Size—the ally or enemy of Social Enterprise?

In our last Social Edge post we looked at the merger activity in social enterprise and suggested that it was sub-optimal, perhaps because of egos, or because the absence of a profit motive which, in theory, compels Boards and CEOs of “for-profit” companies, and is absent with SEs.  Implicit in this, is the presumption that bigger is better.

Many of the conferences I attend host a myriad of sessions on “getting to scale”, a particularly American phrase, but such thinking permeates Europe as well.  With size, organisations can achieve economies of scale.  Also, for SEs with models that operate effectively in alleviating hunger, teaching poor children, reducing CO2 emissions reductions, etc. there must surely be a strong moral case to expand rapidly.

From a funder’s perspective scale seems all-important.  Nearly all I know seek to engage in activities which are “high-potential”.  I have never been approached by an investor looking for something small which seeks just to continue serving a narrowly defined community well.  Foundations and social investors seek result they can measure—and results seem to mean growth.  The need for capital and the orientation of most investors creates a bias towards big, or at least bigger.  How should the non-scale oriented gain funding?

But some contend that as SEs grow their missions are diluted.  The purity of what drove the original team is sacrificed in the pursuit of growth.  How easy is it to stay social or ethical as the line between the CEO and the line staff becomes more attenuated?

Vertically “tall” organisations can suffer a “corruption” of sorts in their missions.  The CEO is focused on one set of objectives, whereas line staff is concentrated on another.  This can be especially true when the business becomes very large and the CEO becomes an important figure—I have seen several then lose sight of their original mission.  And how many really large social enterprises are there anyway?  Mondragon in Spain, John Lewis, The Coop and Welsh Water in the UK (and many of these would not fit many commentator’s definitions of social enterprise)—but the list gets very short, very fast.  Perhaps as SEs get big they become more valuable and greed or delusions of grandeur kick in.

  • Maybe it would be better if they just sold out, cashed in their chips and reinvested some of the proceeds in new social enterprises? Gordon and the late Anita Roddick did this to wonderful effect with the Body Shop.
  • Perhaps there is just a “life cycle” to SEs and we need to just accept that?
  • Will this fascination with size ever cease?

First published in The Social Edge in October 2010

The Social Stock Exchange is back again

This magazine, in its online version of 11 August 2010, published an article entitled “Voluntary groups plan rulebook for social stock exchange”. A few weeks later, on 28 August, Mark Campanale, one of the co-founders of the Social Stock Exchange (SSE), commented at length on one of my blog posts, giving an impassioned plea in support of the SSE.  The Third Sector piece also noted that Campanale, and his colleague Pradeep Jethi, have now raised £500,000 towards their eventual goal of £2 million to launch the exchange. As a personal fan of these two outstanding professionals and their efforts I am delighted. However, as an industry observer I remain sceptical.

Firstly, £2 million seems an awful lot of money to me to be used in this way. I do understand that it is probably good value for something as costly as a stock exchange, but I have always challenged the necessity of a stock exchange to draw in investment for social purposes. The idea that this exchange will open up the market for pension funds to invest in such companies is optimistic at best. Their (pension fund managers and other institutional investors) return criteria will make it nearly impossible for them to consider investment in firms whose primary objective is social or environmental, irrespective of the listing.

My second objection pertains to the idea of this limitation in the first place. Part of the beauty of this new form of business is that entrepreneurs can, for themselves, decide on the precise blend of social and financial objectives that are appropriate for the business model and funding model of the venture. Prescribing in advance that the organisations must be primarily social or environmental will probably prevent a number of leading companies considering the exchange, including such industry pioneers as the Ethical Property Company.  (In the interest of transparency I should make clear that I sit on their Board, but I am speaking in a personal and not a corporate capacity.)

I also feel somewhat uncertain about the idea of third parties, who are not social enterprises, drafting the criteria for such an exchange. My guess is that the most successful exchanges were those whose provisions were drafted by the eventual users.

Just to be clear, I would be delighted if the Social Stock Exchange were successful. It would mean there was an active, transparent and listed market for those shares of companies whose ideals and objectives I so deeply share. From a corporate perspective ClearlySo, the business I run, would also benefit. But despite my hopes and dreams it does not feel as if this SSE project is going on in a direction that will best insure its success.

First Published in Third Sector in September 2010.

Should Tax Incentives for Social Enterprise Stop?

I recently attended the launch of a report by the Centre for the Study of Financial Innovation entitled “Investing in Social Enterprise; The Role of Tax Incentives”.  What followed was one of the most vigorous and lively debates in which I have ever participated in this sector.

