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									Creating Risk Capital for Social Initiatives

               August 2003
Context and Introduction



The Need for a Social Capital Market in Canada



Looking for Opportunities: Parallels in the Private Sector



Conclusions and Next Steps for SCP




                      2
                        Who is SCP?: Our Mission

   Invest in and support social enterprises that employ at-risk populations

   Help these organizations to grow and eventually exist without external
    funding

   Help these organizations provide improved social outcomes and financial
    self sufficiency for the individuals they employ

   Be a catalyst for encouraging other innovative approaches to funding social
    initiatives in Canada




                                        3
                              What is a Social Enterprise
The term Social Enterprise can mean many different things. For SCP, a social
enterprise is a businesses that balances a double bottom line:
1.   The Financial Bottom Line
      ―   The business operates like a private sector enterprise by selling goods or
          services to its customers
      ―   The business strives for at least break even and, in some instances, for limited
          profitability

2.   The Social Bottom Line
      ―   The enterprise balances its financial mission with a clearly defined social
          mission
      ―   For SCP, the social mission revolves around the creation of quality employment
          opportunities for members of disadvantaged or at-risk populations
      ―   These jobs must be provided in the context of a supportive environment that
          helps employees work towards personal and financial sustainability
                                              4
                             Types of Social Enterprises
Historically, SCP has taken a narrow definition of Social Enterprise but going forward
we will work with a broader range of Social Enterprises:
1.   Our narrow definition of Social Enterprise includes:
      ―   Businesses that create employment in a supportive environment for identifiable
          at-risk populations in any geography (e.g. at-risk youth, psychiatric survivors)
      ―   These businesses employ groups who have significant employment barriers
          such as skills deficits, psychological issues, or substance issues

2.   Our broader definition includes Community Economic Development (CED)
     Enterprises:
      ―   Businesses that create employment in geographically identifiable,
          economically depressed communities
      ―   Unemployment in these communities is considerably higher than the national
          average often as a result of the loss of primary industry which supplied the
          majority of employment in the area (e.g. forestry, fisheries)
      ―   The individuals in this community may not have inherent employment barriers
          beyond those created by their geographic location and their current training
                                             5
                      Who is SCP?: Our Approach

Using Venture
   Capital
 Principles
                To Invest in . . .



                  Social Enterprises


                                           With a Vision of . . .


                                       National Network
                                         of Successful
                                       Social Enterprises
                                                                    That. . .


                                                                       Employ
                                                                     Thousands of
                                                                        People

                                       6
               Who is SCP?: What We Bring to the Table

                     Significant research into, and experience with, social
Experience
                      enterprises in both Canada and the United States


                     Internal expertise in business and social mission strategy,
 Expertise            operations, entrepreneurship, and community economic
                      development


  Capital
                     Significant initial funding in place and several funding
                      partners available to provide additional capital


                     Strong operating partnership with international strategy
Partnerships          consulting firm, The Monitor Group
                     Close relationships with regional co-funders such as
                      Community Ownership Solutions (COS) in Winnipeg
                     Have, and continue to seek, additional partnerships with
                      private, public and social sector thought leaders
                                         7
Context and Introduction



The Need for a Social Capital Market in Canada



Looking for Opportunities: Parallels in the Private Sector



Conclusions and Next Steps for SCP




                      8
                                        Our Study
As part of our catalyst role we undertook a study to find innovative approaches to
funding social initiatives in Canada. The study consisted of several components:
 1.   Study existing research from Canada and other countries related to social
      investment
 2.   Learn from the experiences of other social capital providers in Canada and
      internationally
        ―   Interview leading thinkers in the area of social initiative financing
        ―   Focus predominately on the United States and the UK
 3.   Study parallels between private sector capital markets and the market for social
      capital with the help of RBC Capital Markets
         ― Look at opportunities to adapt financial vehicles that fund unique private
           sector organizations to fund social initiatives
 4.   Create next steps for SCP based on our findings
        ― Highlight questions that still must be asked and answered

        ― Create a specific action plan for SCP based on our findings


                                               9
                                 Goals of this Study

Overarching Goals

   Look for ways to create a more buoyant capital market for social initiatives

   Expand the type and number of financial instruments available to fund social
    organizations

