221 – Ethical Investments:  Social Enterprise Impact Bonds

[00:00:06] Santiago: Hi, and welcome to the IDEMS podcast. I am Santiago Borio, an Impact Activation Fellow, and I’m here with David Stern, one of the founding directors of IDEMS.

Hi David.

[00:00:15] David: Hi Santiago. What are we discussing today?

[00:00:18] Santiago: I was about to ask you that because I believe you have a topic in mind.

[00:00:25] David: Okay, well, one of the possible topics is we did an episode a long time ago now on Fundamentally Profitable as part of how we think of IDEMS, and associated to that, we now in particular through Kate, have got our social enterprise impact bonds actually to the stage where we’re relaunching them.

And, yeah, it’s an interesting part of that same strategy and thinking about how we are looking for investment and looking for people to buy into us in a way which supports us as we grow, but is also giving a fair return on investment. So it fits in with our Fundamentally Profitable mindset and model and enables us to potentially grow to the next level.

[00:01:13] Santiago: Okay, let’s take a step back briefly. The episode on Fundamentally Profitable was quite a while ago, we did more recently an episode on two of our working principles, and if I’m not mistaken, Fundamentally Profitable is another one of our working principles. And it’s worth very briefly explaining what we mean, just so that it’s fresh in the audience mind.

[00:01:41] David: Well, we’re a not-for-profit social enterprise. As a social enterprise, we need to be profitable because otherwise we don’t continue to exist. But all of those profits get fed back in to the organisation, to our growth, to the impact we’re trying to achieve. So, it’s not to maximise profit, but if we’re not in profit, then we can’t sustain ourselves, we’re not sustainable, we can’t grow. We have to grow, in our minds, by being profitable.

And this is challenging, especially when we come to thinking about development, software development, we need to invest to be able to build the products that can go out. And much of the technology development that happens doesn’t happen in profit, it happens where you get investment on the expectation of future growth, future profit. And so that question of how we balance these two is really critical.

[00:02:44] Santiago: And a lot of software development companies have huge teams, and it’s quite expensive to develop software. We have a fairly small team, so it’s high investment relative to the size of the team that we have and with really long-term views of return for investment.

[00:03:10] David: Exactly. And so balancing that in, and the fact that recognising to get the sort of professional software we are aiming towards, we are going to need those bigger teams, and therefore at times we will need to be able to invest and actually have funding which enables us to have that directed growth towards product. That’s something which is going to be part of the mix that we are gonna need in the future.

But doing so in a way where the organisation is not at risk, one of the things which the venture model is all about is that you actually put a lot of money in and you still have a high probability of failure. And that’s what we don’t want to do. We want to actually build in this sort of model where we are pretty confident of success because, not necessarily that we’ll get explosive growth or explosive success, but we’ll be able to build things in a way which is, well, fundamentally profitable.

So there’s needs, there’s identified demands, there’s identified next steps. Eventually we may build the things which then do get to the explosive growth, that is definitely something we are wanting to work towards, but we are not wanting to do it in a way which puts the organisation as a whole at risk.

[00:04:28] Santiago: Yeah, and there’s another bit of context that I think it’s important to remind the audience about, which is in IDEMS’ structures and how IDEMS was set up, which is that we cannot look for finance through issuing stocks. That’s part of the statutes that we have and there’s good reasons for that, which I believe we discussed in one of the earliest episodes.

But I think it’s important to understand that the usual or standard model for a lot of software companies is this is going to be a product that brings a heck of a lot of revenue, invest now and you cash in through your stocks in this company. And that’s not something we can do, and we chose not to do it, well, you and Danny chose not to do it.

[00:05:32] David: Absolutely, and this comes at a cost. In some sense, you have to build in an extractive model to such companies because the technology needs to recover, the enormous investment that was made and bring a return for those investors.

Whereas the approach that we’re doing, we do need to be profitable, we need to, we want to scale in a way which is profitable, but we can afford to do so in ways which don’t maximise profit for shareholders because we don’t have shareholders. And so that’s an important balance which is there.

But to be able to get to the scale where we can build software in this way, which is competitive, which is really professional, we are going to need to scale, we’re going to need to grow. And to do that, we’re trying to put in place the structures where there may be other ways of attracting funds. I mean, it is not impossible in the future that we have a subsidiary or something where people can buy equity or where we have a different form of investment, which enables people to be more speculative.

But that’s not where we’re at now. Where we’re at now is we need to be able to get, essentially, a reserve, which enables us to take small steps in consistent ways towards directed investments in things which are strategic, to be more strategic as a company.

[00:06:59] Santiago: Yes. And a lot of our funding has come out of direct contracts, or in some cases loans, and even grants.

[00:07:12] David: Not so much. We have had loans which have helped us with our cashflow in the past, and we’ve been able to take them and pay them back, and that’s been something which has given us confidence in our approach. So we do have a track record of taking on loans and paying them back over time. But we have been built as an organisation on combination of contracts and grants.

