ppforum.ca

Expanding Social Finance in Canada Multi-sectoral consultations report

August 2010

Public Policy Forum Building Better Government The Public Policy Forum is an independent, not-for-profit organization aimed at improving the quality of government in Canada through enhanced dialogue among the public, private and voluntary sectors. The Forum’s members, drawn from business, federal and provincial governments, the voluntary sector and organized labour, share a belief that an efficient and effective public service is important in ensuring Canada’s competitiveness abroad and quality of life at home. Established in 1987, the Forum has earned a reputation as a trusted, non-partisan facilitator, capable of bringing together a wide range of stakeholders in productive dialogue. Its research program provides a neutral base to inform collective decision making. By promoting information sharing and greater links between governments and other sectors, the Forum helps ensure public policy in this country is dynamic, coordinated and responsive to future challenges and opportunities. Public Policy Forum 1405-130 Albert St Ottawa, ON K1P 5G4 Tel: (613) 238-7160 Fax : (613) 238-7990 www.ppforum.ca THE AUTHOR This report was written by Aaron Good, Vice President, with project support from Winnie Wong, Research Associate and Melanie Charron, Project Assistant. ACKNOWLEDGEMENTS This report was prepared for and supported by Human Resources and Skills Development Canada (HRSDC). Additional in kind support was provided by Social Innovation Generation (SiG).

Background

New forms of finance for charities, non-profits and social purpose business1 are emerging in Canada and

abroad to address some of the world’s most pressing and intractable social and environmental

challenges. These include:

Debt and quasi-equity for social enterprises2 in non-profits and charities and both debt and

equity in social purpose businesses

Asset building for charities and non-profits through activities including short and long term loans

to purchase assets, fund operations, and develop new activities

New forms of outcome based financing (e.g. social impact bond) to leverage new pools of

capital and to tie them more directly to outcomes

Current social finance3 activity in Canada is relatively limited and is focused primarily on financing

businesses that contribute to regional economic development (e.g. in rural or remote communities)

and/or have a social purpose (e.g. loans for entrepreneurs with disabilities). In 2008, there were $1.4B

invested in social finance and community investment4. Roughly half of the investment was through

federally funded Community Futures Development Corporations, a quarter was through credit unions,

14% was through ~60 federally seeded Aboriginal Funds, the final 10% was through community loan

funds and regional and national funds that focus more heavily on social enterprise in non-profits and

charities. Based on this information, it is estimated that less than $0.5B was invested in non-profits and

charities – a very small figure in comparison to the over $100B in revenue for the sector, over 60% of

which comes from government funding, gifts, and donations and 30-40% of which is from membership

and earned income5. While capital is constrained in parts of the private sector (e.g. for venture capital

and private equity), it is particularly constrained for even the most basic financial functions (e.g. loans) in

the charitable and non-profit sector.

There may be the potential to increase the flow of assets to organizations that provide both societal

(social and environmental) and economic returns. Based on Social Investment Organization6 data (2008)

1 Social purpose businesses are profit earning businesses that also have societal goals as part of their mission (e.g.

a restaurant that aims to earn a profit, but employs people who are difficult to employ as part of its business model). 2 The term social enterprise is used broadly throughout this paper to include a variety of revenue raising activities

that also further an organization’s mission (e.g. sale of tickets to community theatre, holding a fundraising dinner that raises awareness for a cause). 3 This paper uses a broad definition of social finance, including any funding that generates societal and economic

returns, including but not limited to debt, equity, and outcome contracts that require interim financing (e.g. social impact bonds). 4 Canadian Social Responsible Investment Review 2008, Social Investment Organization

http://www.socialinvestment.ca/documents/caReview2008.pdf 5 National Survey of Nonprofit and Voluntary Organizations 2004, http://dsp-

psd.pwgsc.gc.ca/Collection/Statcan/61-533-XIE/61-533-XIE2004001.pdf

6 The Social Investment Organization (SIO) is a national membership-based organization that includes financial

institutions, investment firms, financial advisors, and various organizations and individuals interested in socially responsible investment.

there were approximately $3T total assets under management in Canada in a range of investments and

funds. Of this:

$600B (20%) are invested in funds that employ some degree of societal consideration in making

investments. Most of these funds are in investment vehicles that take environmental, social and

governance (ESG) factors into consideration when making investments. A smaller portion of

these assets are in vehicles that

o screen out potential investments (e.g. tobacco companies) that do not align with their

ethical standards,

o screen in assets that promote a social/ecological goal (e.g. green energy),

o use shareholder advocacy (e.g. exercising proxy votes to promote standards), or

o directly invest in building underserved community infrastructure.

$1.4B (0.05% of total assets) are invested in social finance (i.e. invested for both economic and

social/ecological returns).

There is potential to grow social finance in Canada. Additional investment could come from a variety of

sources, including:

~$30B Assets under management (AUM) for public and private foundations

~$50B AUM in retail and non-retail funds that employ some ESG screening

~$545B AUM in pension funds that employ some ESG criteria in making investment decisions

(but do not necessarily screen)

~$2.5T in other Canadian assets (e.g. personal savings in banks, mutual funds, other pensions,

corporate assets, etc.)

Social finance consultations

In June – August 2010, the Public Policy Forum (PPF) held a series of social finance roundtables and

interviews. Consultations engaged over 30 leaders from public and private foundations, social finance

organizations, credit unions, banks, investment funds, and private sector companies, as well as high net

worth individuals and social finance experts (see Appendix A). This work builds on previous PPF work on

social innovation including Accelerating Social Innovation: Smart Ideas for Canada, a multi-sectoral

conference developed in partnership with the Social Innovation Generation (SiG) in November 2009, and

an international roundtable on social innovation co-hosted with the Policy Research Initiative (PRI) in

March 2010. The discussions highlighted in this report focused on motivations to engage in social

finance, barriers to social finance in Canada, and potential approaches to increasing dollars for social

(and economic) impact.