   Expand the total pool of capital that is available for social initiatives

Social Enterprise Goals

   Understand the unique aspects of financing social enterprise

   Create new financing vehicles specifically for social enterprise

   Expand the total amount of funding available for social enterprise


                                             10
                                          Our Basic Premise
   Canada has developed a strong social safety net that provides funding for various forms of social services
     ― The majority (approximately two thirds) of this funding is provided by the government with the rest
       being provided by a combination of individual, corporate and foundation funding

   One issue with the current system is that there is an over-dependence on a relatively small set of funders
     ― As a result, external factors such as government cutbacks or economic downturns have a
       disproportionate impact on the social sector
     ― Also, with such a small pool of funders, there will be limited variation in the risk/return profile of the
       initiatives that are funded

   Another issue is that social initiatives are almost entirely dependent on one form of financing – the grant
     ― Even if this one form of financing were as effective as possible, the result of such limited financing
       options is that only projects with one particular risk/reward profile are funded
     ― Moreover, as government funding becomes less available or economic hardships constrain corporate
       and individual giving, budgets for social initiatives are squeezed

   Therefore, SCP believes that a much more dynamic Social Capital Market must be created
     ― This capital market should include a variety of financing vehicles for social initiatives similar to the
       array of financing vehicles available in the private sector
     ― Moreover, these vehicles must be created such that they attract more funding and support for a wider
       array of innovative social initiatives from a broader array of funders

   The risk of not taking creating this market is that we stifle entrepreneurship and creativity around solutions
    to significant social problems
                                                        11
                  Financing Social Initiatives: The Traditional View
Historically the different sectors of the economy have been thought of as distinct and
separate silos governed by with rigid conventions that limit interaction and forms of
cooperation
   Policy / Regulation                         Social Service                              Profit


      Government                   Charities                   Foundations            Private Sector

  • Government raises        • Charities raise             • Raise money from       • Private sector
    tax dollars                money from                    wealthy individuals      conducts business
                               governments,                • Donates money to       • The purpose of
  • Registers charities
                               corporations,                 registered charities     business is
    and foundations
                               foundations (and              as defined by the        predominately to
    based on a rigid and
                               individuals)                  government               generate maximum
    outdated set of
    criteria                 • Charities carry out         • Charities carry out      profit
                               narrowly defined              social programs that   • Businesses provide
  • Provides grants to
                               programs based on             are in line with         some of that profit to
    charities to carry out
                               societal need and of          donor’s expectations     registered charities
    social policy
                               funder stipulations                                    in return for an
                             • Charities preserve                                     improved public
                               funding by staying                                     image
                               within the narrow
                               definitions of a
                               charity as provided
                               by the government

                                                      12
     Illustrative


                    The Social Capital Market: A New Guiding Framework
  A new approach to thinking about funding for social initiatives is to look at each of the
  sectors and the organizations within them as part of a market spectrum within which
  overlap and cooperation between the sectors is possible
    Pure Social Returns                                            Blended Returns                                      Pure Financial Returns




                               The Social Capital Market



  Potential                                                                     Community           Social    Labour Commercial Lending
                          Government, Foundation,            Community
  Funding                                                                        Venture           Venture   Sponsored / Private Capital /
                             Corporate Grants                  Loans
Instruments                                                                      Capital           Capital     Funds     Public Capital


  Potential
                                                           Social Purpose             Community /            Larger / Higher Growth
  Types of                         Charities
                                                            Businesses               Small Business /               Business
 Enterprises
                                                                                      Cooperatives

                                    Government

Participating                                              Charitable Foundations
  Funders
                                                                                        Private Sector


                                                                       13
                    Types of Risk Capital for Social Initiatives
Within this broader spectrum some of the most important yet under-provided
financing vehicles for social initiatives (risk capital vehicles) can be created
                                                                              Risk Capital

                                                  Progressive                         Community
                 Government/Corporate/                                                                      Social
                                                 Foundations /     Community         Development
                                                                                                           Venture
                 Traditional Foundations            Venture          Capital           Venture
                                                                                                           Capital
                                                 Philanthropy                           Capital

