Mind the cap

Potentially interesting developments loom for Community Interest Companies (CICs) after the CIC Regulator launched a review of the CIC dividend cap last week. CICs were introduced as new legal form by the then Labour government in 2005. There are now over 7000 of them with umbrella group, the CIC Association, reporting over 100 new registrations each month.

As Civil Society explains: “Currently, community interest companies (CIC) dividend pay-outs are capped at 20 per cent of the initial investment. There is also an aggregate cap of 35 per cent on all distributable profit of a CIC. The consultation launched this week asks if the cap on dividend pay-outs should be increased to 49 per cent.

So, what’s the problem? As is so often the case with questions of social enterprise, profits and organisational structures it’s a heady mix of strong principles, deep confusion and hot air.

Like all government initiatives to promote social enterprise, the creation of CIC represented a trade-off between practical and political utility. The new Labour government needed a political structure that enshrined in law the idea that it was possible to do good while also making a profit, they also needed a suitable vehicle for ‘spinning-out’ public service delivery into vehicles that would notionally be owned by the wider community.

Added to that lots of people doing good stuff in civil society needed a company structure (or some company strucures) that would enable them to do what they wanted to do without having to set up a charity with a split governance (between paid staff and volunteer trustees).

The various types of CIC – there’s several versions of ‘not-for-profit’ CIC limited-by-guarantee and ‘for-profit’ CIC limited-by-shares – have succeeded in meeting all of those needs reasonably well. Examples of CIC range from NAViGO, which spun-out of the NHS and provides mental health and other services in North East Lincolshire with a turnover of over £22million, to us at Social Spider CIC turning over closer to £150,000 and other similarly small, innovative social enterprises.

The CIC limited-by-shares models have also worked well for charities looking for an appropriate structure for trading arms. Under CIC legislation, CICs owned entirely by asset-locked bodies (such as charities) can pay as much of their profit to those as want to. Where CICs haven’t done so well is in attracting equity investment.

So, what’s currently being debated is what happens when CICs limited-by-shares and owned by entrepreneurs and investors who aren’t charities (or other asset-locked) bodies want to take profits out of the business to repay their investment. There’s (at least) two separate problems with the current situation:

  1. The current rules place strict limits on how much money can be taken out.
  2. As well as being strict, these way these limits are imposed is unnecessarily complicated and gives a particularly bad deal to entrepreneurs who start CICs.

As explained above, the current caps relate both to the initial investment – either the amount an investor puts into the business or, in the case of entrepreneurs putting in sweat equity (unpaid work), the value of their shares at the time they received them – and the distributable profit that the company makes in any given year.

If you’re really interested and you want to fully understand what’s going on, it might be worth making a cup of tea, printing out the guidance here (or downloading it to a suitable device) and sitting down for good read. To explain it very briefly, for companies formed since 2010, shareholders can receive an annual dividend of either 20% of the value of their shares at time of purchase or 35% of distributable profit, whichever figure is lower. That means that even if everything goes really well, it takes investors ages to get their money back and they can’t make a very big profit.

Suffice to say while the CIC structures have proved to be useful, uncomplicated vehicles for various forms doing social good, they’ve (understandably) been far less successful in attracting cash from (non-charity) investors hoping to their money back through dividends.

Explaining his views in anticipation of the current consultation, Richard Patey at Profit is Good explained that: “For us the solution is to simplify the whole process by removing the cap on the paid up value of share and increasing the aggregate cap to 49%” adding that:  “This is still in keeping with the standard definition of social enterprise of ‘principally reinvests its surpluses into the organisation’ and would be a simple and attractive value proposition to would be social entrepreneurs who would otherwise be hampered by their ability to be rewarded for sweat equity and scaling their enterprise’s social impact.

I personally sympathise with the arguments for simplification but – unless the company has significant assets which are locked – I’m not sure that a 49% distribution cap delivers a business that’s significantly more focused on community/social benefit than your average company. How many companies regularly pay out more than 49% of their profits in dividends?

For me, the right approach is a single cap of 20% cap of distributable profit. That way, in the event that a CIC makes massive profits, entrepreneurs and early investors who’ve taken a big risk to get the CIC up-and-running can make significant amounts of money but the community still gets significantly more – either in cash or more services.