Current social finance activity

As noted above there are relatively small amounts of social finance capital in Canada. As outlined in Seth

Asimakos’ May 2009 paper, Building Local Assets: Community Investment in Canada, 20087, which was

supported by the Community Development Partnership Directorate at HRSDC, there were $1.4B

7 http://www.communityinvestment.ca/pdf/Building%20Local%20Assets%20-

%20Community%20Investment%20in%20Canada,%202008.pdf

invested in community investment in 2008, based on the 487 organizations that were surveyed directly

and indirectly. The majority of these assets are directed at for-profit businesses engaged in community

economic development through Community Futures Development Corporations and credit unions.

A recent study8 of nine of the most prominent foundations engaged in social finance found a combined

$32M in community and other mission related investing on an asset base of ~$800M (4%). Some of

these foundations have policies on social finance investment (e.g. to invest up to 5 or 10% of assets).

While it is not known how all of the other ~$29B (~97% of $30B) of foundation assets are invested in

Canada, it is evident that other foundations are not currently investing in social finance at this rate and

magnitude. It was noted by participants that a growing number of private and community foundations

(e.g. Ottawa and Hamilton) are in the process of changing their policies and practices to increase their

social finance investments.

Through the consultations, we learned that respondents are employing a variety of social finance

models, including:

Foundation loans to charities and non-profits to purchase real estate for operations and social housing and to support operations (bridge financing)

Credit union, community loan fund, and foundation loans to businesses at market rates to support community economic development and to promote hiring of individuals who are difficult to employ

Foundation equity investment in a social venture fund that invests in social and environmental businesses

Grants and technical assistance/advice to charities and non-profits engaging in social enterprise (e.g. Enterprising Non-Profits, Social Venture Partners)

Assets for these activities are from:

Foundation endowments and purpose built entities seeded by foundations (e.g. Edmonton Social Enterprise Fund)

Individual donations (e.g. community loan funds)

Depositors in credit unions as stand-alone assets or matched by government/outside investors

Government grants to establish funds (e.g. Chantier de l’economie sociale)

Generally, individuals in organizations that are currently investing in social finance opportunities are interested in doing more. They are limited by several factors which are outlined in detail in this report, including:

Investment board resistance to increase investments

Challenges finding and executing deals Participants noted that while most organizations are not aware of social finance as a concept, many organizations that are not currently engaged in social finance are interested in learning more and several are exploring options.

8 Coro Strandberg, The State of Community / Mission investment of Canadian Foundations

http://www.corostrandberg.com/pdfs/C-MI-in-Canada-Report.pdf commissioned by Community Foundations of Canada and Private Foundations of Canada

At least a dozen community and private foundations that do not currently invest their endowment assets in social finance are investigating options at the staff and board level

Individuals in financial service organizations consulted are generally interested in learning more about social finance but would require acceptable terms on specific products or deals before seriously considering an investment. Institutional investors tend to focus on risk adjusted returns first and specific social impact second.

Motivation for engaging in social finance

All individuals consulted had some interest in engaging in or learning more about social finance.

Individuals in social finance organizations, foundations, experts on social finance and high net worth

individuals contacted highlighted five reasons for supporting and engaging in social finance.

• ‘Concern over enduring social challenges’. Virtually all respondents expressed concern over the

social and environmental challenges facing Canada and the world. Many believe social finance

and the organizations that it supports to be an important tool in addressing those challenges.

• ‘Problems are too difficult for one sector to solve on its own’. Several individuals echoed this

sentiment highlighting a belief that the public sector ‘can’t do it all’. Others expressed concern

that ‘old models don’t always work’ and that ‘there must be a better way’ to generate impact.

Social enterprises and social purpose businesses are seen as new complementary ways of

driving social and economic impact. Social finance is built on innovative, cross-sectoral

partnerships. Several people expressed a belief that due to their broad funding base, they have

a particularly strong potential for impact.

• A desire to use assets, skills, and knowledge to advance public good. Several foundation leaders

expressed strong concern that foundations are only required to use 3.5% of their assets in

support of their mission while 96.5% of their resources are used for ‘something else’. This is

seen by some to make little sense. Investing assets in social finance is seen as a way to get more

impact from existing resources. Some individuals with business and investment skills see social

finance and accompanying technical assistance for social enterprise as a way for them to use the

skills and knowledge that they have developed in the business world to advance social good.

Actively employing these skills and knowledge is more satisfying to some that ‘simply writing a

cheque’.

• A belief that the social sector needs to reduce its dependency on donations and grants. Concern

was expressed over the very fickle nature of current financing streams to the social sector.

Social finance is seen as a way to grow available resources by enabling them to be recycled as

loans are repaid. There is a belief among some that social finance and the organizational

orientations that it supports will help makes organizations more entrepreneurial and focus them

on developing new and more sustainable revenue streams. Most private sector organizations

require a variety of financial tools to operate effectively. Participants explained that loans are

not only required by non-profits launching new ‘business like enterprises’, but also by traditional

charities to finance their buildings and operating capital (e.g. between grants/contracts). Others

noted that social finance models can help reduce some the administrative complexity associated

with grants and provides organizations with an approach to sustainable funding that does not

rely on core operating grants.

A desire to support new, innovative models that drive impact through business like approaches.

“People want to see results,” explained one informant. “They don’t want to continue to fund

old service delivery models that do not change the landscape (e.g. homelessness). If they see a

business model that they believe will have an impact, they will fund it.” Another individual

explained that the private sector ‘invests in failure’ all the time. He knows that his investments

in ‘business plans won’t work out as planned’. Social enterprises that can adapt quickly and

change course as they learn are seen as high potential sources of solutions to enduring

problems. As one individual explained, most of the current funding practices for the non-profit

and social purpose business sector are based on service contracts that provide input (e.g. per

diem) or output (e.g. per person served) funding. These are not only administratively

cumbersome to both the government and to the organizations; they also inhibit innovation in

the design and delivery of public services. New investment models can link funding with

outcomes rather than activities. These models allow for investment in innovative practices in

the design and delivery of services.

Individuals in credit unions echoed many of these points and expressed a desire to use their assets to

support their broader community based mission. They also highlighted a need to engage in

arrangements that make economic sense for their members.