                    Fulfill Social Policy         Promote high-                                          ROI with social
Motivations                                       performance     Encourage Community Development         benefit and/or
                 Donor-driven Social Causes         nonprofits                                           low social cost
                   Government Agencies                             Government
Sources of                                           Wealthy                                               Individual
                    Wealthy Individuals                            Credit Unions     Individual Donors
Capital                                            Individuals                                             Investors
                      Corporations                                    Co-ops
Forms of                                                           Small Loans
Capital                         Project Grants                                                Equity Investment
                                                                   Co-op Shares
Provided
Investment                                        Early Stage /   Start-up / Early    Early Stage /
                     Program Funding                                                                        Various
Stage                                             Growth Stage         Stage          Growth Stage

Form of ROI
                                                                    Interest on                             Capital
to Capital                        Tax Credit
                                                                     Principle
                                                                                        Tax Credit
                                                                                                          Appreciation
Source

Method of                Ongoing Government Funding                  Principle           Capital
                                                                                                         Reinvestment
Sustainability             Ongoing Charitable Gifts                 Repayment          Appreciation


                                                         14
    Illustrative


               Canada Relative to Other Markets: Social Capital Market
Currently, the Canadian environment does not encourage the creation of these risk
capital vehicles and therefore Canada lags significantly behind the United States and
other markets in the creation of new social capital financing
                                                                              Blended Returns
  Pure Social Returns                                                                                                     Pure Financial Returns


                               The Social Capital Market


           Government        Traditional           Progressive                  Community           Development Venture   Commercial Lending /
            Funding         Foundations        Foundations / Venture           Capital / Co-op            Capital         Private Capital / Public
                                                   Philanthropy                                                                   Capital



Canada            Very strong government funding
                  Relatively small number of innovative foundations providing risk capital
                  Relatively small community finance sector



                                                  More limited direct government funding
United
                                                  Large and relatively innovative foundation sector
States
                                                  Fast growing community investment sector



                              Relatively strong government funding
Britain
                              Some innovative foundations
                              Emerging community finance sector with strong government support

                                                                                                 Area of Strength            Developing Area
                                                                         15
         The Environment for Social Investment Outside of Canada
In contrast to the Canadian market, the United States and, to some extent the UK
have a fairly vibrant risk capital market for social initiatives
   The creation of risk capital for social investment has been made a priority in the
    US and other markets through favorable tax and regulatory regimes
     ― US financial institutions are required to invest a portion of their profits back
       into the community giving rise to many community venture capital companies
     ― Social investors in the United States are often provided with tax incentives

     ― In the UK the promotion of social investment has been made an explicit
       priority by the government

   But while the concept of risk capital for social initiatives has been quite ground
    breaking the ways in which the money is raised and invested is quite simple
     ― With few exceptions, money is raised and invested through very typical debt or
       venture capital vehicles
     ― The key difference is that investors are usually asked to accept lower than
       average returns relative to a traditional venture capital fund in exchange for
       social benefit in addition to some tax or regulatory benefit
                                            16
                    The Results of This Investment Environment
While directly comparable statistics are difficult to find, the most obvious and direct
result of the efforts in other markets to drive social investment has been the creation
of significant amounts of social risk capital relative to Canada
                                                                                Risk Capital


                                                                                         Community
                 Government          Foundation        Venture         Community        Development       Social Venture
                   Grants              Grants        Philanthropy        Loans            Venture            Capital
                                                                                           Capital
                                    Foundations        Nascent –          Loan           Little venture financing exists.
                 Government
                                    are relatively     used by a       programs             Some Labour Sponsored
                 accounts for
 Canada                               small and        handful of     exist but are        Funds and others provide
                 65% of social
                                     often donor       innovative      relatively           limited socially motivated
                   funding
                                        driven        foundations        limited                     funding

                                                                      Market more       Growing market – promotion of
                  Foundations make up a large        VP market is
                                                                       advanced -         social enterprise has been
 United           portion of social funding. Still   nascent – few
 Kingdom                                                                national         made a government priority
                   tend to be donor driven but        players exist
                                                                      coordination         with an assigned cabinet
                  demonstrate some creativity           in market
                                                                      taking place                  minister

                                   Make up large                                                           Dozens of
                                                     Original VP         Several           Over 50
                 Tend not to be      portion of                                                           VCs exist that
 United States                                         market –        hundred loan      CDVCs exist
                 as active as in   funding. Show                                                            invest in
                                                        several       funds manage        across the
                 other markets       significant                                                              social
                                                     players exist     over US$3bn           USA
                                      creativity                                                            business

