The following is a tongue-in-cheek response to Rod Schwartz's blog on the great social enterprise lie.

Whenever the supply of capital in the social investment market is discussed someone proclaims that "what investors really need is not high risk investment but reasonably/fairly priced guaranteed returns". This statement is normally met with nods all around, but it is highly misleading.

It is true that many social investors cannot provide investment in the form of risk capital. Their fund structures preclude investing at genuine risk. What many therefore want to provide is debt with either a high interest rate or a guaranteed level of return. Anything less than 5% is considered pathetic and beyond the pale. Social enterprises offering such "measly rates of return" are cited as evidence that the fluffy values of the social sector are too soft for our beloved commercial sector.

This is unfair. Most social enterprises are happy to pay a return that leaves them a modest surplus and takes into account the risk which the investor takes. It is in this latter aspect where the problem lies. Social investors (SIs) seem ignorant/unaware of or indifferent to the low risk of failure or refuse to recognise that this is a necessary part of the calculation of a fair rate of return. Social enterprises do fail, especially early-stage social enterprises, but research suggests the risk is lower than with conventional enterprises, and social investors need to adjust for this if they are to become affordable.

The fact is that for most social enterprises the likelihood of failure is very low so the required rate of return to compensate makes the cost of the investment currently offered by social investors really high, if not downright "Wonga-like". In conventional markets this low risk is matched by the expectation of modest returns, but typically such investments are structured as debt and not risk capital, and the return is only realised when the enterprise repays gradually over time - not possible for many impatient social investors. Secured debt, where the return on a debt instrument is guaranteed whatever the success of the social enterprise, is one answer, but we have found that successful social investors can feel they missed a trick, because investees’ growth makes the return to investors seem low, after the fact. They quickly forget that if things had not worked out the investor would still have seen a return, and the investee would have lost the asset or income against which the investment was secured (up to 100%).

Thus what we believe SIs are really looking for is investments which to an investor gives them "debt-like" security, but at a price that matches what the highest quality investors get for equity in the financial markets. Perfectly reasonable to WANT this; quite different to EXPECT a price which does not reflect underlying risks. Social enterprises agreeing to take on capital at this "wrong" price are playing a valuable role but this isn’t really affordable. For this to become affordable, investors’ capital base does not need to be subsidised by some party valuing the social impact generated by the SEs (Government, foundations or wealthy angels being the most likely candidates). Investors’ understanding of risk simply needs to be enhanced. Finding pots and blending them into the mix to facilitate transactions is not the key to social finance. Being clear and honest about what is really going on is vital.