Individuals in chartered banks, pensions, and other financial services companies generally had less

experience in the social finance world. Informants tended to express a desire to think creatively about

how to benefit their community in a way that makes sense for their organization. They were generally

interested in learning more about potential options. As their organizations had the strongest profit

imperative, these individuals were generally most concerned with returns. To begin investing in social

finance, it is likely to require more knowledge of options and risks and likely some form of enticement

(such as government backed guarantees). Simpler, easier to understand social finance investments were

generally seen as more attractive to this group, as they are likely to require less organizational capacity

to understand and potentially act upon. Informants noted, that in some jurisdictions these organizations

also engage in social finance as a ‘social license to operate’ in the face of real or potential public

scrutiny. As the California Public Employees' Retirement System (CalPERS) told its state legislature when

it was being reviewed, ‘we care about California in a way that Fidelity never will’. Canadian financial

institutions could see social finance as a means of building public support and limiting opposition.

Barriers to social finance investment

Individuals cited six broad barriers to increasing social finance dollars in Canada. These barriers are in

two inter-related categories – supply of dollars for social finance and demand for assets (particularly

among charities and non-profits). As in any market, a perception of market viability may increase the

number of organizations interested in participating. More supply of social finance debt can lead to more

non-profits starting social enterprises, which can lead in turn to more interest from potential investors.

Four of the barriers focus on investor supply of finance dollars:

1. Legal barriers

a) Concern Canada Revenue Agency (CRA) may consider as a contribution to a non-

qualified donee

b) Requirement to divulge equity investments greater than 2% of investee value

2. Cultural barriers on investment boards (e.g. foundations, pensions) and with individuals

3. Deals perceived as more risky and tend to generate lower returns/no ‘home runs’

4. Challenges and high transaction costs of identifying and completing individual deals

The final two barriers focus on the demand side. These relate to the ability of charities and non-profits,

to take social investment funds:

5. Limited number of non-profits, charities, and social purpose businesses with the necessary

financial literacy and capacity to manage debt and develop and run fundable enterprises

6. CRA ‘no-profits for non-profits’ opinion has put a ‘chill’ on social enterprise activity.

1. Legal barriers

While legal barriers and fiduciary duty of financial organization to put returns ahead of all other

interests, have been widely cited as barriers to investment in social finance, there appears to be no

law that prohibits the consideration of non-financial issues in choosing investments. According to

one legal expert who was consulted, current trust laws (provincial) require that fund managers be

‘prudent investors’ across their portfolio. This is different from requiring that every investment

maximize returns. A diversified portfolio of investments is generally considered prudent. Prudent

investors must also conduct sufficient diligence to have a degree of comfort that the down side risk

is acceptable (e.g. to get comfortable that they are unlikely to lose money on a low return

investment).

Second, the tax expert explained that organizations can ‘invest in a manner that takes into account

the interests of the investors’ even if they do not maximize returns. Publicly traded companies can,

for example, make strategic investments that maximize their strategic (long term) capabilities or

market share even if they are inferior financial investments. Some legal experts argue that

foundations, endowments, pensions, businesses, and others can also consider strategic (non-

financial) criteria.

There are contrary views. According to one expert, there is no case law on pensions in Canada, so

there is a tendency to follow US examples. In the US, pensions can engage in social finance that has

both a market rate risk-adjusted return and collateral benefit as long as market adjusted return is

equivalent to next best investment. Some individuals argue that pensions can invest in the long term

stability of their community which will benefit not only its members but its other investments.

Others argued that we are in practice limited by US case law. Virtually everyone agreed that

ambiguity could be decreased in Canada by introducing a law that either permits pensions (and

others) to consider ESG factors in making their investments or requires them to report when they do

not consider these factors (as in the UK).

While there are no definitive laws prohibiting social finance, foundations face two specific legal

barriers to some social finance investments.

a. The Canada Revenue Agency (CRA) may consider a low interest foundation investment in a

social purpose business or a non-profit that is not a registered charity as a contribution to a non-

qualified grantee

Tax law requires grants to only be made to qualified grantees (primarily registered charities).

Foundations can invest in a range of companies with the expectation of risk adjusted market

returns. Investments that are deemed to be below ‘a risk adjusted9 market rate’ may be considered

by CRA to convey a benefit to a non-qualified grantee, which would make these investments

prohibited. As market interest rates are ever changing and as rates of return vary greatly with risk, it

is difficult to define a specific interest rate that must be changed. Even if a foundation believes that

it is charging a fair rate of interest, CRA may disagree. In this scenario, the foundation would have to

spend hours of time and potentially legal and advisor costs to defend the investment. Additionally,

the foundation risks that it may have to cancel the investment and/or pay a penalty. Several

participants noted the gap between Canadian policy and international best practices (e.g. UK) on

supporting foundation investment in social finance.

A variety of approaches were discussed to address this issue. CRA could issue guidelines governing

acceptable investments to non-profits without charitable status and social purpose businesses

based on a variety of factors, including relation of the interest rate charged to the prime lending

rate, the term of the investment (e.g. 1 year vs. 5 years), and whether it is secured against assets. It

could further examine approaches on equity investments. To provide confidence to foundation

boards, these guidelines would have to be clear, easy to understand and well publicized.

A second, more comprehensive, approach is to make legal changes that enable and promote ‘below

market’ foundation investments in non-profits. One approach is to establish a new class of qualified

donees (e.g. eligible investees) in which foundations could invest at a ‘below market’ rate of return.

CRA could, for example, develop criteria for eligible projects operated by non-profits that are not

charities. If a new hybrid corporate structure (e.g. a low-profit limited liability corporation or

community interest company) were introduced then the new ‘eligible investee’ status could be

conveyed to this group as well. This approach would allow foundations to invest in those

organizations without restriction. Much has been written on potential corporate forms for

Canada10. Investigating options in this space requires substantial analysis and consultation.