                                                            17
                                       Why This Matters
  The failure to foster an environment which encourages the creation of risk capital
  through social investment leads to:
                           And. . .                       Which Leads to. . .           And. . .
    Lack of Social               Few Social                Less Risk taking and            Limited Social
Investment Institutions      Investment Vehicles                Innovation              Investment Expertise

• Financial support for   • Support almost               • Traditional forms of      • Little or no expertise
  social initiatives        always comes in the            financing tend to be        exists in Canada
  comes mostly from         form of a grant for a          conservative and            around creative
  government agencies       program of a                   based on programs           financing and social
  and traditional           registered charity           • There is little or no       investment
  foundation or           • The only value                 incentive to take risks   • Even a decision to
  corporate                 proposition to                 or try new solutions        change the
  philanthropists           philanthropists is in          because failure             environment today,
                            the form of a tax              results in the              Canada will continue
                            receipt                        withdrawal of funding       to lag behind other
                                                         • Long term                   markets because no
                                                           sustainability and          expertise has been
                                                           working capital is          created
                                                           nearly impossible to
                                                           secure
           The net result is a much less vibrant and creative set of approaches to
           important social and cultural issues in Canada
                                                    18
         What Could be: The Spectrum of Financing Institutions
By encouraging social investment several different financial institutions could be
created in Canada that would support a wide range of innovative social initiatives
                                                 Risk Capital
                                                  Financing


                   Loan Financing                                        Equity Financing



      For Profit                    Non Profit                  For Profit                  Non Profit

   • Subordinated             • Community                   • For Profit             • Non-profit
     Debt funds                 Loan Funds                    CDVCs                    CDVCs (e.g.
   • Community                • Community                   • Social Venture           SCP,
     Bonds                      Banks                         Capital Orgs             Community
   • Loans from               • Government                  • Angel                    Ownership
     Financial                  Loan                          Investment               Solutions)
     Institution                Programs                      networks               • Venture
                                                                                       Philanthropists


                                                       19
                    What Could be: Resulting Financial Options
The resulting financial vehicles could help to create a more dynamic capital market
that provides financing alternatives which exhibit a variety of investment
characteristics and financial / social motivations
                                     Loan Financing                                              Equity Financing

                           For Profit                    Non Profit                    For Profit                   Non Profit

                                                    Community
   Investor            Community Service                                                                      Community Economic
                                                     Development                  ROI with a heart
   Motivation          Profit                                                                                  Development
                                                    Political Policy
                       Non-profit
                        organizations               Business in                  Environment
   Areas of            Community                    economically                 Medical
                                                                                                               Economically
   Focus                                                                                                        depressed regions
                        businesses                   depressed areas              Education
                       Social enterprises
                       Financial Institutions                                    Individual investors        Individual investors
   Source of                                        Government
                       Financial Services                                        Some institutional          Governments
   Capital                                          Community Donors
                        customers                                                  Investors                   Financial service orgs.

   Investment          Mid-stage                   Early stage                  Mid-stage                   Mid-stage
   Stage               Growth                      Growth                       Growth                      Growth

                       Interest Charges                                          Capital appreciation        Tax relief
                                                    Charitable tax receipts
                       Often subsidized by                                       Competitive with other      Small capital
   Form of ROI                                      Some interest payment
                        other business units                                       investments                  appreciation
                                                    Social Returns
                       Social Returns                                            Social Returns              Social Returns

   Fund                Principle Repayment         Principle Repayment
                                                                                  New fund                    Ongoing Fundraising
   Sustainability      Marketing                   Fundraising

                                                                        20
Context and Introduction



The Need for a Social Capital Market in Canada



Looking for Opportunities: Parallels in the Private Sector



Conclusions and Next Steps for SCP




                     21
                     Drawing on Private Sector Learnings
While the Social Capital Market in Canada remains underdeveloped, several unique
structures do exist in the private sector that take creative advantage of existing tax
laws and regulations:

    We hypothesized that some of the unique structures used in the private sector
     could be used to create more investment in social initiatives

