Another social entrepreneur burned by the Dragons

This week’s episode of Dragons Den – my second favourite TV show after Mary Queen of Shops – saw another social enterprise pitch elicit a mixture rage and confusion in the BBC’s lair of venture capitalism. The Dragons generally say no to social enterprise but the reasons for this week’s rejection were more interesting than previous snubs.

Sculptor Richard Austin was asking for an equity investment in a private company selling his ‘Sculpta-face kits’ which would put its profits into a sister-organisation, a CIC delivering sculpture workshops for community groups and disadvantaged people. Social Enterprise magazine reports that:

“… the Dragons became heated when they heard his idea, saying there was a conflict of interest. Duncan Bannatyne became so angry he stormed out of the room and Peter Jones said the private company would ‘exploit’ the social enterprise. Only Deborah Meaden said Austin had made the right move, but declined to invest. Austin left the den with nothing.”

Explaining his reasoning, Austin said:

“Funding workshop leaders was difficult, so I was advised to retail the kit. Because the CIC is not for profit, I was advised to set up another company, the profits of which would filter into the CIC. I’m just a sculptor. If someone gives me business advice, I take it.”

Mr Austin’s experience reinforces my longheld view that rather than taking generalist business advice – particularly state-funded generalist business advice – at face value, we should instead ask these advisers a slightly adapted version of a series of questions famously asked by Tony Benn of powerful people: What practically relevant experience have you got? Where did you get it from? In whose interests do you exercise it? To whom are you accountable? And how can we get rid of you?

There is a vaguely logical general case for the hybrid business structure that Mr Austin was advised to put in place – a social entrepreneur needs equity finance to fund their trading activity and doesn’t want to set up a charity to spend the profits because the need for a volunteer board would compromise their independence so sets up a CIC Limited-by-Guarantee to spend the trading profits (that aren’t paid to investors) and to bid for small grants.

Where the logic break’s down is where you apply it to the situation that Mr Austin is in and the actual approach that he wants to take.

Problems include:

1. Mr Austin apparently doesn’t want to apply for grants and as there’s no tax benefits to running a CIC it’s not clear how it’s practically useful to him

But more importantly:

2. The whole issue of a for-profit company working closely with a not-for-profit company is very different when the two companies are very small businesses run by the same person.

To avoid the possibility of the problem that Peter Jones and Duncan Bannatyne alluded to – of a failing for-profit business being propped up by a not-for-profit CIC – the for-profit business would ideally need to be wholly owned by the CIC meaning it couldn’t sell equity. This ownership wouldn’t prevent the CIC propping up the failing business but it would prevent private investors benefiting from that propping up.

The alternative, if the for-profit company wasn’t wholly owned by the CIC, would be for it to either be entirely operationally independent from it or – at a great hassle and expense – for the financial and staffing relationships between the two to be outlined and managed in meticulous detail to make sure that the CIC was never using grant funded staff, premises or equipment to support the work of the for-profit company (without being directly reimbursed for doing so).

Both these approaches are fairly pointless though when the end result is money going into a CIC which is not applying for grants. The CIC serves no practical or financial purpose.  Mr Austin would be far better off just running one company limited-by-shares and doing all his work through that. Of course, The CIC Association (of which I’m a member) would point out that only single structure that would allow an entrepreneur to both sell equity and enjoy the (very limited) benefits of CIC status is CIC Limited by Shares.

There’s often good reasons for larger organisations to set-up different trading, social enterprise and charitable arms but, at a turnover in the 10s of £1000s, the only obvious reasons for it that I can think for anyone advising the approach that Mr Austin has taken is that the adviser finds the idea of hybrid business structures really exciting or there’s been a major misunderstanding.

By far the easiest approach for entrepreneurs in Mr Austin’s position (both in terms of running the business and explaining it to other people) is to jump one way or the other. Entrepreneurs should either put all their activities into a straight for-profit company or all the activities in a not-for-profit – at least until there’s enough activity two form two operationally independent businesses (even then, I’m not sure it’s really necessary to do so but it is worth considering).

At the relatively early stage of a business journey, faffing around with structural complications at best creates a waste of time and energy that could be spent on delivering social change and at worst – as Peter Jones and Duncan Bannatyne suggest rightly suggest – creates a framework for propping up a failing for business for-profit with grant funding.

None of this detracts from the good work that Richard Austin does but it does show the need for competent specialist business advice for social entrepreneurs.