9 A rate of return that is higher or lower based on riskiness of the investment.

10 See for example: More Reflections on Legal Structures for Community Enterprise by Richard Bridge

http://www.centreforsocialenterprise.com/f/More_Reflections_on_Legal_Structure_for_Community_Enterprise_April_2010.pdf and MaRS White Paper: Legislative Innovations http://www.marsdd.com/buzz/reports/sociallegal

b. Requirement of private foundations to divulge equity investments greater than 2% of equity

value

Private foundations must divulge holdings in excess of 2% of any company in which they invest11.

They must also divulge all holdings in that company by their trustees and their family members and

business associates. Additionally, the foundation, its trustees, and their family and associates may

not own more than 20% of a company. While these provisions are designed to restrict foundations

using tax sheltered dollars for private gain, they also restrict the ability of private foundations to

invest in small organizations including those that have a social objective. It is more likely to exceed a

2% (or even 20%) equity stake on a relatively small social finance deals than on traditional equity

investments. As many foundation trustees feel that questions about their personal investments are

a breach of privacy, foundations may avoid small equity transactions to avoid a requirement of

canvassing trustees.

While this barrier only impacts equity transactions by private foundations, it may further limit social

finance enthusiasm and activity among private foundation boards.

11

See CRA Excess Corporate Holding Regime for Private Foundations, http://www.cra-arc.gc.ca/E/pub/tg/t2082/t2082-10e.pdf

2. Cultural barriers to considering social finance as a ‘legitimate investment option’

While legal barriers have some impact on foundations, cultural barriers appear to have a much

greater impact on whether investors, including foundations, consider social finance investments.

One participant was so convinced that barriers are primarily cultural that the participant quipped,

“fiduciary duty is just a politically correct way of saying, ‘we don’t want to’”. Cultural barriers are

particularly large for organization that are not mission driven, such as banks, pensions,

endowments, some credit unions, other financial institutions and by high net worth individuals.

Participants generally believed that most people are not aware of social finance or do not

understand the term. Culturally, the very term ‘social finance’ is seen as limiting and inaccessible to

many. For some, the term implies inferior returns. For others it sounds complex or esoteric. Some

get tripped up on whether environmental impact is part of social finance and others are confused

over whether it includes positive screening, negative screening, or both. Several informants

suggested that ‘impact investing’ is a better term since: a) the term ‘investing’ is clear and broadly

understood, b) impact investing includes both social and environmental, and c) it focuses on the

positive ‘impacts’ of the investments (as distinct from approaches that avoid investments associated

social or environmental ills). Several people recommended that the term ‘impact investing’ be

adopted immediately.

Informants described an enduring divide (or firewall) between foundation investment committees

and program activities. ‘A foundation may be trying to promote healthy eating to combat child

obesity through their programs, but investing in a company that makes junk food on the investment

side. It doesn’t make sense. We need to show them that there can be a better way.’ As noted above,

‘it’s fairly clearly established in law that investors can consider factors other than maximizing

returns’, but many investment committees need to be educated on that point.

Informants explained that investment committees are generally composed of individuals who have

traditional investment backgrounds. These individuals tend to be familiar with traditional

investment grade products and fund managers who deal in them. They generally have less

experience and familiarity with alternative investments. As a result they often discount and discredit

social finance investments. As investment committees are judged based on investment performance

against the market, any investment that provides a lower risk adjusted return will negatively impact

their perceived effectiveness, even if that investment advances their organization’s mission. Some

foundations have addressed this issue by explicitly excluding social finance investments from both

its asset base and returns when assessing its investment performance.

External investment managers may reinforce an organization’s concern over social finance

investments and may further discredit the investments. Informants noted that investment advisors

’see social finance investments as competitive offerings’ to products that they are selling. They ‘have

a huge incentive in ensuring that money is not spent elsewhere’ and may ridicule social finance

investments claiming ‘you can’t make money in those kind of investments’ or ‘those aren’t serious

investments’. Informants noted that investment managers have entrenched interests against new

products which may threaten their position as gatekeeper on information about and access to

products for their client. They may also be concerned with fees. Traditionally distribution fees can

be as high as 3-5% of investments12, according to one informant. Most social investments do not and

cannot support distribution fees, which makes them unattractive to the industry.

These dynamics have an even greater impact on investors outside foundations where the

‘separation of economic and social that social finance is trying to break down’ is even more

apparent. Informants explained that high net worth individuals and other individual investors seem

increasingly interested in considering social finance investments. Currently, they are, however, often

advised to invest traditionally and to make a donation by their financial advisor. Advisors may simply

be unaware of existing options as they do not fall in their area of expertise. Their advice to invest

traditionally and make a donation both retains fees for the advisor and restricts the development of

a social finance market.

To date, it is not clear that any Canadian pension, endowment fund, charter bank, or other

traditional financial service company has included social or environmental impact as a positive goal

of their investment strategy13. A few do, however, have policies of avoiding investments that

contribute to environmental or social harm (e.g. investing in tobacco).

A very real cultural barrier for some potential institutional investors is reputation risk if a deal ‘goes

bad’. No bank or pension fund wants to deal with potential public backlash if they must recall a

social housing loan or decide to refuse a new loan to a church. While the likelihood of some of these

events may be low, they may need to be insulated from the bad press that they could provoke (see

intermediaries in section 4 as an option).

Despite cultural opposition, several Canadian foundations have formal policies to invest a portion of

their assets in ways that explicitly advance their mission. Several of these are newer foundations,

whose founders explicitly wish to drive change through investment (e.g. Bee Hive), others have

reached what one informant termed the ‘aha’ moment through different avenues. Some

foundations leaders worked for years to convince their board and to put a formal policy in place

(e.g. J.W. McConnell Family Foundation). Others experienced significant negative impacts from

economic downturns and viewed social finance as a means to diversify their exposure while

furthering their mission (e.g. Hamilton Community Foundation).

Some credit unions, which are also mission driven organizations, are also increasingly investing

assets in social finance, often at the urging or their members and boards and under the leadership

of their senior management. Many continue to look at social finance in a similar manner to other

institutional investors.