The report catalogued the considerable number of tax incentives available for investors in social enterprise in the UK—many of which have been available for some time.  Government officials in many countries are studying case studies like the UK and toying with alternatives.  At the CSFI debate, numerous practitioners argued for a series of sensible refinements.  Others noted that the field of play should at least be level with the private sector.  There is, however, a compelling case for an end to all incentives.

First, there is little evidence they succeed.  In the UK it seems the progress of the sector has happened despite and not because of the incentives.  Areas of particular benefit seem to have enjoyed less rather than more growth.

Second, the vast array of incentives is a highly complex and difficult and expensive to negotiate.  Small wonder the cover of the report was an image of a maze.

Third, they are highly distortive.  There is considerable evidence they also displace important private sector efforts in the social enterprise area.  When these incentives are augmented by the creation of Government funded or backed vehicles, as in the UK or Ontario, Canada, for example, (thus far the US has been relatively light on such distortions) this can seriously impede private sector involvement.

Fourth, Government incentives can be highly volatile and vulnerable to a shift in the political winds.  Thus, well-intended initiatives can be undone at the stroke of a pen, which is disruptive and damaging to the operations impacted.

Fifth and most importantly, at such times, it is difficult to argue that our sector is as deserving as so many whose lives have been destroyed by such man-made calamities as the credit crisis and the resultant fiscal retrenchment, or the recent oil spill in the Gulf of Mexico.  Our genuine concern for the social impact of our sector needs to take into account the human suffering around us.  Moreover, with private capital making its way into the social or impact investment space, are we really in a position to justify our pleas?

Nevertheless, questions remain:

  • Are there specific areas where there is simply no choice but to require governmental capital or fiscal incentives to correct a genuine market failure (rather than frustration over speed)?
  • Which sorts of governmental activity can have the biggest impact? In which circumstances?
  • Are any particular countries especially effective in social enterprise development as a result of governmental action? Many of my examples reflect my own Anglo-Saxon orientation.  Are there other models which are working?  Do recent fiscal programmes in France offer a new path to follow?

First published in The Social Edge in July 2010.

The case against tax incentives for social enterprise

The new Chancellor of the Exchequer has spoken. Our fiscal crisis is severe and deep cuts are required to restore our national finances.  Failure to do so, the government claims, will imperil our nation and risks a funding crisis a la Grecque.

Whether or not one shares the assessment of our predicament this is the context against which we must measure our reactions as a sector.  To listen to the comments of my peers it would seem that our present mission is to shout for our share of dwindling government resources.  This approach is seriously flawed for several reasons.

First, there is very little convincing evidence that the myriad of incentives already allocated to this sector have done much good.  The recent report by the Social Investment Task Force laid out progress since it was set up in the early years of the Labour government.  Causality is always difficult to determine, but the report’s claims in this regard are appropriately modest.  Although much has happened since that time the unavoidable observation is that this was merely contemporaneous with government tax incentives, rather than as a result.

In areas was where government has been particularly generous, such as in the area of Community Investment Tax Relief, its take-up has been noticeably disappointing.  This is partly due to the unnecessary complexity and restrictions of the scheme, but not only.  In fact, most of the exciting activity in social investment has happened in the unsubsidised market.

This is not dissimilar to the venture capital arena where tax credits have failed miserably to create an enterprise culture in the UK—generous treatment for VCTs has only served to depress already pathetic UK venture capital returns.

Second, the incentives are too complex, as an excellent report co-sponsored by the CSFI and NeSTA and written by Vince Heaney and Katie Hill has pointed out.  Indeed the cover of the report shows a maze—this is apt.  When structures are this Byzantine they are hard to effectively exploit.

The third and final reason to be opposed is the current environment.  We exist as a sector on the premise that social objectives matter, and are at least as important as financial or corporate goals.  Our mantra is that of the “triple bottom line”, or “people, planet and profit”—society is at least tied for first with our personal and corporate interests.  At a time when across the country the most severe budget cuts are underway, it is callous, if not unseemly to be lobbying for more.

Our sector has been the recipient of extraordinary largesse over the past decade.  Private sector money has begun to come in increasing amounts—with interest accelerating.  Hundreds of millions more are promised via the Big Society Bank or the Green Investment Bank.  In such an environment it strikes me that the socially positive action could be to make a point of asking for no more cash, so that it can be spent on those who really need it.  Perhaps we should consider asking the Government to use the money from unclaimed assets to pay down the national debt as a gesture?

Until we demonstrate that we are truly different from the rest, we can hardly claim to be.

First Published in Third Sector in June 2010.

Can Social Enterprises be Commercial?

