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Brian Kenny: This time on "The Business," the man known as "the father of venture capital" and his newest venture. I'm Brian Kenny and this is "The Business," the official podcast of the Harvard Business School.
In 1956, Ronald Cohen was an 11-year-old boy living in Cairo, Egypt. It was a turbulent time in the region. Britain, France, and Israel were battling Egypt for control of the Suez Canal. The Cohen family decided that it was no longer safe for them in Cairo. So they packed one bag each, and a small stash of money, and became refugees. Cohen's mother was British, so the family headed to London. They started their lives from scratch. Young Ronald didn't speak a word of English.
Fast-forward to today. Ronald Cohen is now "Sir" Ronald, knighted by the Queen of England for his "services to the venture capital industry." In fact, he's one of the titans of private equity. He co-founded Apax Partners, a global venture capital and private equity firm, which has had a string of winning investments, including Waterstones, Virgin Radio, AOL, and the cloning of Dolly the Sheep. Now, Sir Ronald has turned his laser-like focus on investing to the not-for-profit sector and the practice of “social impact investing”-- doing well by doing good. When he came to our studio, he said it's an idea whose time has come.
Sir Ronald Cohen: If in the 19th century, people spoke in terms of financial return alone, and the 20th century we brought the dimension of risk and return, in the 21st century, we've already brought the third dimension of impact. So risk, return, and impact is what it's going to be about.
BK: And that means private investment in areas that have long been overlooked and underfunded: preventing health care epidemics, providing schooling for girls in developing countries, and promoting ideas to keep former prisoners from re-offending and being thrown back into jail.
Sir Ronald is the chairman of the Social Investment Task Force, which was formed by the G-8 countries. Last fall, the Task Force released a report that found, among other things, that "the financial crash of 2008 highlighted the need for a renewed effort to ensure that finance helps build a healthy society."
So we started off our discussion with Sir Ronald Cohen by asking for his definition of social impact investing.
SRC: Social impact investing is seeking to achieve a social objective as well as a financial return at the same time, and to measure both. The concept, of course, has existed forever: that you can invest and achieve good. But that would be called investment with impact, in our terms. Impact investment is when you set out an objective that is just as important as the financial one, but is a social one (social, for us, includes environmental) and you seek to achieve both. And what it does is it gives the key to the capital markets to social entrepreneurs by linking the achievement of a social return to a financial return. So it's actually very significant for the funding of not-for-profits, just as it’s significant for the funding of social entrepreneurs who want profit-with-purpose businesses, and to lock-in a social mission, and set social objectives for for-profit businesses. It's a huge change of mindset, but it is an idea, in my view, whose time has come, and I see a lot of evidence of that through the work of the task force.
BK: Tell me about some of the evidence that you’ve seen. What's driving the change?
SRC: What we're beginning to realize is that you can measure social performance. And in the U.K., for instance, the government has put on the web (and you can access it by going to the Cabinet Office site) the cost of 640 social issues. It costs £63,000 pounds, $100,000 a year, for a kid to be in care because of problems at home. It costs £22,000 a year for a reoffender to go back and be kept in jail. It's about $30,000. And this is evidence of the fact that government has realized that if you begin to put these figures out, if you begin to calculate them, it begins to create a market for dealing with them. So if you're a not-for-profit dealing with young reoffenders, and your cost of intervention to prevent somebody from going back to jail within 18 months of release (which is what happens in two-thirds of cases around the world) is a third of the cost of the government, clearly there's an opportunity to help these young people lead better lives, save money for the government, and remunerate the organization that's doing the work, which is often a not-for-profit, as well as the investors who put the money up. And because government is transferring the risk to the investor, and paying only for success, you open the gates to innovation. Previously, if government commissioned a service, it would stipulate what is going to be delivered for the money it's going to be paying.
SRC: But here it agrees on what success is going to mean, it measures it, it compares it often with a control group, and it pays out following verification by accounting firms and others, only if success has been achieved. From the point of view of the organization actually delivering the service, it has absolutely no constraint on the way in which it approaches the issue. It can innovate in any way that it believes is fit. And the investors then have the choice of picking a social entrepreneur to try and help reoffenders, or young girls who drop out of school in Rajasthan, or pre-diabetics across the world. Israel is putting together a Type-2 diabetes prevention bond on the Israeli or on the Palestinian side, but also across the whole of the Middle East, and across the whole of Asia, not to mention the United States and Europe. Diabetes is an epidemic now. So you can begin to innovate if you're motivated to help others.