Virtually every informant expressed a need for further work to promote social finance investments

as a viable and legitimate investment option for foundations, pensions, endowments, all types of

12

i.e. if a broker sells a stock, they may receive a 3-5% commission on the value of the stock. 13 The Public Service Alliance of Canada (PSAC) pension’s $2 million investment in affordable housing in Ottawa is

perhaps the only example of a pension investing in social finance. For details, see Engaging Institutional Investors in Social Finance in Making Waves http://www.cedworks.com/files/pdf/free/MW200332.pdf

financial service organizations, and individual Canadians. Some noted that these efforts should be

directed at investors, by-passing gate-keepers who may favor existing products. There are a range of

potential approaches raised including:

o Supporting efforts (e.g. by Community Foundations of Canada) to educate capital

holders and the public on a new alternative for investing capital

o Introducing legislation or publicly making it clear that organizations can choose to

consider non-financial factors (e.g. ESG factors) and meet their legal fiduciary

responsibilities or requiring them to divulge when they do not consider ESG factors

o Creating an award (e.g. Governor General/Prime Minister) to celebrate leaders in social

finance/social innovation

o Helping create the infrastructure necessary to support and legitimize social finance

investment as described elsewhere in this report,

Investigating and supporting the development of investment intermediaries (as

described in section 4)

Establishing and branding a new hybrid (for profit/social impact) corporate form

(as noted in section 1a)

Supporting the development of financial literacy and social enterprise (as

described in section 5)

3. Deals perceived as more risky and have lower returns

Informants believed that investors tend to view social finance deals as higher risk than other

investments. Several argued that this is based (at least in part) on lack of information. Some argued

that many social finance investments (e.g . bridge financing against government contracts,

investments in social housing or other secured assets) are in fact very low risk. Financing new social

enterprises/social purpose businesses falls in the higher risk venture space. It is unclear that these

deals are any more risky than traditional venture deals.

Three approaches were put forward to address concerns over risk. First, governments could absorb

some of the (real and perceived) risk by offering loan guarantees on investments or funds that meet

certain criteria. Second, they could invest first loss capital in social finance funds. This approach

would limit government exposure (e.g. government might only need to invest $10M to attract

$100M in private capital vs. offering a guarantee for the whole amount), but it would have to invest

the money up front. Both of these approaches would allow others to be more confident that they

will earn their expected return (or at least not lose their principal), which leverages greater dollars.

Third, governments could also help publicize repayment rates of previous deals or risk profiles of

existing deals either directly or by supporting others to do so (see description of intermediaries

below).

Regardless of perspectives on risk, there was general agreement that social finance deals are less

likely to generate the high returns that tend to make the traditional venture space successful. As

one informant explained, in the traditional venture space, it is not uncommon for one deal to

generate an 80% return that will ‘make up for ’ five or ten poor performing deals. There are very few

of these ‘home run’ deals in the social finance space. ‘The best you can hope for is a few singles.’

Some informants suggested that tax credits, similar to the mining exploration tax credit, could help

bolster returns and make investments more attractive. They argued that a tax credit could also

compel individuals to make a large investment instead of a much smaller donation (for which they

receive a tax credit).

Others were less convinced that tax credits are necessary or desirable. They argued that credits

could undermine the legitimacy of investments, and were concerned that they may distort choices

and products so that much of the tax benefit from the credits ends up flowing to financial service

organizations. Others noted that organizations that control the largest capital pools (e.g. pensions)

do not pay tax. They argued that these organizations would be more attracted to loan guarantees or

first loss capital.

4. Challenges and high transaction costs of identifying and completing individual deals

‘There are dozens of ways to invest in the ‘non-social sector’. And there’s a huge infrastructure set up

around attracting investment. Opportunities to invest in the social sector are very limited.’

While some foundations, credit unions and social finance funds currently invest in social finance

deals, deals are relatively complex and expensive to complete. Participants cited the high

transaction costs associated with social finance deals. As noted above, most deals can be ‘done’ but

potential investors may need to hire a lawyer to ‘figure out how to do them’. They also need to

conduct appropriate diligence so that they understand the risks (e.g. likelihood that they will lose

their return and/or their principal). While companies listed on stock exchanges are covered by

analysts and evaluated by ratings agencies, most organizations seeking social investments are not.

Conducting diligence on these deals requires time and skills and/or money to hire a business

evaluator. These diligence costs make many social finance deals very expensive. Since most social

finance deals are small, costs are high on a percentage basis. These costs further impact returns. An

investor may be willing to invest in a social enterprise for a 4% annual return for a two year

investment, but if half of that return is used to finance diligence and legal costs, the investment may

no longer be attractive to them.

Several organizations have emerged to conduct diligence on individual deals. As noted above, 35

community loans funds, several aboriginal trusts, a handful of credit unions across the country and

at least one social finance organization conduct diligence and provide loans to social purpose

businesses. At least one social enterprise fund provides loans to charities and non-profits, and a

small number of social venture funds provide equity financing to new social purpose businesses. On

a national scale, these entities are relatively small and not widely known or understood. There are

also gaps in the market that they cover. Foundations may, for example, want to make loans to

registered charities, but may have trouble doing so without assistance. Only a few of the existing

social finance organizations have taken significant investment from multiple large sources (typically

foundations or individual investors). It is unclear that any have attracted any institutional

investment to date.

Most social finance deals are particularly small for institutional investors, such as banks and pension

funds. These investors control very large pools of capital (in excess of $2T), but they tend to invest it

through large funds delivered by internal asset managers and through external intermediaries.

‘Investing deal by deal is not feasible.’ Institutional investors require funds or investment managers

who are handling large volumes of assets. Institutional investors also tend to limit the share they

hold in any single investment. The combination of required scale for individual investments and

limiting share in individual funds requires funds to be particularly large to attract institutional

investors. If, for example, an investor needs to make investments of $10M and they only want to

control 10% of the total fund, the fund must be at least $100M.