    We decided that one of the best ways to study different structures was to go to
     the very organizations that have been creating unique capital structures in the
     for-profit sector for decades
      ― We approached RBC Capital markets to request assistance from their
        corporate finance division to research potential parrellels between the social
        capital markets and the private sector capital markets
      ― RBC generously donated the time of 3 of their team members

      ― Together RBC and Social Capital Partners undertook an initial four month
        research project


                                           22
                           Overview of the RBC Research
   The main thrust of the research was to look into tax driven capital structures that are
    used in the for-profit sector
     ―   Each of these structures took advantage of tax breaks offered by various
         governments
     ―   These tax breaks tended to be used to promote specific industries
     ―   Other tax breaks were associated with particular legal incorporation structures

   The industry specific tax driven structures are most often used to fund companies in
    the for-profit sector that are unable to generate typical market returns
     ―   These organizations are in industries such as film, sports, and mining exploration

   The tax breaks that are specific to certain legal structures tended to be used to attract
    investment from certain types of investors
     ―   These structures included Limited Partnerships which attract high net worth
         investors looking for tax losses and Labour Sponsored Investment Funds which
         attempt to attract small investors to the venture capital market




                                                23
                                      Overview of Social Investing Models
The key premise of our work with RBC was that there could be a way to apply tax
laws such that investors could invest in organizations that provide strong social
returns while receiving financial returns closer to those found in typical investments
                  Low                                   Economic Returns / Risk Profile                 High
  High




                    Charitable
                   Foundations




                          Community
                             Loan
                           Programs
 Social Returns




                                  CDVCs



                                            Socially
                                          Responsible
                                             VCs


                                                            Environmen
                                                              t / R&D
                                                              Funds

                                                                                 Labour
  None




                                                                                Sponsore   Sector /
                                                                                                       “Pure”
                                                                                 d Fund    Regional
                                                                                                       Equity
                                                                                           Focused
                                                                                                      Investor
                                                                                             LP

                                                                         24
              Assessment of the Need for Tax Driven Structures
Based on financial models in Canada, the U.S. and internationally, RBC believed that
there may be an opportunity to utilize a structure driven by various tax credits and
deductions to attract incremental financing

     Social enterprise and other non-profits are unlikely to generate sufficient
      profitability to attract investors on the basis of the economic return alone

     Without encouragement such as preferential tax treatment, social initiatives
      are unlikely to attract funding beyond what is currently provided through
      governments, foundations and corporations

     As a result, non-profit organizations would have to benefit from various eligible
      tax deductions in order to generate new pools of capital and appeal to new
      types of investors

     The viability of a proposed structure would be highly dependent not only on
      the tax credits available but also on the specific social cause and the potential
      for strong social returns

                                             25
                             Conclusions from the Study
However, despite initial optimism, we discovered that under the current tax regime it
would be difficult, if not impossible, for most social initiatives to utilize tax driven
financial structures to raise new risk capital from a more varied group of funders
    The system of tax credits is generally ad hoc and highly variable amongst different
     industries and provinces
    There is little concerted effort on behalf of governments to encourage non-traditional
     investment in social initiatives
      – The Federal government has used tax incentives to promote investment in other
        industry sectors such as film, professional sports, and mining exploration but not
        social investment
    Some provincial governments have started to use limited tax incentives to generate
     investment in CED projects
      – The ability to use tax credits would be highly dependent on the geography and type of
        business and therefore would not likely be the basis for a concerted investment
        strategy
    Therefore, the opportunity to create unique, tax driven, financial vehicles in Canada
     appears very low today given the current tax environment
      – Facilitation of these financial vehicles would require government commitment to
        fostering blended return financing for social initiatives
                                                26
                 Assessment of Opportunity for Tax Driven Structure
The target market for such a vehicle will depend on the magnitude of the eligible tax
deductions provided
                             Current Charitable
                                                                                            “Tax-Driven” Model
                             Donations Model

                        Charitable donations eligible to       Deductions provided through combination of flow-through of
Tax-Deductions           be deducted in computing                operating losses and business/regional specific tax credits
Provided                 taxable income
                                                                46% tax savings as operating losses are realized (timing uncertain)
                        46% tax savings (assumed tax            plus other available tax credits
                         rate) in year of donation
                                                            Alternative A: “Donor” Tax-Driven               Alternative B: “Investor” Tax-
                                                                           Model                                    Driven Model
                                                                     Tax Credits < 100% (but  46%)                Tax Credits > 100%

