Impact investing can go very wrong. Here are the three biggest pitfalls the social finance fund should avoid

In Winnipeg’s North End, an Indigenous-owned grocer, restaurant and gallery opened its doors in 2013 to revitalize the low-income neighbourhood. The social enterprise, called Neechi Commons, secured a 50,000-square-foot building with a large mortgage.                                                       

Five years later, however, the Commons was forced to close after struggling to stay afloat financially and falling behind on interest payments. When the social enterprise shut its doors, it owed $3.9 million to its primary lender, Assiniboine Credit Union.

In the world of social finance, nearly all of the stories you hear about are successes: achieving a positive social impact, good returns for investors or even both. Cases like Neechi Commons, however, show that it does not always go to plan.

As the federal government works out how to launch the $755-million Social Finance Fund, which could form part of its ambitious COVID-19 recovery plan, there are lessons to heed from when social finance projects fail. According to social finance experts, investors and practitioners, there are three important pitfalls the social finance fund and its investees should avoid.

With a compelling social mission, business judgement can be neglected

Over the last decade, social finance has been thrust into the mainstream of politics and finance. Endorsed by governments and major financial institutions in Canada and around the world, it’s very much in vogue.

Kai Chen, co-founder and manager of True North Impact Investments, says this can lead to bad investment and business decisions. “Because it’s such a sexy topic, I think there’s a lot of leeway given to it in terms of investment rigour,” he says. Chen points out that good projects that promise both a social and financial return, which he calls the “true gems,” are actually very hard to come by. 

In Winnipeg, the non-profit Neechi Commons created its business with the important social objectives of helping to tackle poverty and provide economic opportunities for Indigenous people. However, relying on business in a low-income community, it could not survive at that scale without ongoing charitable subsidies, with such a high upfront investment, says Jesse Hajer, assistant professor of economics at the University of Manitoba who focuses on social finance. The non-profit struggled to pay off its lenders after taking on a huge mortgage and renovation costs which it could not afford.

“Neechi Commons is a classic example of not being investment ready, because their business model failed due to the investment structure,” says Richard Tuck, a Winnipeg-based social investor and CEO of Wakopa Financial Workers’ Co-operative. “Not enough due diligence was done; it is like no one actually asked: OK, how will this [investment] impact your business?” 

Tuck says social purpose organizations must not take shortcuts in testing their business and financial assumptions, no matter how exciting the potential social impact is. “When I look at many of the organizations in Manitoba, they don’t have a deep enough understanding of their business, financial and revenue models, or what the consequences of an investment might be,” he says. 

Social purpose organizations must not take shortcuts in testing their business and financial assumptions, no matter how exciting the potential social impact is.

As research by Imagine Canada recently exposed in the charitable sector, many organizations are far from ready to take on social finance investment. The government’s $50-million Investment Readiness Program is only helping a limited number of charities, non-profits and businesses prepare their social finance projects.

With the government looking to invest hundreds of millions over the next few years, without greater efforts to boost investment readiness there is a danger that the quest for social impact could lead to unsustainable projects.

Social finance solutions may need several different tools to succeed

With a successful business model in place, the idea of social finance is to help projects or organizations become sustainable independently – reducing their dependence on philanthropic and government grants or donations. But in reality, that’s often not possible right away. 

“Most major social challenges require for-profit, non-profit, government to be working together,” says Alexandra Baillie, president of impact investing firm Good & Well. Particularly when working with communities marginalized from the mainstream economy, she says, extra tools like grants are often needed to help build the necessary capacity for a social impact organization to find its footing in the marketplace. 

The Social Finance Fund is being designed to leverage matched investment from private and philanthropic sources, but other supports can be necessary – such as research grants or social procurement – beyond the financial instruments earmarked by the federal government. 

Baillie says a great example of this was their investee, the Far & Wide Collective, an online store founded in 2013 which sold handmade, fair trade crafts made by artisans in Africa, Asia and Latin America to global buyers. It closed in 2018 because the international craft sector was too underdeveloped to scale the enterprise into a profit-making business. 

“The main problem was that we needed an ecosystem,” says Hedvig Alexander, Far & Wide Collective’s founder. Despite support from Good & Well, the social enterprise lacked the resources to build sufficient capacity alone. The craft sector has a fragmented global supply chain, which needs to be developed to attract larger buyers and compete with mass-made alternatives.

“Of course, you can’t be subsidizing business that doesn’t have a business case,” Alexander says, but “if we agree, as countries or philanthropists, that we want to elevate people who have been missing out, there has to be some shared financing and investment to make that happen.” There are more than 300 million craftspeople worldwide, she says, who are predominantly women in the global south.

 Baillie points out that the federal government is ideally positioned to work with social finance projects in tackling social and environmental priorities domestically and internationally – such as the empowerment of women artisans in the developing world. The government has so much other work ongoing in these areas outside of social finance, Baillie says. “How can they leverage the Social Finance Fund and collaborate?” 

At home, for example, social procurement from provincial and municipal governments has supported the development of a number of social enterprises. In Manitoba, a social enterprise in construction called Building Urban Industries for Local Development (BUILD) – which helps to train those with barriers to employment such as Indigenous youth – was able to grow through contracts with the provincial government. “We would not have been able to do this work at all, or be operating at the scale we are, without that type of institutional partner,” says Art Ladd, BUILD’s executive director.

Social finance can make business better, but social services worse

Many social finance investments involve making markets work better for people, like creating greener sources of energy, building more affordable houses or boosting economic opportunities for Black, Indigenous and People of Colour.

However, social finance tools such as social impact bonds – which pay investors based on social outcomes – have also been used to perform functions that are usually the sole responsibility of governments and charities, such as reintegrating prisoners into society or providing early childhood education.  

“When you start introducing social finance into those realms, it creates all these problems with respect to excluding people who should be included in the program, distorting incentives, generating conflicts between investors and service providers,” says Jesse Hajer.

This is because projects often necessitate picking a select group of people to benefit from a project, while investors’ and service providers’ incentives may be at odds depending on how financial and social success are defined.

An example of this distortion occurred in the UK, where investors raised money to reduce numbers of people sleeping on the streets in London. The social impact bond was structured so that investors would gain a return if numbers of rough sleepers decreased. An investigation found that the St Mungo’s charity, as part of their work, had helped immigration enforcement teams to deport foreign rough sleepers. Investors, therefore, were profiting from the deportation of vulnerable people.

Though an extreme story, this case study demonstrates how introducing a profit incentive to social impact work can have unintended negative consequences. It also illustrates a power imbalance, where recipients of social services like the homeless or other disadvantaged communities are treated as consumers – or even commodities.

Introducing a profit incentive to social impact work can have unintended negative consequences.

Béatrice Alain, director of the Chantier de l’économie sociale in Quebec, says there is a dangerous trend of non-commercial community organizations being pressurized to develop commercial activities to finance their frontline activities, which can be used as a way for governments and other funders to cut their support.

“Certain sectors or certain projects within organizations are not market-oriented,” Alain says, and organizations on the ground should not be asked to adapt their practices to meet financial actors’ interests and terms.  A woman’s shelter doesn’t charge for its services and should not do so, she explains, whereas in the case of a social enterprise selling coffee to support women’s employment, there is a much clearer commercial angle. 

A tightrope between profit and impact

In different ways, these cautionary tales all demonstrate how difficult it can be to merge the worlds of profit and social impact. They show how failing to understand either side can not only lead to worse results but negative social or financial impacts. If the federal government is to create a successful social finance market in Canada, closing that gap may prove vital.

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