Government and Financial Innovation: Putting their Tax Policies where their Mouth Is

Who likes to pay taxes? Anyone? Anyone? Bueller? Yeah, I didn't think so. But the fact is taxes pave our roads, defend our borders, and educate our children. Despite the many benefits we still have a strong aversion to paying any more than we have to pay. This creates murky waters for social enterprises that are looking for investors yet do not fall clearly into the US tax code as either a for-profit or non-profit.

This week our class focused on capitalization vehicles as well as measurement techniques for social enterprises. The ambiguity of social innovations and tax code structure often leads to investors putting their money into either for-profit investments or donating to charity leaving social innovations in the dust.

What to do about this quandary? In the article "The Funding Gap", Michael Chertok, Jeff Hamaoui, and Eliot Jamison talk about the massive effect government's have when it come to shaping individual's investment habits. The United Kingdom took the lead in 2005 by creating a category called the Community Interest Company (CIC) .

CIC's operate as a non-profit / for-profit hybrid that is legally bound to benefit the community and not just churn a profit. According to the CIC Annual Report the UK approved applications for 1,296 CIC's for fiscal year 2009-10. The UK has a population of about 61.5 million people. It could be argued that if the US had a similar tax code that 6,469 CIC's would have been approved based on population considerations.

Imagine how much money would flood into the social enterprise arena with a CIC code!! Hope Consulting estimated that the United States has a $120 billion market demand for investments that also serve a social purpose. (Read more about this in their May 2010 study " Money for Good ") A tax code similar to the UK's CIC would be a good start in actualizing that $120 billion potential.

Leveraging the tax codes is just one step in convincing potential funders to invest. Savy investors want metrics showing the effect of their investment. Here were not just talking about ROI, we're talking social impact. There are numerous suggestions on how to measure social value. Ted London at the Ross School of Business at the University of Michigan has published in the Harvard Business Review about considering how a social venture changes an areas Economics, Capabilities, and Relationships for Sellers, Buyers, and Communities. The Acumen Fund has produced metrics to help value a social venture. However, it will take time and collaboration before a tested set of best practices are adopted widely by the community.

If you were deciding to invest in a social venture what metrics would motivate you to invest? As a graduate student, I will be working to get out of debt for years to come. However, I am attracted to investments that have sound financial stability with a history of R&D investment. I would be looking for the GE of social innovation, but maybe that's me as a risk averse investor unsavvy investor. I would expect that the managers of VC firms focusing on social impact would be attracted to much different criteria than myself. We do have one thing in common though. Neither of us want to see our dollars go to waste, but rather fuel the development of ventures that seek to better the world.