Charities drive to beat the squeeze

Charity Runners
By Anthony Harrington, The CA Magazine

20 February 2015

After a difficult year, charities are facing up to the realities of looking for alternative routes to finance, from social impact bonds to crowdfunding.

However one measures it, 2014 was a tough year for charities. Consumer discretionary spend has been under constant pressure, making fundraising unusually difficult, while local authorities have had to face up to deeper and deeper cuts to their funding, causing them to squeeze service suppliers. For charities specialising in providing services to local authorities in exchange for funding, this has meant doing more for less, often to the point where service delivery itself is under threat.

The inevitable response from government, local authorities and charity advisers has been to urge charities to think more "innovatively" about funding. This generally boils down to one of two things. One is urging charities to be "more businesslike" and to look for commercial avenues to generate capital, perhaps through launching a subsidiary social enterprise. It also means looking at innovative funding options. The two really massive innovations currently at play in the sector are social impact bonds (SIBs) and crowdfunding.

So far, only 16 SIBs have been launched in the UK since the first one was introduced in 2010. SIBs are still very much in their infancy and could not yet be called anything like a solution to the funding crisis. However, the SIB concept, founded in Britain by Social Finance, a body set up in 2007 to look at funding and other challenges in providing care for vulnerable people, has now gone international, with around eight other countries running their own SIB schemes.

David Hutchison, a former banker, has been the CEO of Social Finance from the outset. He said: "One of the major tensions we had to grapple with was that those who pay for voluntary and community organisations providing services to the disadvantaged and vulnerable are not the people who use these services. So you can get tensions between the interests of funders and the interests of users. Add in short-termism and bureaucracy and you can get a very dysfunctional system. It seemed obvious that the situation could be improved by finding structures that would offer flexibility and long-term funding for such projects, while at the same time encouraging innovation in service delivery to improve outcomes."

The SIBs innovation

The hugely innovative factor in a SIB is not that it draws on government funding based on a programme contracted to deliver defined outcomes, as outcome-based payments have been in vogue for a while. It's rather that SIBs shift the risk of non-performance, and hence no payout, from the service provider to a group of investors. Many charities that would like to be service providers shy away from outcome-based contracts with local and central government precisely because they cannot afford to take the risk that they won't meet the outcome target and will end up massively out of pocket. Shifting the risk to a group of investors means that the charity gets paid regardless, as the service provider, and the investors end up losing their money if the project "fails".

The basic idea, as David explained, is to find an area such as repeat offending on release by short sentence prisoners, which costs the state significant and quantifiable sums, and to get government to agree to pay over part of the savings that will accrue to the state if interventions can be devised that will measurably improve outcomes.

He said: "SIBs have to start with an issue that... concerns a problem government is struggling to solve. The government then co-designs the solution with us and leaves it up to the special purpose body created to manage the SIB to decide how to deliver those outcomes."

By definition, there is much greater delegation and freedom for service providers to devise appropriate solutions than in a traditional contract where key performance indicators are defined in minute detail.

David admitted that defining a SIB contract is hard work, requiring a lot of research to establish acceptable baseline measurements to define outcomes, but Social Finance is now an expert in crafting SIB contracts and manages the contract between the government and the investor group.

So what are the incentives for foundations and others to become SIB investors?

Sara Llewellin, CEO of the Barrow Cadbury Trust, a founder investor in the Peterborough SIB, says there were several attractions.

"We are developing a social investment portfolio and a SIB, because it holds out the prospect of the capital being returned, allows us to use some of our capital, instead of just our investment income, to generate social benefit. On top of this, we have a long-standing commitment to work in the criminal justice system and to seek to improve rehabilitation rates. We have been grant funders of previous work done by the St Giles Trust, a service provider to the Peterborough SIB so that gave us confidence. Plus, we believe strongly in multi-agency working and collaborative ventures, and both are key to SIBs," Sara says.

The Barrow Cadbury Trust also liked the fact that it is the investors, rather than the charity, who take the risk of non-payment. "There are good reasons why charity trustees have been reluctant to enter into outcome-based contracts. It is much better for charities to deliver on a fee-for-services basis. We also think SIBs have great potential for getting central and local government to make funding available sooner for early intervention in what is in effect a redesign of service provision. That is very exciting for us," she comments.

Sara says that it is not that important for the Trust as an investor to get a return on its investment. As a grant funder it is used to dispensing money. "We think foundations in particular have expertise in measuring and delivering social value and one of our main reasons for being founder investors in the Peterborough SIB was to provide input into social design and service delivery," she comments.