                        Individuals, businesses, and           Individuals, businesses, and            Individuals interested in realizing
Target Market            government interested in funding        government interested in                 additional tax deductions
                         non-profit/charitable                   funding non-profit/charitable            combined with potential upside
                         organizations                           organizations                            from participation in underlying
                                                                                                          businesses
                                                                                                         Social return as secondary
                                                                                                          consideration


                        Specific social cause                  Specific social cause                   Economic returns (magnitude,
Investment/
                                                                                                          timing and certainty)
Donation                Reputation/brand and track             Reputation/brand and track
Considerations           record of specific charitable           record of specific charitable           Reputation/brand and track
                         organization                            organization                             record of investment manager
                        Efficiency of deriving social          Efficiency of deriving social           Nature of underlying
                         benefit with funding provided           benefit with funding provided            investments
                                                                27
                         Summary of Investment Features
Several structures could potentially offer tax advantaged social investment
  Structural Feature                                    Summary                                      Applicability to SCP


                              Opportunity to increase after-tax dollars through a tax deferral
                                                                                                             O
                         
    Tax Deferral              mechanism by allowing the investor to keep significant portion
                              of taxes payable, which can be invested for up to 10 years at a
                              minimal return in order to fund the future tax liability

                              Repayment of 100% of investor’s original investment at
                                                                                                             P
                         
 Principal Protection         termination provided by a forward agreement with a financial
                              institution with additional upside potential provided through
                              the underlying portfolio of investments

                              Investor can deduct 100% of operating losses renounced to
                                                                                                             P
                          
   Tax Deductions             the Partnership, resulting in potential income tax savings of up
                              to 46%
                             Downside protection is provided through the reduction of
                              money-at-risk for the investor

                              Investors are allowed to apply various different tax credits in
                                                                                                           O/P
                          
   Investment Tax
                              calculating income tax payable assuming that the underlying
       Credits                businesses are targeted by the Tax Act in supporting growth
                              in such industries (i.e. SR&ED, CRCE, LSIF)


                              Utilize specific tax credits available to certain institutions (i.e.
                                                                                                              P
                          
  Institution-Specific
                              banks) and pass through these benefits to investors
      Tax Credits

                                                       28
                     Application of Investment Features to SCP
Structural Feature                    Summary                         Advantages / Disadvantages         Investor Demand


    Principal             SCP establishes an investment            Investors have 100% capital                High
   Protection              trust that invests the proceeds           protection and have additional
                           raised in a fixed portfolio of            upside through ownership of the
                           equity securities and a managed           underlying businesses
                           portfolio comprised of the
                           targeted businesses of SCP               Investment trust maximizes the
                                                                     tax efficiency by ensuring that
                          Approximately 50% of the                  any realization of income /
                           proceeds raised by SCP would              distribution is characterized as
                           be invested in a fixed portfolio of       capital gain / return of capital
                           equity securities and the balance
                           would be invested in the                 The major disadvantage is that
                           managed portfolio                         only 50% of the actual proceeds
                                                                     raised would be available for
                          A chartered bank would enter              investing   in   the    targeted
                           into a forward agreement to               businesses
                           purchase the fixed portfolio,
                           offering investors 100% capital
                           protection

                          SCP establishes a limited                Investors may realize upside           Medium
 Tax Deductions            partnership that invests in the           potential through ownership of
                           targeted businesses                       the underlying businesses
                          Flow through of operating                However, any realization of
                           losses of underlying businesses           income / distributions from the
                           results in a potential 46%                Partnership will be characterized
                           income tax saving for investors           as income and taxed at the
                                                                     investor’s marginal tax rate

                                                         29
                     Application of Investment Features to SCP
Structural Feature                    Summary                        Advantages / Disadvantages         Investor Demand

