Using loans and equity finance is a relatively new tool for the Third Sector.
A loan is simply borrowing money, which you have to pay back over a set period with interest. Loans can be ‘secured’ against an asset (like a traditional mortgage) or be ‘unsecured’. Secured loans generally have more favourable terms, because the investor is taking less of a risk.

Equity finance is an investment in exchange for a stake in an organisation, usually in the form of shares. The big advantage of equity finance is that it never has to be repaid and there is no interest paid on the money. Equity investments are true risk capital, as there is no guarantee of the investor getting their money back. The investment is not tied to any particular assets that can be redeemed from the organisation, and, should the venture fail, an equity investor is less likely to get their original investment back than other investors. But, in return for this risk, they have a long term stake in the organisation, and will normally receive part of any surplus (profit) made.

Voluntary and community organisations use loans and equity finance to invest in new developments – like developing buildings or trading activities – and to bridge gaps between spending and receipt of income.

New forms of loans and equity finance specifically tailored to the Third Sector have developed in recent years. These include Community Development Finance Institutions (CDFIs), which are aimed at voluntary and community organisations in disadvantaged areas, who are often denied finance by mainstream sources.

The main benefits of loan and equity finance are to:

• provide the injection of cash that makes things happen now
• encourage thinking beyond the short-term (a culture promoted by time-limited grant funding)
• promote business planning
• money to use as you choose

(can be grants, equity or debt)
Patient capital is not a separate form of finance from debt and equity, but is typically in the form of investments designed to give an organisation the time and space to develop and grow. It is particularly helpful for organisations that are trying to move away from grant-dependency but are not yet completely comfortable with purely commercial forms of finance. Patient capital providers make longterm investments and in some cases provide additional, ongoing support. Patient capital can take the form of debt (such as a ten-year loan), grants or equity (which would tend to involve long-term partnering arrangements
rather than shorter-term investment focused on financial gain). The Adventure Capital Fund is one example of a patient capital provider. It supports community enterprises by giving them access to long-term, low-interest loans that give the enterprise time to develop its income-generating ability.

Conventional venture capital describes equity investments made in growing enterprises by professionals who invest in unlisted companies and then help them to grow. Venture capital providers view their role as wider than just providing finance. They usually have a hands on investment style and will want a seat on the board of directors. Studies have shown that there is little supply of conventional venture capital to the social enterprise sector because of the difficulty in providing a commercial financial return, ownership issues, and a lack of clear exit possibilities for investors to realise their returns (The Financing of Social Enterprises: A Special Report by the Bank of England, Bank of England May 2003).

However, there have been some recent attempts to create social venture capital funds. For example, Foursome Investments targets organisations with clear environmental and social objectives. However, Foursome operates on a purely commercial basis and targets levels of return similar to traditional venture capital
funds. Bridges Community Ventures only invests in the 25% most deprived wards of England and also expects commercial levels of return. To date there are no social venture capital funds in the UK dedicated to supporting social enterprises.

Venture philanthropy aims to apply the hands-on management techniques of venture capitalists to grantmaking. Venture philanthropy funds give grants, but do so in a way that resembles an investment. The venture philanthropy fund will usually stay involved with the organisation, and the venture philanthropist may take a seat on the board. Venture philanthropists aim to improve the quality, efficiency and effectiveness of the services offered by the organisations that they invest in. They do more upfront research on the organisation receiving the grant, make fewer but larger grants, pledge multi-year funds and provide managerial or technical assistance to strengthen the enterprise’s organisational capacity.

There are a few organisations in the UK that identify themselves as operating as venture philanthropists. They include WIN (World in Need), SHINE (Support and Help in Education), ARK (Absolute Return for Kids) and Impetus Trust. These organisations support charities, with SHINE and ARK focusing exclusively on children’s charities.

New forms of loans and equity finance specifically tailored to the Third Sector have developed in recent years. These include Community Development Finance Institutions (CDFIs), which are aimed at voluntary and community organisations in disadvantaged areas, who are often denied finance by mainstream sources. Two examples of financing of particular interest to social enterprises are Industrial & Provident Society (IPS) share capital issues and Programme related Investment (PRI)

An IPS share capital issue is similar to a share issue by a company, with two main differences: an investor can only invest up to £20,000 in any one enterprise, and however many shares the investor holds he or she has only one vote. This makes share capital in an IPS very different from company shares, as a higher financial stake does not translate into more say in how the affairs of the IPS are conducted. Some social enterprises particularly like this feature as they find that it fits well with their ethos and helps to limit the extent to which a large investor could ‘hijack’ the original purpose of the social enterprise. This kind of capital is also particularly suited to trading organisations with a large number of members/supporters who may be able to invest a small amount to help the enterprise grow. It brings the advantage that members feel more engaged in the enterprise because they have invested in it. However, it is important that supporters are made aware of the financial risks involved. Some social enterprises have converted their legal structure from a company structure to a registered society in order to issue shares in this way.

Charitable trusts and foundations are allowed by the Charity Commission to make loans to organisations in order to further the trust’s or foundation’s charitable objectives. They can make the loans on concessionary terms if they choose, or can charge full commercial interest rates. PRI loans are not yet widely used by UK charitable trusts. A PRI loan can be used in conjunction with other forms of funding to plug a funding gap, thereby allowing a project to go forward. This type of capital is typically subordinated to other loan capital that an organisation might raise and is used as leverage to raise other debt finance. Although PRI loans do not have to be short to medium term, all of the PRI loan funds that exist at the moment in the UK lend for up to five years. For a social enterprise, a PRI loan is ideal when grants are not available, and where the enterprise is not yet in a position to tap other forms of commercial funding, whether due to lack of available security or because it is at an early, untested stage of operation. Most commercial finance providers look for a track record of typically three years, and if you do not have this you will need to find financial sources that are willing to take on the higher risk associated with start-up operations.