Introduction

Commingling funds combine philanthropic with commercial capital. While they vary in terms of the target social outcomes and the way they are structured, they share several attributes: all commingling funds are designed to achieve a financial return alongside a clear social impact, and to use their governance structure to define and protect the fund’s social mission. For this reason, they can appeal to both philanthropic and more commercially sensitive investors. 

Philanthropic investors like trusts and foundations are using commingling funds to explore their distinctive role as investors. These funds enable foundations to leverage commercial capital that might not otherwise be invested for a social purpose by providing cornerstone investments and taking different risk positions. This allows the funds to achieve social outcomes at scale and address entrenched social problems that require large investment. 

Commingling funds are typically structured in one of three ways, differentiated by the way in which philanthropic capital helps leverage commercial investment into the fund:

• Pari passu (literally “on equal footing”): In these funds, all parties invest on the same terms, taking the same risk in expectation of the same financial return. Philanthropic investors can act as principal investors in a fund, sometimes providing a cornerstone investment. In so doing, they give confidence to others to invest and so leverage investment from more commercial investors. 
• Risk-reward: Investors take on different risk according to their motivation. Those with a focus on achieving social impact take a higher risk position in the fund but receive a greater proportion of any financial returns. This reduces the investment risk for more commercially focused investors who receive a lower proportion of any financial returns.
• But-for (the commercial investors would not follow “but-for” foundations): Like risk-reward funds, investors also enter but-for funds on differential terms according to their motivations. Foundations and other impact-focused investors take a subordinate position in the fund, which means they accept a higher level of risk for a smaller proportion of any financial returns. They do this to attract commercially focused capital that otherwise would not be invested, and so create a fund to tackle an issue at a scale that otherwise could not be achieved.

In addition, commingling funds are a platform to share knowledge and skills. For example, the Gatsby Foundation invested directly into the African Agricultural Capital Fund and used its networks, knowledge and experience of investing in East Africa to attract major partners to the project, including J.P. Morgan and the Bill & Melinda Gates Foundation. In this case, the commercial investors are not only a co-investor of funds, but also a “knowledge partner” in investing in a new field.

Setting Up a Commingling Fund 

By convening both capital and expertise, commingling funds play an important role in building social investment marketplaces. However, establishing a commingling fund can be costly and time-consuming due to the complications of establishing new structures in a nascent market, and the professional and legal costs which inevitably accrue. Commingling funds are often bespoke structures, being developed without the possibility of using templates as reference points. This can add an additional layer of time and cost to the development process. 

For organizations thinking about setting up a commingling fund, the following four guidance points could be useful: 

Guidance point 1: Build an economic case for the fund 

Any investment fund needs to develop an economic case, whereby an assessment is made of the types of investments the fund will make and the expected returns. This analysis will ultimately determine how the fund is designed, in terms of whether a fund has a pari passu, risk-reward or but-for terms structure. Structuring a fund that has different investor “layers” is only necessary if one group of investors would not otherwise invest in the structure. Where a layered structure is chosen, however, it is essential to consider the fiduciary responsibilities of any charitable investors in the fund. In the UK, for example, any private benefits accrued as a result of charitable activity can only be “necessary and incidental” to furthering the charity’s objectives. Trusts and foundations must be able to justify the necessity of taking higher risk or subordinate positions in funds to leverage capital that otherwise would not be invested in the space. 

Guidance point 2: Develop an investee pipeline 

A key consideration for any organization looking to establish a commingling fund is the capacity of its potential investees to take on investment capital. Even in sectors with a robust investee pipeline, some investees may require business support and guidance to become investment-ready. 

For this reason, some funds have technical assistance facilities for the kind of activity that the UK Cabinet Office’s Investment and Contract Readiness Fund³⁶ carries out. These facilities, built alongside the fund, can help ensure that the fund has a strong pipeline of opportunities for investment. The facility attached to the African Agricultural Capital Fund (and funded by the United States Agency for International Development) is a good example of this in action. This facility provides investees with agricultural expertise and business and finance training to help sustain and improve their operation and commercial viability. 

Guidance point 3: Create a governance structure that hardwires the social outcome 

A key draw for social investors is ensuring that the social outcomes they seek are hardwired into the design of the fund to avoid mission drift. Based on our research, this is usually achieved through a fund’s investment policy and governance structure. For example, the investment policy of the Bridges Social Entrepreneurs Fund³⁷ states that the fund can only invest in social enterprises with a clear social mission protected in their legal structures. The fund’s investment committee is therefore obligated to consider only investees that meet this criterion.

Measuring impact is equally important and can be done in different ways. The New York City Acquisition Fund,³⁸ for example, is able to measure its impact through the number of affordable housing units it creates or preserves, while the Big Issue Invest Social Enterprise Investment Fund³⁹ assesses social impact by using a performance measurement system developed in cooperation with Investing for Good, an impact investment advisory firm. 

Guidance point 4: Choose a legal structure that can accommodate different classes of investors

Determining which legal structure is appropriate for a fund is an essential part of the fund-structuring process. In the UK, a number of commingling funds use an English limited partnership. While this is not the only legal form that UK funds can adopt (commingling funds could use a limited liability partnership structure, for instance), a limited partnership is attractive because it is a versatile entity well understood and recognized by a wide range of investors. It can also have flexible profit-sharing arrangements and could therefore be well suited to accommodate the different economic entitlements of different investor classes.

Where Next?

The cost of setting up a commingling structure can, in some instances, make it difficult to justify the economic case for a fund. Governments, however, can play a role in making it cheaper and easier to establish commingling funds. 

The UK government has been working to establish a pilot commingling fund to test the barriers to creating these structures and establish what levers government has to break them down. It recognizes the value of commingling as a tool to generate social outcomes and hopes the guidance points set out above, and the lessons learned from the pilot process, will encourage others to follow its lead.