                          The Fund is registered as a             Investors have 100% capital                High
 LSIF Tax Credit           labour-sponsored       venture           protection and have additional
                           capital corporation under the            upside through ownership of the
                           Income Tax Act (Canada) [the             underlying businesses
                           “Tax Act”] and as a labour-
                           sponsored                               Investment trust maximizes the
                                                                    tax efficiency by ensuring that
                          investment fund corporation              any realization of income /
                           under the Community Small                distribution is characterized as
                           Business Investment Funds Act,           capital gain / return of capital
                           1997 (Ontario) [the “Ontario
                           Act”].                                  The major disadvantage is that
                                                                    only 50% of the actual proceeds
                          The Fund is taxable as a mutual          raised would be available for
                           fund corporation under the Tax           investing   in   the    targeted
                           Act and Corporations Tax Act             businesses
                           (Ontario). The Tax Act and
                           Ontario Act both allow an
                           individual to invest in Class A
                           Shares of the Fund and to obtain
                           a personal income tax credit.

                          For instance, a chartered bank          Investors may realize upside           Medium
   Tax Credits             can act as an intermediary in the        potential through ownership of
   Available to            investment        process      and       the underlying businesses
     Certain               captures the incremental capital
    Investors              tax benefit entitled to banks from      However, any realization of
                           investing in small businesses            income / distributions from the
                           and flows these benefits through         Partnership will be characterized
                           to the investor                          as income and taxed at the
                                                                    investor’s marginal tax rate
                                                        30
Context and Introduction



The Need for a Social Capital Market in Canada



Looking for Opportunities: Parallels in the Private Sector



Conclusions and Next Steps for SCP




                      31
                                     What Needs to Happen?
If the Canadian regulatory environment does not afford opportunity to create social
investment structures then what steps should be taken to create more risk capital?
 1.   Creative Thinking from Financing Organizations
      –   Traditional philanthropists must consider new ways of encouraging innovation and risk taking
      –   We need to re-think our focus on funding narrowly defined programs and think of ways to invest
          behind the most innovative social agencies and entrepreneurs
      –   Considerable learning can be gleaned from the Venture Philanthropy movement

 2.   Creative Thinking from Members of Individual Social Initiatives
      –   Leaders in social organizations must change the value proposition that they offer to funders
      –   We must move away from asking for funding because it is the right or nice thing to do
      –   We must move toward a model where funders are provided with a clear value proposition based
          on innovation and the creation of real social change
      –   Consideration should be given, where appropriate, to the applicability of revenue generating
          social enterprise as a way of creating sustainability

 3.   Commitment from Policy Makers
      –   Canada needs to create an environment that encourages the social capital market to flourish
      –   Regulatory and tax laws should promote the creation of new financing organizations and vehicles
          the expand the amount and the types of capital available to social initiatives
      –   Without government commitment to creating this environment, efforts of individual philanthropists
          and social entrepreneurs are likely to remain isolated and small scale
                                                       32
                                          SCP’s Role
In response to these broad suggestions, SCP feels that it has an active role to play
within its own area of expertise to create new examples of risk capital for social
initiatives
     SCP has developed skills and expertise in the area of social enterprise
       – We will continue to play in this space with the goal of creating risk capital for these
         types of organizations

       – We will do this by trying to create new investment vehicles and value propositions for
         social enterprises

     We do not see these enterprises as the panacea for all social issues
       – Where appropriate we help others create alternative and entrepreneurial approaches
         for other types of social initiatives

       – Where appropriate, we will use our learnings to help others in their efforts to
         advocate for changes to tax and regulatory policy that might help to create a more
         buoyant social capital market in Canada




                                                 33
     Creating New Value Propositions for Social Enterprise Investors
  In our view, one of the most crucial ways to create risk capital for social enterprises
  is to demonstrate potential new value propositions to philanthropists and other
  would-be social investors
                      Current Value Proposition                  Alternative Value Proposition

            • A grant for a specific program of a        • Money to be provided as loans or equity
              registered charity                           investments in social enterprises
Investor
Provides    • Perhaps some ongoing intellectual          • Perhaps some ongoing intellectual
              support                                      support

Investor    • A tax receipt that amounts to $.46 or      • The principle is returned within 5-7
Receives      less on the dollar                           years
            • Recognition by the charity of the          • In addition to the principle a modest
              donation                                     return may be provided (perhaps 3-5%)
            • Anecdotal reports on how the money is      • Specific social and financial return on
              being used                                   investment reports
            • Requests for further money to sustain      • Recognition by the social enterprise of
              the program                                  the investment
                                                         • The Ability to re-invest the money in
                                                           other social initiatives
                                                         • A self-sustaining social enterprise
                                                    34
                      The Social Capital Market: Where SCP Will Play
 Grant                                                                                                      Investment
Funding                                          Social Capital Partners                                      Funding

