VCM0017

Written evidence submitted by Big Society Capital

Big Society Capital was set up in 2012 as an independent investment organisation with c.£625 million capital to help grow the social investment market in the UK. The objective was to create and grow a sustainable market for social investment, so that more social purpose organisations, social enterprises, and charities would be able to access repayable finance at a much larger scale and increase their impact for public benefit. So far, this visionary investment has paid off as we have helped increase the money invested into creating positive social impact eight-fold since 2012. Today approximately £6.6 billion is invested into social purpose organisations, social enterprises, and charities in the UK.

Venture Capital is an important aspect of our investment programme. We believe high-impact technology businesses play a critical role in tackling some of the most pressing social issues of today including ranging from financial inclusion to growing levels of mental ill-health. To date, we have backed 14 venture funds, supporting 191 mission driven technology startups reaching approximately 10 million people. An example of a technology company backed through our venture capital funds is Wagestream. Wagestream was set up to eradicate pay-day lenders and improve financial wellbeing for lower income workers by allowing them to live stream their earnings between pay cycles reducing their reliance on predatory forms of credit. Social investment enabled Wagestream to reach over 100 companies with 350,000 employees, supporting 65% of users to cover an unexpected bill with their own wages.

Other organisations in our portfolio include AgilityEco, which has supported nearly 40,000 UK households living in fuel poverty, helping them with utility bills, energy efficiency and household finances, and Switchee, the UK’s first smart thermostat and asset management platform for large social landlords.

Impact is an important part of the venture ecosystem in the UK

As the UK’s venture capital market has grown, so has the number of companies that are using technology to solve some of society’s most pressing problems. There are now over 30 venture capital funds investing for impact in the UK, and many more that invest in impactful companies as part of broader mandates. At Big Society Capital, we have seen 10x as many impact venture funds seeking investment in 2021 versus 2018. The UK is positioned as a leader on the topic, with investors in other jurisdictions looking towards the UK for best practice.

By innovating around user needs, drawing on fast feedback data, and rapidly scaling what works, these ventures are transformative agents for positive change. Beyond benefits to consumers, impact is also a source of value for companies and investors. For example, through accessing and retaining customers, attracting and inspiring talent, reducing risk, and improving access to capital.

Government action could position UK as global leader on impact venture

There is a huge opportunity for the UK to unlock billions more pounds of investment for impact venture and cement its role as an international leader on the topic. However, there are several barriers which are holding the market back from reaching its full potential which government action could help unblock.

We illustrate the high-level barriers and actions as follows and would be delighted to follow up with more detail, if of interest to the Committee:

• Building an inclusive venture ecosystem:
• Increasing diversity in terms of ethnicity, gender, and other protected characteristics, especially around funding flows. According to British Patient Capital, total VC investment into female founders is under 5%, while a report by Extend Ventures showed that less than 2% of VC funding flows to Black entrepreneurs. Additionally, according to DiversityVC, women hold only 20% of investment roles in VC firms, and 83% of investment committees have no members who are women.  Compared to the United States, where public pension funds often have pools of capital dedicated to diverse managers, in the UK there is less institutional capital available to support emerging diverse managers, who face higher fundraising barriers. Encouraging pension funds to include gender and ethnicity questions in their investment decisions, similar to the Asset Owner Diversity Charter signed last year by several UK pension funds with more than £1tn under management combined, could promote increased investment in more diverse managers.

• Opening new pools of capital for venture capital investment
• Due to restrictions on Defined Contribution pension schemes and marketing to individual investors, most working people in the UK lack exposure to venture capital. These investors lose out on the gains and diversification benefits of venture capital, as well as the opportunity to directly support the growth of high impact companies. Building on the recent consultation and draft proposals by the Department of Work and Pensions to make it easier for DC schemes to invest in illiquid assets could help broaden exposure to venture capital.

• Early stage funding for high impact ventures
• Grant funding or subsidy to launch early stage high impact businesses – such as through incubators, accelerators, and venture builders. Perceptions of higher risk for impact ventures due to the size of the target markets they’re addressing, or shallower scaling pathways, can discourage private investors and prevent high impact startups from getting off the ground. This then leads to less innovation tackling the most pressing challenges or targeting services for the most vulnerable members of society. Blended capital can help de-risk unproven business models and build track record in new investment products that meet the needs of high-impact companies, such as revenue-based finance.
• Grant funding or subsidy directly for startups with high impact models to help them scale. This could flow through a UKRI or Innovate UK programme, or be channelled through venture fund managers. High impact companies can face longer scaling timelines due to the need to build an evidence base or reach harder to access customers. Blended capital can help such firms get over the venture investing “valley of death”. (Example: PRIME Coalition’s Prime Impact Fund, which brought together philanthropic/grant capital and investor capital to fund clean tech startups)
• Grant funding or subsidy for startups intended to fund activities around impact practice. Startups currently don’t have the resources early in their development to understand and then manage their businesses for higher impact. The right kind of grant capital alongside support could build societal impact into the DNA of the next generation of influential companies. This could flow through a UKRI or Innovate UK programme, or be channelled through venture fund managers. (Example: a grant programme funded by the Wellcome Trust that piloted this on small scale with mental health startups – evaluation report here)

• The role of key bodies, such as the British Business Bank and the programmes which it oversees
• There remains a funding gap for impact-focused emerging managers across the venture system, at both early and later stages. We therefore recommend developing an “impact target” for British Business Bank funding programmes (i.e. a mandatory allocation to impact and impact-related funds) or setting up a dedicated impact funds programme to sit alongside the Enterprise Capital Funds programme.

• The operation and effectiveness of the current tax incentives in the venture capital market, including any options for change
• Social Investment Tax Relief (SITR) launched in 2014, incentivises individuals to invest in social purpose organisations by offering a reduction of 30% of the investment in that year’s income tax. Investors can invest up to £1 million per year, directly into enterprises or indirectly via investment platforms, and must retain the investment for at least three years. It was modelled on the Enterprise Investment Scheme (EIS) to provide familiarity for investors and fund managers, but with a focus on social purpose organisations. The scheme was introduced to address the struggles facing social purpose organisations such as social enterprises and charities in raising finance, both because they are often ineligible to partake in other tax relief schemes such as the EIS (for example, charities cannot issue shares), and because of the prevalent perception that a focus on impact could compromise profitability.
• SITR requires fundamental reform in order to fully realise its ambition. HM Treasury estimated that total SITR deal flow would be £83.3 million in the first 3 years, but it only achieved £5.1 million.[1] Currently only 110 organisations have availed themselves of the tax delivering £17.8 million of investment since 2014.[2] Factors have inhibited its growth:[3] a lack of awareness of the relief; widespread belief that SITR was too similar to EIS and not targeting the specific needs of the social investment sector; slow administrative processes around the relief; unclear or insufficient guidance on its use; and complex eligibility restrictions.[4]
• A tax relief for social investment should be the ideal fit – scalable, adaptable, avoiding breeding dependency and encouraging risk-taking, but SITR as currently executed constrains that potential.
• Tax reliefs have been used consistently by governments to deliver policy objectives such as economic growth, tackling market failures and creating social value. While the UK tax schemes are not delivering on these objectives for the benefit of social investment and the impact venture market, if designed appropriately they have the potential to do so.

June 2022