But I should be clear, the grants that we get are not for IDEMS, they’re for specific pieces of work that IDEMS does, which is an important distinction. We have as an organisation, not received grants for our core structures, yet. That is something which we are thinking about, where we are thinking about trying to present this in ways where we could get support because, actually, that core structure is something which we believe is presenting a new approach.

But at the moment, we get contracts and grants to do collaborative work with others. That’s broadly the heart of our work. And a lot of that has led to us developing technologies. And we’ve been developing technologies to do that. This part of the transition that we envisage for the organisation over the next five, ten years is that we expect those technologies that we develop to actually hit the market, so to speak.

[00:08:38] Santiago: Yeah, and we also discussed our general business model, the three part business model, in one of the earlier episodes, where we develop public goods, that is the software that we are developing, it tends to be open source, that is the public good, we have the human services, which is these collaborations with other people, but what we want to get to is to have the software in such a way where we can start offering digital services, which is what will bring more revenue and sustainability to the company. 

[00:09:16] David: And it’s interesting that our digital services, these might be, you know, SaaS services, Software as a Service, they might be any number hosting services, there could be any number of services which were attached to, not just the open source software that we develop. But what we’re recognising more and more is that these coherent combinations of open source software put together into wholes for communities, and defining those communities, and serving them with a coherent software package or set of software packages based on open technologies, and maybe some non-open technologies as well, is at the heart of what we envisage moving towards as we move forward as part of the services we offer.

[00:10:04] Santiago: I think as well individual components that are required for others to be able to use specific software. So one example of that would be, in order to use STACK, you need to have a Maxima installation, Maxima’s a computer algebra system that STACK relies on. So some people struggle, some organisations struggle to get that Maxima installation, but it can be hosted externally, and we are offering that service to a few institutions that would have all the infrastructure required except for that little bit that is stopping them from exploiting STACK as a technology.

[00:10:48] David: This is a really important piece of the puzzle that we keep coming up against, what partners need are these coherent, easy, comprehensive solutions. But the open source world is all set up around specific, specialized, often very powerful, expert components. And there’s a slight mismatch then in certain cases between the needs of the users and what is actually being produced.

So more and more what we’re seeing as a role for ourselves in the future is bridging that gap for specific communities.

[00:11:27] Santiago: Okay.

So we went through a lot so far, a bit of why we need investment, where we get investment from, where we’re trying to get to. I think that we need to move on to how we are hoping to raise the funds that we need.

[00:11:49] David: Well, it is this idea that there’s lots of different services that are needed out there, and one of them that people need are financial services. Savings, at the moment if you have savings and you put them into a bank, you can get a fixed term savings account, which over a five, six year time period, you put your money away and you get four point something percent if you are lucky in the UK at the moment, a year. And it’s a very sensible thing to do, and it’s guaranteed by the banking regulation, the banking industry, and it’s safe.

You could also put your money into stocks and shares and these sorts of things, and then you might get more return on investment, but you might also lose it. And that’s also well established. But in both of these cases, what’s not so clear is, is what you are doing being used for social impact?

And there are things where you can make choices and choose to invest in, let’s say renewable energies or things like that. And that is something where, again, there are more and more funds which are trying to move in that direction. And you know, we are not a bank, we’re not in a banking industry, and we do have access to funds and loans, really good bank for us has been the Charity Aid Foundation, who we’ve taken a loan from, we took a cashflow loan from them a couple of years ago and we’ve now basically paid that off, and we are now in discussions with them about, well, if we were to look for investment, could we do this with them?

And what we found is that with them, we could get 5.5%. Now as you can think, there’s a slight difference and it’s not a huge difference between the four point something percent that you could get from the banks and the 5.5% we can get on a loan.

We believe that if we can offer that 5.5%, it isn’t as secure, it requires for us as an organisation not to go bankrupt and we have no intention of going bankrupt, that’s where this Fundamentally Profitable comes in. We are trying to build in a way which is secure and safe. So this isn’t like venture capital where there is a high chance of failure, but when you succeed, you get a huge return.

We are trying to be as safe and as stable as we can as a social enterprise in an unpredictable world. But we can offer the same terms that we could get a loan for to individuals. And if you are an individual who is sort of doing okay and is looking to put away 2000, 10,000, 20,000, that sort of order of magnitude for five to six years, and you want to do so in a way which is socially impactful, we think we could offer that as a service.

Now at the moment, this is for individuals. If we got much bigger, then think about this if you’ve got a pension pot, or if you are something like a foundation, or you’re a university college who has a endowment and you need to then use the interest of that endowment to run your activities.

That’s a model where there is a need for them to make ethical, they don’t need to get huge returns on investment, but they need to have relatively safe returns on investment. That’s what I’d love us to be working towards, to get to that place of being able to be a trusted partner, able to give safe, stable returns on really ethical projects, things which are gonna have high social impact, but which provide a genuine service for investors. 

