Research summary - Defining investment readiness

Official title: Defining investment readiness in the social finance sector from an investor’s perspective

Author of report: SVX Invest for impact

Why this study

The Government of Canada began the Investment Readiness Program (IRP) in the spring of 2019. After the launch, we wanted to understand what "investment readiness" means in the current social finance network. This research:

• looks at public documents on best practices, and
• studies how impact investors measure how ready social purpose organizations (SPOs) are to receive investments

This research finds other factors that influence their decision to invest. For example, it can be:

• the SPO’s structure
• the social values of both parties, and
• the investment strategy

The main objectives of this research were to:

• give an overview of best practices in deciding investment readiness
• find other factors involved in making investment decisions, and
• suggest ways to assess SPO’s Investment Readiness

What we did

The study used data collection tools and methods to review, measure, and confirm the results. Before having interviews with investors all across Canada, researchers analysed the public documents about investors’ due diligence. The researchers put together the results from the interviews to develop advice for the IRP. To confirm the results, they presented the findings to stakeholders from the sector. Finally, the researchers submitted a report that clearly outlines the results of the research.

What we found

The study found that each investor accepts a different level of risk and level of return. Many look for specific areas of impact, such as one of the United Nations Sustainable Development Goals. Some have an interest in only specific asset classes (for example, debt or equity). The researchers found a few common areas, despite each investor’s unique profile and each potential investee’s unique challenge.

The reason SPOs don’t receive investment is mostly because of the investor's desired portfolio. The SPOs' readiness to receive capital is secondary. The SPOs may be in the early stages or their impact or sector focus may not have aligned with that of the investors. This research aimed to understand why deals have fallen through after the 1st screening.

Investors found that many SPO management teams didn’t have enough financial know how. This was the most common challenge they faced when deciding to invest in SPOs. Non-profits, charities and smaller community based entities begin to view impact finance as a source of capital. These new entrepreneurs need to:

• develop a realistic financial forecast, and
• defend cash flow numbers

In many cases, investors familiar with the SPO would provide the following to help them develop the required financials:

• direct support
• coaching, or
• advisory services

This allowed them to get financing both from their investment review committee and from other investors.

Lack of tax prompts and the higher costs of coping with regulatory barriers limit private market investments in SPOs.

Barriers exist for larger institutional investors and wealth managers to invest in SPOs. Securities regulations, which require their constant 'know your client' attention, make smaller investments into SPOs nearly impossible. The tax laws around charitable giving make impact investing look riskier to investors. They often go back to tax prompts of donations instead of coping with the regulatory challenges mentioned above.

What it means

We began IRP in the spring of 2019 to help SPOs improve their ability to take part in the social finance market. It is a 2 year, $50M grants and contributions program. It plans to build the capacity of organizations to access social finance opportunities, such as the upcoming Social Finance Fund.

The report features a number of recommendations that will be useful in:

• making sure the IRP is a pipeline to social finance investment, and
• growing the number of social finance investments

The suggestions are as follows:

• build financial knowledge
• increase due diligence
• focus on the business model
• build relationships
• change regulations

Build financial knowledge

One of the biggest gaps identified by investors in the readiness of SPOs is their financial knowledge. This happens more often in the non-profit and charity sector. There, the leadership is more experienced at grant writing, but may not understand what investors want to see, such as:

• accounting
• financial projections, or
• the financial returns

Increase due diligence

Performing adequate due diligence on smaller and riskier investment opportunities can:

• add burden, and
• make investors not consider certain SPOs

Investors prefer less risky and more solid investment opportunities because of limited investor resources. This occurs even with sharing impact or sector focus.

Focus on the business model

In all investing, getting the business model is key. The entrepreneur’s lack of skill to quickly and fully describe the business model and opportunity is a deal breaker.

Build relationships

Investing often comes down to relationships. If an investor does not know the SPO, an investment is less likely. Investors and SPOs can build their relationships through events, referrals, or network connections. Without an existing relationship, investors hold the business to a higher level of analysis.

Change regulations

Many investors who have interest in impact investing often go back to giving because of tax prompts. Giving prompts for impact investing could help much needed capital get to SPOs. This can help SPOs to reach stability while returning the capital back to investors.

Contact us

Income Security and Social Development Branch, Social Innovation and Community Development Directorate.

Email: ESDC.NC.SSPB.RESEARCH-RECHERCHE.DGPSS.CN.EDSC@hrsdc-rhdcc.gc.ca