However, Sara recognises that many investors in SIBs will be looking for a return, especially when SIBs become mainstream funding instruments. The real breakthrough with SIBs, she points out, will come when pension funds start participating. While SIBs are very specialised and, by definition, are only suited to areas where government can be persuaded that sufficient savings can be made if it pays for interventions, crowdfunding can accommodate a far greater range of charitable projects. By all accounts charities are still very much feeling their way as far as crowdfunding is concerned and results have been very mixed. Cancer Research UK has had more success than most charities. In mid-November, the charity took its first steps into crowdfunding, launching an appeal for donors to fund any or all of three specific research projects with donations of their choice.

According to Cancer Research, the new money will enable researchers to tackle whatever additional questions arise as a consequence of their work – particularly where tackling those questions would take the project outside the terms of the original funding.

"Research breeds research and as a project progresses new ideas emerge. Without a way to quickly inject new funding into scientifically solid ideas, these additional questions could be left hanging," the charity's pitch to donors says. So far, in just two months the charity has raised a reported £1m in crowdfunding.

Commissioned income

For most charities, however, both SIBs and crowdfunding are quite a long way from their present thinking. Douglas Parkhill, director of finance at the charity Missing People, is quite clear that they are not yet even on his horizon. He said: "You would never rule anything out, but we prefer to direct our attention to areas such as corporate funding, which has been a major source for us, plus some foundations and individual giving. Statutory funding has been more and more difficult to get, admittedly, but we continue to benefit from some quite reasonable European Union funding."

Generating income from providing services to local authorities and police forces is another very useful source for the charity. Douglas said: "In my view, looking for commissioned income, where you provide specific services to bodies such as local authorities, is very much the way that charities will have to move in the future. Our argument is that when someone goes missing, an organisation such as ours, with relatively low overheads and a high level of expertise, can provide a very cost-effective service to hard-pressed police and social services. We can offer services such as return-home interviews with the family after a child that has run away is returned to their home, and this can help eliminate further such episodes."

Douglas said that he and his colleagues deliberately diversified their income streams because they anticipated the current reductions in statutory funding. He said: "This is just good management, but it is very tough for a charity to do. Clearly, those charities that can anticipate the market and move in time are the ones that will thrive in future."

Adapt or pay the cost

Alan Eccles, partner with law firm Brodies, said: "Those [charities] who do not modernise and develop will be affected by the retrenchment that is sweeping around the world."

He said: "The moral of the story is: know what you are good at, focus on your purpose and ensure you can explain and articulate what you do to the wider public. Especially when it comes to funding applications, being able to articulate clearly what it is that the charity does tends to lead to further success and funding."

Alan pointed out that spinning off a commercial arm, or a social enterprise, for the right reasons, and with the right structure and governance, can be an excellent thing for a charity. "There are some elephant traps here so they need to understand the taxation and governance issues, and they need to ensure that the charity and its commercial or social enterprise arm are always going in the same direction," he said.

Retaining reserves

Adrienne Airlie, chief executive and head of charities at Martin Aitken & Co, pointed out that not-for-profit organisations often have difficulty retaining sufficient reserves. Many funders, she said, will scrutinise a charity's reserves and will refuse funding if they think the charity is too "cash rich". This short-sighted approach forces many charities into a continual crisis condition where they do not have sufficient reserves to tide them over any dip in their funding.

Adrienne convenes the ICAS Charities Committee and is keen to develop a dialogue between chartered accountants who work in charities and those who work in local government. She said: "We need local authorities to wake up to the fact that you cannot just keep squeezing and squeezing your suppliers when those suppliers are charities."

Alexis Graham, head of charities at Maclay Murray & Spens, said that the issue of charitable trusts, which the Office of the Scottish Charity Regulator (OSCR) consulted on in 2014, is going to be very important through 2015. Alexis said: "This is OSCR's first big change and with it OSCR seems to be moving more in line with the English Charity Commission. This with the new annual return puts the focus much more on governance and on how trustees are running their charities."

"The questions OSCR is asking trustees to declare as part of the return are simply good practice and enshrine the best principles of trust law. It is going to be very interesting to see what action OSCR takes on the feedback it gets from the next set of annual returns," she notes.

Gavin McEwan, partner and deputy head of charities with Turcan Connell, said that his team are seeing considerable interest from their larger charity clients in social investment. For smaller charities, however, this and crowdfunding are still very much unknown territory. Gavin argued that funding pressures will inevitably drive smaller charities towards crowdfunding.

He said: "Crafting a prospectus for a crowdfunding project requires a good deal of thought and skill and charities will need to draw on the expertise of their advisers."


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