[00:15:27] Santiago: And correct me if I’m wrong, but that service specifically is issuing bonds.

[00:15:35] David: Yeah, what we call Social Enterprise Impact Bonds. And these are, if you want, they’re loan notes. So instead of the bank making a loan to us, individuals can buy the bonds, they’re not yet transferable, they’re not yet tradable, but they’re issued as legal documents.

We had a set of lawyers who produced a huge legal document for us, which we’ve gone through and we’ve made sure we’re happy with, we’ve put in extra clauses to say that if for whatever reason you need to come back early, we will do our best not to penalise you for wanting to withdraw earlier and accommodate that if possible, even though the legal requirement is that it’s a long-term bond.

But these are things where we want this to be something which serves the people who are investing in us so that this becomes something which is genuinely mutually beneficial. We recognise that right now I would not want people to be investing in us if their future depends on this investment. That’s not what we are looking for. We’re not looking to be managing people’s pensions pots at this time, we don’t want that responsibility.

But if you have something, you know, an amount where you can afford to take a little bit of risk, because who knows what the future will bring, but take that little bit of risk, but in exchange for something which is highly ethical, where it’s going to enable, we believe, really substantial social impact, with an amount which you can afford, I believe this should be attractive.

And we have colleagues who have already invested in this way, we’ve got sort of 30 to 40%, no, it’s actually, I think closer to 40%, of the amount that we are looking for already. We’re now looking to get the other two thirds.

[00:17:23] Santiago: What does that amount to?

[00:17:26] David: So that amounts to a third of our turnover from last year. So this is how it’s currently calculated, we are wanting to issue bonds, we actually think that it may be sensible to go up to 50% of our turnover in the long run, but right now a third of our turnover is what we are comfortable that’s an amount which is not going to destabilise us, it’s not gonna put us in difficulty to repay, it’s a very safe amount and it will enable our cash flow and broadly corresponds to the fact that many of our contracts are paid in arrears four months afterwards, which is a third of a year afterwards.

So it’s sort of like having a third of our turnover upfront, which we are then able to use for cashflow. That’s really at the heart of what this is conceived. That is where, in other contexts, thinking of it as six months of the cash flow would be sensible.

[00:18:21] Santiago: And cash flow, for transparency’s sake, has been a challenge for IDEMS.

[00:18:27] David: Absolutely, it’s been a nightmare to be honest. It’s something where, in our early years, we made some conscious decisions to prioritise growth over building up of reserves. And that was good, but we ran our luck a bit. And then our luck ran out a couple of years ago, and I think we’ve written about this in our end of year reports for 2023, which was the first year where we made a loss.

And we really had struggles and we are very grateful to the Charity Aid Foundation that actually provided us a loan, a cashflow loan, which helped us through that difficult period and got us back on our feet. We were back in the black last year in 2024. But cashflow has remained a real challenge and it’s holding us back because we are needing to invest in, you know, even just the next steps of recruiting people to have them ready for the upcoming projects, but also being able to write the grant applications in other areas, and be ready for future areas, and just manage our cashflow without always being on edge. 

[00:19:38] Santiago: And also get other levels of expertise, or other areas of expertise. I’m working a lot with Kate on trying to develop a strategy for commercialisation of some of our STACK work, and neither one of us is specialist on that area, so we’re doing our best and I think we’re making very good progress, and we have support structures and feedback mechanisms from external colleagues and supporters. But still being able to actually build a commercial team, or a communications team. 

[00:20:18] David: And make that as a strategic investment because we have the leeway in terms of our cashflow to see, well, okay, this will bring a return on investment three, six months down the line, we can make that because our cashflow gives us that. This is exactly where, at the moment, we are more constrained than we would like to be in some of these decision makings.

And it’s not just that it’s constraining, it’s that it’s holding us back from opportunities that we see where we’d like to be running, and instead we’re at a slight crawl.

[00:20:52] Santiago: Okay. Well, David, we’re running out of time, so, any final key information that listeners might need to know about this?

[00:21:02] David: Well, I mean, it’s something where we believe, done right, this is something which is a potential win-win for many people who are comfortably off, who have enough, but would like to invest a small amount in a meaningful way, which will be socially impactful, and give them a sensible return on investment.

I guess the last thing I’d like to say is that, even if you are not able to or wanting to invest right now, but you are interested in this thinking, this is something where we’d love to engage in this. This is something we see as being a really important shift, a really important counterbalance to some of what’s out there in terms of particularly venture funding, where, oh, you are hoping you’re gonna make it, it is gonna suddenly explode and you’re gonna make it big. Whereas the failure rates are also quite high.

We feel that this is a genuine different approach to building technology, to being able to provide investment in such a way that it helps a, well, I suppose what we hope for is a more socially impactful growth and entrepreneurial growth.

[00:22:20] Santiago: Well, thank you very much, David.

[00:22:23] David: Thank you. It’s been good to discuss this.