BK: It sounds too good to be true. But, in fact, you give examples in the report of where this is actually happening. Let's talk about the recidivism one that you mentioned, and the experiment that's happening in Peterborough, England.
SRC: Yes, so the very first social impact bond to be developed was launched in 2010. I'm very proud to have set up the organization that has developed and launched it and to be involved in its launch. The results have been measured, and the government will end up paying investors between 6% and 7% in all probability, given the results which have been achieved. But more importantly, hundreds of young people who previously would have been left at the gate with £42 in their pocket, $60, which was insufficient to make it to the first government payment, now have some form of training, some place to live, a way to sustain themselves until they get their first check from the government, and the prospect of staying in work, and getting psychological support to achieve that.
BK: Do you have the numbers on what the recidivism rate dropped to once this program was put into place?
SRC: So, there has been an improvement to the order of 20% relative to people in the country who have not had this type of help. A real, measurable impact.
BK: And the money that was used, you mentioned social impact bonds; I'd like you to define that in a moment. But the money from the sale of those bonds was put into buying the kinds of support services that the prisoners need.
SRC: Yes, so the money went--it was £5 million ($8 million), which went to fund three or four organizations that were working with prisoners. So far as the prisoner is concerned, he or she is dealing with one organization that is trying to help and which has a philanthropic motive in helping (rather than a profit motive), which makes a big difference in the psychology of prisoners. Now, when you begin to put a big sum of money like that, £5 million up front, it's no different than starting a new tech company, you know? A £5 million investment is a significant amount of money. If you compare that with what happens with philanthropy typically, and I'm sure you and I are in the same place, we've given money to a lot of organizations doing charitable work, and we've said to them, “We'll give you money for a year or two. After that, please go raise money from somebody else, and please don’t spend any money on your overheads.” And the reason we've done that, if you think about it, is because nothing was measured. We couldn’t tell whether they were doing a good job or not.
BK: Right, it was a good cause, but you didn’t know.
SRC: You didn’t know. The watershed really came in 2010 when we realized that you could do this with recidivism. We at Social Finance realized that this must apply in many more areas than recidivism alone. Lots of people said, “well, it'll only be recidivism because the police have the information on their computers.” But actually, there are 26 social impact bonds across the world. They cover a dozen social issues, including homelessness, adoption, foster parentage, teenage unemployment, and dropout rates for school for girls in Rajasthan. Chicago just announced a $17 million social impact bond to deal with four-year-old children who come from less privileged backgrounds, to make sure they get the sort of training that's going to help them stay in school. So you're beginning to realize that, while not everything that counts can be counted, there are many things that can be counted, can be measured. And to the extent that you can measure, you can link it to a financial return and you can raise capital for it.
BK: Can you make as good a return on a social impact bond as you can if you were investing in other types of organizations?
SRC: You can on a risk-adjusted basis. What do I mean by that? These are investments that are capturing a new set of opportunities. So if you get a 7% return from improving literacy in Africa, or preventing people from getting diabetes? These are not investment returns that go up and down with the stock market, or even with interest rates, because there's a wide band of interest rates according to the success which is achieved. So, effectively, it gives you diversification in your portfolio. Social impact bonds and development impact bonds are what are being categorized today as absolute return instruments, which is what everybody is looking for.
BK: It takes an ecosystem to make this work. Do you have to build that ecosystem with each one of these?
SRC: Governments have begun to do that. In the U.K., we already have tax incentives for investing in social impact bonds. As I've mentioned, we already have information on the web about the cost of social issues. The Law Commission has already looked at the fiduciary duties of the trustees of foundations and said, “You know, you’ve got an obligation to achieve an acceptable return.” But that doesn’t say just financial. It's financial and social return. So, you're beginning to change the ecosystem to enable impact investment to get to scale.