Canada does not have a social finance intermediary that is considered by most to be large enough to

attract institutional investment dollars. While there is no one answer of how large a fund must be,

an attractive fund was generally considered to be at least $50 million in assets, to have a diversified

investment portfolio (e.g. 15 to 20 deals), and have strong management with a proven track records.

To attract funders, the investment pitch must help them to develop solid business cases to present

to their boards. ‘You can’t just do this at a small scale,’ explained one informant. ‘You need

aggregators’. While deal diligence may be done efficiently on a local scale, informants believed that

aggregators should be national or regional.

Intermediaries that are able to syndicate deals (i.e. sell shares to many parties) could also help

create the scale necessary to form a secondary market for social finance investments. ‘If you want to

sell Bell Canada stock, another investor will buy it from you. Bell doesn’t need to come up with the

money.’ This isn’t true of social finance investments. A lack of secondary market makes it hard to

‘exit’ social finance investments, which further restricts their attractiveness to investors, particularly

larger institutional investors.

Social finance intermediaries have evolved in other countries. The United States government

established the Community Development Financial Institution (CDFI) Fund in 1994. Over the past 15

years, it has accredited over 870 individual CDFIs (e.g. loan funds, credit unions, banks, and

community development venture capital funds that focus on community development). During this

time, it has awarded over $1.1 billion in loans and technical assistance grants to community

development organizations and financial institutions. These investments have leveraged private

investment dollars, so government funds account for only 7% of the $15B in assets in CDFIs.

Government has allocated ‘New Markets Tax Credits which will attract private-sector investments

totaling $26 billion’14.

In 2002, the UK Government provided £20 million of matching investment to create a community

development venture fund to fund social purpose businesses, Bridges Ventures15. To date, the initial

14

See http://www.cdfifund.gov/who_we_are/about_us.asp 15

See Social Investment 10 Years On, the Final Report of the Social Investment Task Force http://www.socialinvestmenttaskforce.org/downloads/SITF_10_year_review.pdf

matching investment of £20 million by the Government has led to over £120 million of private

sector investment. In each of these examples, the establishment of a social finance market which

attracts private capital has required intervention on the part of national governments.

Canada also has provincial examples. The BC government has given the Vancouver Foundation $2M,

which it has invested in VanCity’s Resilient Capital Fund, which is in development. Informants

reported that the Ontario government also seems to be considering an investment in a new $20M

social venture fund, and that Quebec has a number of examples of supporting social finance funds.

While a mature market would have a variety of offerings targeting different types of social finance

organizations (e.g. for profit, non-profit) at different stages of development (e.g. early

stage/venture, growth financing, secured mortgage financing), there was a broad belief that it is

difficult to develop all markets at once. Governments could play a variety of roles in establishing one

or more scale intermediaries that could:

Efficiently identify, provide diligence, and execute deals,

Spread risk and build scale by syndicating those deals across a range of investors (including

individuals)

Attract institutional investment dollars (through scale, efficiency, and returns)

These three goals could be accomplished by a single intermediary or by multiple organizations.

While informants did not appear to have strong opinions on which specific model is most attractive,

several highlighted the need for a fund to be supported by, but independent from, government.

Determining where to focus and which option is most desirable requires further analysis and

discussion. There are hundreds of potential intermediary models to address these goals. The

following three approaches are illustrative. Each would address all three goals simultaneously.

The first approach is to create a capital pool and to rely on the market to develop the intermediaries

on its own. Government could show leadership by asking (or compelling) their employee pension

plans, the Canada Pension Plan, Employment Insurance Fund, and other entities to announce that

they wish to invest a portion of their assets in social finance funds beginning at some date in the

future. They could further ask or compel foundations, banks, endowments and others to invest

some of their capital in accredited social finance intermediaries (e.g. 0.5% of bank assets, 10% of

foundation assets), and might make it easier for pension to make investments (e.g. by explicitly

allowing them to use non-financial criteria or requiring them to divulge if they do not). Under this

scenario, government would need to specify the rules for accreditation of these intermediaries and

would provide sufficient lead time for the market to respond with options.

A second approach would be to help establish an independent national intermediary. To incent

others to invest, the federal government could offer loan guarantees, which have been used

successfully to leverage large capital pools in the US (and have rarely been called upon, resulting in

minimal cost to government). For an institutional investor, a government guarantee can lower the

risk rating of a government savings bond. Alternatively, government could invest first loss (highest

risk) dollars. To support the development of local and regional loan funds, the national fund could

lend to accredited community and regional funds. It was noted, that under this scenario,

investments would have to make financial sense to institutional investors to attract their capital.

A third approach is to hold a request for proposal for national and/or regional or thematic social

finance funds by existing organizations (e.g. banks, pensions, credit unions). Under this scenario, the

federal government could place investment dollars and/or subsidize development and operating

costs of one or more new funds. These funds could be general or thematic in nature. As one

individual noted, “There are so many opportunities, but each one needs significant attention.” One

approach to building a social finance market is to pick one or two areas and to focus on ‘building the

model’. Housing/homelessness and employment were noted as possibilities for pilots. A thematic

approach may also include a measurement of savings to public programs driven by results from

investments in the fund.

Developing any of these approaches or others would require significant clarity around level and

nature of desired federal investment, an assessment of potential partners and their interest, and an

assessment of impact.

5. Limited number of non-profits, charities, and social purpose businesses with the financial literacy

and capacity necessary to manage debt and develop and run fundable enterprises

While building the supply of dollars and infrastructure for social finance is essential, many

informants highlighted the need to develop the demand side for social finance debt and equity as

being equally important. This is particularly true among non-profits and charities that do not have a

history of developing fundable, self sustaining businesses or of presenting a business case for

financial investment that generates an economic return to investors. One individual explained that

when they established a fund to provide social enterprise loans, they anticipated more uptake. Their

organization has learned that it not only needs to help charities and non-profits develop fundable

business cases, it also needs to educate them on social enterprise as a revenue generation model.

Another informant explained that they could expand their loan program to social enterprise and

social purpose businesses five to seven times if there were adequate demand among fundable

models.