Of course, what happens to CIC and other social enterprise profit remains a relatively minor issue overall. I’d be interested to hear what others think about this. Is it realistic for large numbers of CICs to take on equity investment? Does anyone have an experience of taking an equity investment as a CIC?

 

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8 Comments

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8 responses to “Mind the cap

  1. David its really hits the nail on the head where you state:
    ” I’m not sure that a 49% distribution cap delivers a business that’s significantly more focused on community/social benefit than your average company. How many companies regularly pay out more than 49% of their profits in dividends? ”
    It does a convoluted and opaque logic that leads a person to say I want to be social-values driven and produce social value – but there again I want to have for myself (and other investors) nearly half the value created in cash to take elsewhere?

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    • Beanbags admin

      Well, I think there’s a spectrum of motivations for investing but a CIC with a relatively low cap on distribution – such as 20% – is clearly a different model to what’s offered by a conventional company limited-by-shares and makes a clear statement about the focus the company.

      It clearly isn’t suitable for Dragon’s Den style venture capital but there may be an as yet unrealised possibility for investment with broadly social intentions if the process can be made as easy as possible to understand (and some of the regulations on share offers can be made more appropriate for these kinds of investments).

      49% is a red herring but I’m supportive of people making investments in companies that do social good but allow investors to take out as much profit as the company can bear.

      I’m just not convinced the CIC model or a new model is necessary to do that. I think people can do this through by adapting existing conventional CLS structures if they want to.

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    • Edward reading the South China Post as one does, I came across your recent comment on an article about a social enterprise development fund to tackle poverty.

      http://www.scmp.com/comment/insight-opinion/article/1085427/social-enterprise-funds-should-help-avoid-poverty-not-just

      It was’t you comment but the suggestion in the article that dref my attention, that they should emulate the UK system of social finance intermediaries.
      As long term advocates of deploying social enterprise to tackle poverty, I noted the contrast between this and our own advocacy which suggested:

      “Project funding should be placed as a social-benefit fund under oversight of an independent board of directors, particularly including representatives from grassroots level Ukraine citizens action groups, networks, and human rights leaders.

      This program provides for near-term social relief for Ukraine’s neediest citizens, most particularly children who normally have least possible influence and no public voice. Over a few years time, the net cost financially is zero. Every component is designed to become financially solvent, through mechanisms of cost-savings and shared revenue with other components. One component, Internet, provides essential communications infrastructure as well as a cash surplus to be used to offset any lingering costs of other components such as childcare, and otherwise goes to a permanent social benefit fund under oversight of the aforementioned independent, citizens-based non-government board of directors.”

      This civil society led approach against poverty was I noted, the approach being adopted by Northern Ireland. So why are England’s social enterprises being left to swim in a shark tank?

      http://economics4humanity.wordpress.com/2012/08/29/social-investment-is-northern-ireland-different/

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  2. So we come full circle to the suggestion made 16 years ago:

    “This business model entails doing exactly the same things by which any business is set up and conducted in the free-market system of economics. 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.”

    There was also the suggestion that foundation funds. aka program related investment could be used to seed this “community interest” business model.

    “If twenty percent were set aside to fund a “P-CED enterprise”, that money would never go away, but would instead grow as it should in business.”

    http://economics4humanity.wordpress.com/2012/10/29/friedman-shareholder-primacy-and-beyond-csr/

    The alternative to the dividend cap is an agreement to place funds in a permanent irrevocable trust for onward social investment, a CDFI.

    In the 2003 paper setting out a social enterprise strategy as a preventative measure against terroriism in a peaceful Muslim community, the combination of the community investment business and a CDFI presenting a mutally supportive environment for affordable social lending.

    http://economics4humanity.wordpress.com/2012/09/22/creating-shared-value-mk1/

    All published online in the interest of radical transparency. So, where are the equivalent arguments for the CIC model?
    .

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  3. By now, it should be fairly obvious that what I’ve been describing on social media over the years is an alternative to capitalism. On a business network yesterday, someone attending the recent Good Deals conference reported a somewhat cynical response to the suggestion from financiers that capitalism needed to change.