                         Social Service                                       Social Enterprise




         Either on its own or through its partnerships SCP will offer a range of funding options
             – These options will be tailored to fit with the needs these businesses
             – These funding options will include both granting and for-profit vehicles
         SCP will work with social enterprises that fall close to, but on either side of the breakeven point
             – In all instances these enterprises will strive for breakeven over time
             – The speed at which they reach breakeven and the extent to which they are expected to exceed
             it will depend on the type of investment provided
         The vehicles will also attempt to meet the return on investment requirements of SCP’s investors
             – However, the purpose of these vehicles will not be to make typical venture capital returns
             – Rather, SCP will look to create value propositions that are an improvement on the traditional tax
             receipt
             – In some instances this will mean generating returns greater than breakeven
         Throughout all of our work we will continue to look at the bigger picture
             – We will track blended returns that include both social and financial variables
                                                           35
    Illustrative


                      Financing Options for Social Enterprise
  The choice of funding vehicle will depend on the potential for returns which are, in
  turn, related to the stage and type of business
          Growth




                                                                             Equity / Enhanced
                                                                                   Equity


                                                            Subordinated /
Stage
                                                            Enhanced Debt
        Early/ Mid

                                   Low Interest
                                     Loans




                     Grants



          Start-up


                               Social Enterprise                                   CED Enterprise
                                (50% – 103%)       Enterprise Type /                (103% plus)
                                                   Potential Return
                                                       36
How Might SCP Structure Itself to Create these Value Propositions?
SCP may restructure itself to create a range of venture capital vehicles for financing
social enterprise in Canada.

          Social Venture Foundation                                 Social Venture Fund




                                           SCP: Fund Manager



 Deal Characteristics                                          Deal Characteristics
 • C$2M fund                                                   • C$5M fund
 • Social enterprises started by                               • For profit or nonprofit social
   charitable organizations (qualified                           enterprises (non-qualified donees)
   donees)                                                     • Funding in the form of equity or
 • Funding in the form of grants or very                         subordinated debt instruments
   low interest loans                                          • Enterprises strive for limited profits
 • Enterprises strive for break-even                           • ROI in the 3-5% range for investors
 • ROI in the form of a tax return                             • SROI measured around
 • SROI measured around employment                               employment and sustainable
   and sustainable livelihoods                                   livelihoods
                                                   37
                  Necessary Conditions for Going Forward
Before SCP moves ahead with a strategy to expand its work with social enterprises
and CED businesses, the following conditions will have to be in place
 1. Lead Deals
      –   SCP will have identified 2 – 3 lead deals that could be shown to potential
          investors in a fund as examples of good CED investments
      –   These companies would have a demonstrable ability to generate returns in the 3
          – 10% range while creating employment in an community that has experienced
          some form of economic dislocation
 2. Aligned Investor Group
      –   SCP will have identified a group of investors who are aligned with the objectives
          of the fund and willing to be involved in a pilot fund
      –   These investors would have to be willing to invest a combined total of at least
          C$3M
 3. Regional Partners
      –   In order to effectively invest in multiple geographies across multiple industries
          SCP will have to create a network of strong co-investors and partners
      –   Partners will help create deal flow in specific geographies and perform some on-
          the-ground management duties for mutual investments
                                              38
          Questions That SCP Will Answer With the First Fund
Through our work with social enterprises SCP hopes to answer questions that will
help lead the way forward to creating more social capital vehicles

    Can investors be convinced that there may be advantage to viewing some
     investments through both a social and financial lens?

      – Under what conditions and using what value propositions?

      – What types of investors are most likely to be interested?
    What types of investment vehicles should be created to allow investors to
     consider investment in social initiatives as a viable use of capital?
    Are there specific investment characteristics that make the most sense for
     these types of vehicles from a risk/return standpoint?
      – Assuming that Social Enterprises and CED businesses are the best
        investment types, what are some of the key success factors for making
        these organizations work effectively?


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