A cultural shift needs to occur among non-profits and charities. Several informants spoke at length

about the lack of capacity in the sector to manage loans that may be required to operate effectively.

Developing and managing full social enterprises is even more challenging. As one individual

explained, “Non profits may say ‘We operate with donations and grants. We have no experience

using debt’. We need to get them out of that mindset. There are lots of programs for individual

entrepreneurs. We need programs to help social entrepreneurs.” While informants were aware of

initiatives to support charities and non-profits, they noted that many of them have insufficient

funding and expertise to provide the in depth advice and assistance required for these organizations

to successfully manage their charity as effectively as possible or to launch social enterprises and take

them to scale.

Less concern was expressed over capacity among social purpose business. Organizations that

provide them with loans did, however, note high number of hours that they spend coaching and

supporting loan applications for these organizations. It appears that capacity support for social

purpose businesses would also be useful.

Three options for assisting non-profits and charities to develop and grow financial capacity and to

launch and build social enterprises were discussed during the consultations. The first is to provide

planning grants to organizations to hire staff or advisory services with the necessary expertise to

develop and run financially sound organizations which include a range of revenue generating

activities, including social enterprises. It was noted that grants would have to be significant enough

to attract levels and quality of support that are high enough to achieve success. Some effort may

also be required to connect organizations with advisors.

A second option would be to proactively extend business development services that are currently

directed at small businesses to charities and non-profits. These services include programs at the

Business Development Bank of Canada and the Community Futures Development Corporations, and

access to the Industrial Research Assistance Program (IRAP). ‘Community futures corps only serve

rural areas,’ remarked one individual. ‘We need to bring them to where the people are – in the

cities.’ This option would involve not only removing any existing barriers in programs terms and

conditions, but also ensuring that they have units staffed with individuals who understand charities

and non-profits and that programs are marketed to charities and non-profits so that they become

aware of new options. Some individuals expressed concern over the effectiveness of these

traditional models in responding to the needs of social businesses, charities, and non-profits.

A third option is to establish a new initiative (or series of initiatives) to support social enterprise

development. This new entity could be housed in an existing organization (e.g. Clearly So, MaRS, the

Accelerator Centre) or as a stand alone. Government could partner with others to help establish it

and businesses could be asked to provide in-kind support (space, people). Charities and non-profits

could be required to pay ‘affordable’ (subsidized) rates to access the services. A new initiative

might also include a forum to showcase business models developed (e.g. similar to the Social

Innovation Forum in Boston).The establishment of a new initiative to support social enterprise

would require further study and discussion.

6. CRA’s ‘no-profits for non-profits’ opinion has put a ‘chill’ on social enterprise activity

Several participants raised concern over a recent CRA interpretation16 that states that non-profits

can earn a profit (e.g. through a social enterprise) ‘only if it is incidental and generally

unanticipated’. The interpretation states that ‘it does not matter what the profit is used for, a [non-

profit] cannot have any profit earning purpose.’ In addition to legal and tax implication impacts of

the interpretation, informants were concerned that non-profit boards may refuse to even consider a

social enterprise if they are unsure whether it is permissible.

There are several options to remove barriers and promote the development of social enterprises.

The first is to expand, clarify, and promote the related business policy by deeming any revenue

generating activity that directly or indirectly promotes the mission of the organization to be a

related business. Some participants argued that this option is insufficient since it opens social

enterprises to costly legal challenges on whether a business is or isn’t related.

A second, more comprehensive option is to introduce a destination test, similar to the one that has

been adopted in the United Kingdom and included in Ontario’s Bill 65 (Not-for-profits Corporations

Act, 2010). Under a destination test, non-profits and charities would be allowed to engage in any

and all types of revenue generating activities so long as the proceeds of the activity are directed at

mission related activities.

A third approach is to introduce a new tax category that would allow charities and non-profits to

record a small profit before they would be subject to taxation. This tax category could also be

extended to a new hybrid corporate structure mentioned above in section 1a.

16

https://cra-arc.knotia.ca/Login/ViewEmailDocument.aspx?uniqID=92485&productID=649&sGotoStr=2009-0337311E5+E&pageLanguage=en

Summary and recommendations

Throughout the consultations, three key themes and sets of recommendations emerged.

Promoting social finance as a legitimate field for investment

Social finance is a relatively new and underdeveloped field in Canada. While many cite its strong

potential for social and economic impact, many individuals in the business and financial management

communities have limited awareness or understanding of social finance concepts and approaches.

Participants believed that:

The federal government must promote social finance as a legitimate (and desirable) option by

investigating and developing options to:

– clarify and promote the legality of social finance activities for foundations, pensions,

endowments, and other financial services organizations

– engage in partnerships to support the education of foundations and institutional investors on

the merits and risks of social finance investing and develop and disseminate information on the

scale and scope of the sector, and

– celebrate social finance and social enterprise achievements through a range of activities

including a national award

Leading in the development of investment options

Perhaps the strongest approach to legitimizing social finance is through the establishment of one or

more large, government backed funds. Attracting a broader range of investors requires stronger social

finance infrastructure. To address these barriers, participants believe that:

The federal government must investigate and develop options to partner with provincial and

territorial governments, philanthropy, and the financial sector to support the establishment of one

or more social finance funds that will source and assess deals, aggregate investment capital, make

investments, and measure and report on economic and social impact

In developing the fund it will need to consider a variety of factors including investment targets (e.g. non-

profits, businesses, funds), type of investments (e.g. debt or equity, terms), sources of capital (e.g.

government grant or investment, foundations, pensions, individuals), and investment

incentives/requirements (e.g. requirements for foundations to invest in accredited vehicles, guarantees,

tax credits). These efforts should build on and complement existing fund development efforts. A series

of questions for consideration in exploring and developing investment intermediaries are outlined in

appendix B.