    That it’s something we’ve been active in for over a decade isn’t wecome news and the mere mention has me blocked from many conversations online. I may not comment on Guardian Sustainable Business or Social Enterprise magazine nor many others.

    The extent to which media hamstrings us was brought home to me yesterday with a brush with Murdoch. Not only is this very traditional form of capitalism undermining social benefit in my village, they also advocate for a ‘mob boss’ as a champion of Ukraine’s chidren.

    http://economics4humanity.wordpress.com/2012/12/03/the-cloud-a-brush-with-murdoch/

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  4. I don’t think it will make any difference for the CIC in attracting equity investment. We require only 50% of profit to be distributed for social purpose at the SE Mark. In reality equity investors are only interested in 100% gain. The problem is the nature of current equity model and those driving it and not the SE business model.

    I would of course disagree with the statement that what happens to social enterprise profit is a relatively minor issue. It is what distinguishes social enterprises from the mainstream capitalist business model as well as the values and behaviours. I am really fed up with the fact that no-one appears to look into the (social enterprise advocate) companies that argue against this position as you might find that they have a vested interest!

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  5. Beanbags admin

    Hi Lucy,

    I broadly agree that the move to a 49% cap, if it happened, wouldn’t make it significantly more likely that CICs would attract investment from professional investors investing with a primarily financial motive. I think there is potential for CICs to do share offers to sell equity to non-professional investors but the regulatory framework makes it more or less impossible.

    So, currently it’s perfectly legal for a small CIC to set up a campaign and to raise £10,000 by asking for 20 people to give them £500 based on the fact they’ll never get it back BUT it’s not possible to put out an offer for 20 people to invest £500 on the basis that they’ll get a 2% share in the CIC and might get some of it back at some point if they’re lucky.

    I think there’s potential for a CIC equivalent of the Community Shares model (the regulations for IPSs have some exceptions which enable smaller IPSs to carry out share issues.) Not sure if these changes will enable this to happen. Hope so.

    Not sure now’s the time for me to revisit the question of whether or not profit distribution is the main thing that distinguishes social enterprises from mainstream capitalist businesses. I understand that many people in the movement think it is.

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    • To my knowledge there’s only one social enterprise which even mentioned capitalism in proposing the social application of profit:.

      “Traditional capitalism is an insufficient economic model allowing monetary outcomes as the bottom line with little regard to social needs. Bottom line must be taken one step further by at least some companies, past profit, to people. How profits are used is equally as important as creation of profits. Where profits can be brought to bear by willing individuals and companies to social benefit, so much the better. Moreover, this activity must be recognized and supported at government policy level as a badly needed, essential, and entirely legitimate enterprise activity.”

      In 2004, the optimum UK model for our suggested ‘at least 50%’ of profit was the Bencom or Community Benefit Society.

      Since about 2010 there’s been a LLP version of the CIC model. Prior to this Chris Cook, former head of the International Petroleum exchange saw the potential for a social benefit model and the concept of a asset based capital partnership as an alternative to bank debt. I’ve been talking to him about its use in social enterprise over the past few years:

      I met Jim Brown of Baker Brown Associates last year and he confirmed to me that Community Shares can’t take sweat equity into consideration as this finance model does.

      I can see no good reasopn why a CIC or any other business form of social enterprise can’t engage it for shared risk and reward. Similarly when my colleague, Terry who proposed this approach as an alternative to capitalism, described to Axiom news how entering an investment agreement like this with a conventional investor without straying from the non divident distribution approach. It’s about thinking outside the model.

      http://www.axiomnews.ca/node/966

      in 1999, acting purely as a consultant he’s been able to leverage $6 million for a community microfinance bank in Tomsk and the Crimea project brough the US Embassy to the table with $40 million.

      That however doesn’t protect any given project and its social benefit from predators who might opt to strip out the social objective for personal gain and in dialogue with Skoll Social Edge 3 years ago, he expressed concerns which proved to be justified It cost us about £500k in total ijnvested and him his life:

      http://economics4humanity.wordpress.com/2012/10/02/do-we-need-ethics-in-social-investment/

      Social enterprise without solidarity and support will ensure that we’re all picked off one by one.

      Like

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