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6 Comments

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6 responses to “Another social entrepreneur burned by the Dragons

  1. David, a CIC is a for-profit company. One which is constrained by an asset lock to prevent funds being transferred out and a dividend cap to limit the extent of profit distribution.

    The CIC overcame a limitation of the preceding CLG model which I adopted in 2004, in that unlike the CLG which has no shares, it offers the opportunity to attract investment capital albeit limited by the constraints above.

    Bannantyne and Jones would be justified in their concerns, were the CLG to have been suggested instead.

    I also joined the CIC association because ours is also a community interest model. It began with a thesis describing a business operating for profit, which suggested that:

    “The only difference is this: that at least fifty percent of profits go to stimulate a given local economy, instead of going to private hands. In effect, the business would operate in much the same manner as a non-profit organization.”

    Startup grants are available to all forms of business, though from my own membership of the CIC association where I’ve raised the question, I know that adopting the CIC confers no benefit in qualifying for grants.

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  2. beanbagsandbullsh1t

    Jeff,

    A CIC can be either a for-profit (CLS) or a not-for-profit (CLG) – in theory you can also have a CIC plc. My CIC is a CLG. As I understand it, the vast majority of CICs are not-for-profits.

    A CIC CLG as a not-for-profit company – rather than as a CIC – has extensive grant raising opportunities that a straight for profit company doesn’t have.

    I’d assumed that Mr Austin has a not-for-profit CIC – as, I assume, did Bannatyne and Jones – as that would provide some reason for having two companies.

    If I’ve misunderstood the situation and Mr Austin actually has a straight CLS putting its profits into a CIC CLS then the advice he’s received is even more inappropriate that I’d thought. I can’t think of any possible reason for the formation of two companies in that situation.

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  3. Hi David,
    the existing CIC is a CLG, he has grant funding to achieve the workshops and didn’t want the income raising plan ‘causing problems’ for it, although medium term he wanted the sales activity to reduce their dependence on the grant funding.

    Im unsure whether they’ve tried and failed to get a grant/or indeed a loan through his existing CIC, completely flipping this on its head also shows the fact that existing money streams dont cater for this ‘culture’ of social enterprises……..seed funding generally is not what the Dragons are into whatever the structure/purpose.
    By all accounts the 3 mins didn’t reflect the 1hr 15mins, re the advice he has received I think your reference to Tony Benns guidance says it better than most.
    Fair play to him for having a go, he’s genuine in what he’s trying to do
    John

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  4. I think this is an interesting case and I probably have an unusual perspective as someone who has raised 2 rounds of private equity investment into different social enterprises.

    The second time I tried to use a CIC with shares vehicle but the asset lock on dividend payments meant that we could not structure an attractive enough deal and we ended up creating a CLS vehicle instead. I do not think that CIC with shares will work as a vehicle for attracting private sector equity until the asset lock is made more flexible.

    I agree with Jeff’s point that a CIC is a for-profit company, but that the profits are not for private distribution. This is different from traditional not-for-profit companies that they are primarily about meeting their costs and maybe having a small reserve.

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  5. beanbagsandbullsh1t

    Dave,

    Not surprised the asset lock has caused problems in terms of raising equity finance. I find it difficult to imagine a situation where investing in a CIC CLS will appeal to anyone with a major interest in getting a return.

    Have any CIC CLSs raised a meaningful level of investment from anyone other than founders, friends and family (John M may know more about this)?

    My use of not-for-profit is as an easily comprehensible shorthand for ‘does not distribute profits to shareholders’. Wouldn’t dispute that CIC CLGs may be supposed to have more potential than other CLGs to generate profits which are reinvested in doing social good.

    Not sure whether this is actually the reality, so far. Is there any research on whether CIC CLGs are more likely to generate a surplus than charities or other non-profits of a similar size?

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  6. Understood, there’s a not-for-profit form of the CIC. It was using a CLG form in fact back in 2004, before CICs arrived that I’d failed to get funding for a plan to invest surplus from community broadband into CDFIs and other social enterprise activity.

    An interesting case has arisen in this part of the world where South West Internet CIC having applied for RDPE funding find they’ve been passed over in favour of local councils with their secret bids who now appear to be teaming up with BT to bid against them in the areas they already serve.

    Director Tin Snape describes it on their website.

    Central government is allegedly encouraging Big Society, yet local government competes against social enterprise.

    As I’ve reported elsewhere, it’s the same with quangos. The British Council for example arriving to promote social enterprise 8 years behind us and using Price Waterhouse Coopers as their partners.

    Now that really is Bullshit, as far as Big Society goes.

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