Supporting the development of financial capacity in charities, non-profits, and social purpose businesses

Building a social finance market requires support for non-profits and charities to develop their financial

capacity so that they can manage loans and develop and launch social enterprises. Participants believe

that:

The federal government must investigate and develop options to work with partners to support and

build the non-profit and charitable sector financial capacity necessary for them to fully utilize social

finance tools and to develop fundable enterprises by:

– Expanding grant making activities supporting financial capacity development for charities and

non-profits, including specific grants to develop and grow social enterprises

– Promoting and ensuring accessibility of all federal small business programs to non-profits and

charities

– Supporting the development of a new independent initiative to help charities, non-profits, and

social purpose businesses with business planning, financial management, and the establishment

of new enterprises, and

– Introducing a destination test for non-profits and charities immediately and eventually a new

corporate form for low-profit, community interest organizations

Glossary of Terms (as used in this report)

Debt – A loan to an organization or individual that is repaid with interest.

Equity – Purchasing shares in an organization. The value of the return will vary with organizational

performance.

Social finance - This paper uses a broad definition of social finance, including any funding that generates

societal and economic returns, including but not limited to debt, equity, and outcome contracts that

require interim financing (e.g. social impact bonds).

Social enterprise - The term social enterprise is used broadly throughout this paper to include a variety

of revenue raising activities that also further an organization’s mission (e.g. sale of tickets to community

theatre, holding a fundraising dinner that raises awareness for a cause).

Social purpose businesses - Profit earning businesses that also have societal goals as part of their

mission (e.g. a restaurant that aims to earn a profit, but employs people who are difficult to employ as

part of its business model).

Appendix A - Individuals Consulted

Shari Austin, Royal Bank of Canada Jan Belanger, Great West Life, London Life, Canada Life David Berge, Underdog Capital and VanCity Credit Union Rick Blickstead, Wellesley Institute Tim Brodhead, J.W. McConnell Family Foundation George Brown, Ottawa Community Loan Fund

Malcolm Burrows, Scotiabank Denis Couture, Caisse de dépot et placement du Québec Tim Draimin, Social Innovation Generation

Jim Fletcher, BC Social Venture Partners Martin Garber Conrad, Edmonton Social Enterprise Fund Kelly Gautier, Mercer Responsible Investing Derek Gent, VanCity Community Foundation Ida Goodreau, Vancouver Foundation (Board Member) Danette Harkness, Coast Capital Laird Hunter, Muttart Foundation (Board member) Ann Jackson, Phillips Hagar and North Tim Jackson, Accelerator Centre

Tessa Hebb, Carleton Centre for Community Innovation

James Little, Royal Bank of Canada

Betsy Martin, Community Foundations of Canada

Julie McDowell, Clearly So

Ross McMillan, Tides Foundation Nancy Neamtam, Chantier de l’economie sociele

Hilary Pearson, Philanthropic Foundations of Canada Rebecca Pearson, VanCity Savings Credit Union Joseph Rotman, Philanthropist

Nora Sobolov, Community Forward Fund Joel Solomon, Renewal Partners Coro Strandberg, Strandberg Consulting

Ilse Treurnicht, MaRS Discovery District

Tamara Vrooman, VanCity Savings Credit Union

Bill Young, Social Capital Partners Maureen Young, Coast Capital

Appendix B – Supporting the development of one or more intermediaries

There are a broad range of options for designing and supporting one or more intermediaries that will

reduce the organizational challenges and transaction costs associated with completing individual social

finance deals.

In evaluating and assessing options, the following questions should be considered.

1. What are the goals of the intermediary?

a. What type(s) of entities does it seek to support through its investment (and other)

activities?

i. Which corporate forms (e.g. charities, non-profits without charitable status, co-

operatives, social purpose business)?

ii. For what organizational goal (e.g. start-up/test/refine/prove a new idea

entity/concept, grow a proven concept, support the short and long term

finances of an organization)?

iii. For what type of societal impact?

b. What type(s) of capital is it trying to attract (e.g. foundation, bank, pension,

endowment, and/or other fund, individuals, provincial/local government)?

2. What activities must it (or a partner) engage in to achieve these goals? Examples include:

a. Generating deal flow? Examples could include:

i. Awareness/outreach/promotion of social finance

ii. Technical support and/or grants to develop business plans and investment

proposals

iii. Development of partners (who would invest in others)

b. Screening/diligence (e.g. legal, commercial, and financial)?

i. Of deals

ii. Of partners (who invest in others)

c. Providing loans/equity /synthetic equity? Examples could include some/all of the

following:

i. Mortgages/secured loans against assets

ii. Loans against contracts

iii. Unsecured loans of mature organizations

iv. Growth loans (to develop new revenues in existing areas)

v. Start-up/venture loans

vi. First loss loans/loan guarantees and other forms of synthetic equity

vii. Equity (e.g. in for profits, co-ops)

d. Technical support and/or grants to current investees?

e. Impact measurement and/or knowledge sharing (best practices)?

f. Investor sourcing/relations?

3. Which activities should be delivered by the entity vs. through a partner(s)?

a. Would it invest directly or through other intermediaries or both? How would it

accredit/select partners?

b. What other activities could/should partners provide (e.g. deal flow

generation/assistance, diligence, impact measurement)?

c. How would it work with each type of partner (e.g. grant/contract to provide services,

loan to other fund to reinvest)?

4. How would the intermediary be managed? Options include, but are not limited to:

a. a subsidiary of government

b. a crown corporation

c. a fully independent national entity/several regional entities

d. part of one or more private corporations or non-profits (e.g. in which government

would invest assets through an RFP process)

5. What incentives/requirements (if any) would government provide for others to invest in the

fund? Possibilities include but are not limited to:

a. Funding development and/or operating costs

b. Providing (matching or lump sum) funding at same terms as other investors

c. Investing first loss capital/providing loan guarantees

d. Guaranteeing returns to individual investors (e.g. issuing a bond)

e. Providing tax incentives, such as but not limited to

i. A non-refundable tax credit on investments (e.g. 1-3% to supplement returns)

ii. Making investments RRSP/RESP/RDSP eligible (for individuals)

f. Requesting or mandating investment by foundations, banks, pension, endowments,

and/or other investors

6. How large does the model need to be to achieve its goals? Are there opportunities to launch a

pilot?