a result, the social enterprises were able to unlock more funding through social investment and secure new contracts.

Investment vehicles

The second stage of the Cabinet Office’s evaluation determines whether an investment vehicle can be established in practice. Are investors interested in putting in their capital? Is there a capable external management team to run the fund?

Government support can range from identifying potential investors to negotiating fund terms and procuring a fund manager. The approach varies according to the specific fund and the procedures of the lead department that is establishing the fund.

For example, in the fall of 2014, the UK government facilitated the partnership of committed investors for the $100 million Dementia Discovery Fund – an innovative venture capital fund that brings together expertise and resources from J.P. Morgan, the UK government, national social sector organizations, and global pharmaceutical companies.

“This fund allows pharmaceutical partners to pool their risk in that early phase, and that’s a nice incentive to bring investment into dementia.” said Matthew Norton of Alzheimer’s Research UK.

The UK government made a cornerstone investment into the Dementia Discovery Fund of about $22 million. Alzheimer’s Research UK. committed another $5 million, GlaxoSmithKline $25 million, and Johnson & Johnson a further $10 million. Pfizer Inc., Biogen Idec, Takeda and Eli Lilly and Company are contributing the rest and other investors will be able to join later on. SV Life Sciences was appointed as the fund manager. The investment projects will be selected by a scientific advisory board. The fund will support preclinical research from a range of start-ups and other organizations such as universities. The fund will then look to realize returns through a range of mechanisms, for example licensing successful treatments to a pharmaceutical company. This will generate the partners’ market return on the initial investment.

An important question for the public sector to ask is: where does the role of the government end? Evans stressed that the UK Government does not run the funds but rather facilitates the establishment of the investment vehicles. The objective is to increase the capacity of organizations to deliver social impact by growing the market for social finance in various sectors.

“For government, this opportunity is enormous – to my mind, social investment stands to make perhaps the single most significant difference to how we fund and deliver social services in years to come,” said Iain Duncan Smith, secretary of the UK’s largest public service delivery agency, the Department of Work and Pensions.