BK: So that can work in places where there's a solid infrastructure, and there's a functioning government. A lot of the change that needs to happen has to happen in parts of the world where that doesn’t exist. Do you see it moving in that direction? Do you see the opportunity for that to become maybe the next phase of this?
SRC: When you look at developing countries, they have been dependent on aid for a period of time. Now remittances are much more important than aid. They're four or five times, perhaps, the size of official aid. Direct investment is probably two or three times official aid. And there's a real opportunity for governments to begin to use their official aid through instruments like development impact bonds. So if you want to help literacy, are you better off just giving grants to non-governmental organizations, NGOs as they're called, or are you better off creating a development impact bond where certain governments would pay when certain improvements have been achieved in the level of literacy? The answer is, of course, that if you're backing social entrepreneurs to achieve an improvement in literacy, you stand a much better chance than if you're just giving grants to people.
BK: Of course.
SRC: Because you begin to focus on an objective and when you focus on an objective, you wake up in the morning wondering how you're going to achieve it, and you go to bed at night worried about the fact that you might not. That releases tremendous innovation and energy. So I believe that in the area of international development, we're going to find enlightened governments in Africa, and Asia, and elsewhere, that begin to prioritize areas where impact investment can really help them. And I think those areas are going to be areas like literacy, like sickness. There's already a sleeping sickness development impact bond that is being worked on in Uganda. There's a malaria social impact bond being worked on in Mozambique. There's an attainment level on a school social impact bond or development impact bond that's being worked on in Rwanda. The difference between one and the other, by the way, is that a social impact bond is typically paid for by a government. A development impact bond has an outcomes payer, a development organization of a government or a foundation, you know, or even a corporation.
BK: Right. You’ve mentioned entrepreneurship a number of times. At Harvard Business School, we've certainly seen a change in the last five or six years, with the students coming in having much more of an entrepreneurial mindset and seeming much more focused on starting ventures right as they graduate versus what used to be the pattern, which is they would wait 10 or 15 years before they started to step in to entrepreneurial pursuits. How important is that spirit of innovation, and that courage, frankly, to take risk, to the success of this?
SRC: When I spoke in 2010 to the graduating class of the business school, I said to them that when I had been here (I graduated in '69 from the B-school) the big thing in the air was small companies. And in those days, everybody thought that only big companies could bring great technological breakthroughs. Everybody thought if you wanted to do that, you went to IBM. Now, look how much the world has changed, where you’ve got a number of companies that are less than 25 years old, roughly, that have overtaken the IBMs of this world. The next big thing is social entrepreneurship and investment in my view, and it reflects itself here at the B-school in the number of students who are taking social entrepreneur courses of one kind or another. It reflects itself in the number of people who come to see me. Every day, I see young people who say to me, “You know, I want to do something that has more meaning than just making money.” After all, the characteristic of a bright, young person is to want to change the world. And just as we developed venture capital as a response to the needs of startups and young companies that wanted to take risk to achieve technological innovation then, so, today, impact investment is a response to the needs of social entrepreneurs to have risk capital to change the world for the better.
BK: That gets to my next question, which is what would you say to the cynic out there who says, “This is just a bunch of feel-good stuff, you can't succeed at this”?
SRC: I would say the same thing as I said when people said to me, “this is all hopelessly optimistic, new company startups led by dropouts are going to overtake IBM. It's crazy.” Well, it didn’t prove to be crazy, and this isn't going to prove to be crazy either.
BK: Sir Ronald Cohen, thank you for joining us.
SRC: Thank you.
BK: Sir Ronald Cohen is one of the co-founders of the global equity firm Apax Partners.
A heads up to HBS and potential HBS students out there-- Sir Ronald spoke at the Harvard Business School campus last year and told students that if he were graduating today, he would launch a career in social impact investing. So, if you didn't hear it there on campus, you heard it here on "The Business."
Join us again in two weeks for our next podcast. In the meantime, check out all our archives by going to our website. And tweet us anytime to comment and ask questions for future guests on "The Business." Our Twitter handle is @HarvardHBS. And don't forget to subscribe to "The Business" on iTunesU and follow us on SoundCloud.
Thanks for listening.