“Oh that’d be a bit corporate, don’t you think?”  This I was recently told by a social entrepreneur, following a suggestion I thought would improve their performance.  It was not just the reply I found troubling, it was the face the respondent made.  He sort of scrunched up his face the way you might at the smell of rotten eggs.  I also felt that feeling I feel many times working in the social enterprise sector—“whose side are you on, mate?” they seem to ask.  “I thought you were one of us but when you talk like that it makes me think you never left the City/Wall Street”.

In so many ways I find a real distaste for what I would consider good corporate practice.  Another social entrepreneur is always late.  Meeting always begin 20 minutes after they were meant to.  I feel emotionally unable to just start arriving 20 minutes after the official start time, although others do—so my time is wasted and I quietly (generally) fume.  It is not that mainstream entrepreneurs are by nature any more punctual—of course not.  But when they arrive late, they apologise, and there is some recognition of the fact that this is unacceptable behaviour which needs correcting.

Another example is the mess in which I find some of the offices.  Don’t these companies have customers, I think.  What are they to make of the state of this room/office?

This is not to suggest that social entrepreneurs go to the expense of creating lavish offices which seek to impress—surely a waste of scarce resources.  But tidiness and order are not evidence of moral turpitude or corporate sell-out, just of an organisation in good operating condition.  Again, it is the attitude rather than the reality which grates; the sort of nonchalant acceptance that a mess is one quaint aspect of running a social enterprise, especially an early stage one.

Nowhere is this more harmful than when it comes to fundraising.  Where traditional entrepreneurs strive hard to hone their pitch, the social entrepreneur acts as if he/she is somewhat “put upon” but the unnecessary and tedious demands of the potential investor to get an earth-shatteringly important story into a mere few minutes.  We find this sometimes at our Social Investor Speed Dating events from social entrepreneurs.

Not all are this way, and I exaggerate (as ever) to make the point, but I contend that there is nothing harmful in operating to the best standards of commercial behaviour.  It does not undermine but rather enhances the social mission.  It does raise questions:

  • How far can a social business or enterprise go in becoming commercial before it ceases to be social?
  • Which corporate traits are best avoided?
  • When we at ClearlySo host our annual Social Business Conference, and focus on just the financial and performance issues, are we undermining the social ethos? Should we not be including sessions on furthering the social mission?
  • Is the nonchalance I mentioned above just an essential characteristic of the visionary social entrepreneur which we need to accept and celebrate?

First published in The Social Edge in June 2010

The electoral aftermath and the impact on the social finance sector

By the time you read this, the UK general election will have taken place and, if the pundits are to be believed, David Cameron will be the Prime Minister presiding over either a small majority, a coalition with the Liberal Democrats or some smaller third party or parties, or be trying to rule within a minority Government.  In nearly every possible constellation, except for perhaps a coalition with the Liberal Democrats, the Conservatives will be in a relatively weak Parliamentary position, vulnerable to pressure from disaffected members within its own ranks or to bye-election defeats.  Despite his pleas to the contrary it does not look as if the United Kingdom will give David Cameron the electoral mandate he desired and, for so long, looked likely.

Nevertheless, it’s my challenge to try to write before the election results are in about the prospects for the social enterprise, investment and finance director thereafter.  I have written in our ClearlySo Social Business Blog, about the inherent advantages which social businesses and enterprises possess in terms of their ability to raise capital more cheaply and secure talent, products and services more efficiently.  This will make the sector popular in the aftermath of an election as a source of private sector solutions to public sector problems.

For a Conservative party looking to provide momentum to its concept of the Big Society, the sector offers a great deal of opportunity.  In particular this has to do with the areas of community ownership and “re-mutualisation” (including, among other things, perhaps financial institutions like Northern Rock).  There is no doubt the Tories possess conviction concerning local ownership and accountability in public service delivery.  Both social enterprises and community owned organisations, will be able to assume ownership and management of local assets; a likely feature of a Conservative government.  I expect the Tories to move rapidly in this area as they seek to contrast their approach with what they have characterised as “Labour dithering”.  I expect many mistakes along the way, which will undoubtedly be picked up by the appropriate tabloid papers, however I welcome such experimentation–the existing models certainly have not worked.

Where I also expect the Conservative Government will be equally hyperactive is with respect to financial innovation.  The social impact bond, which I have discussed elsewhere, has been has been incubated under Labour government but has been proceeding at a glacial pace, thanks to the Treasury.  I expect the Tories to move quickly to unleash this and other instruments which enable financially innovative solutions to address social problems, such as prison reoffending, which the first social impact bonds seeks to address.  In many areas where traditional practices have made progress impossible I expect the Tories to be radical.

One final area of likely progress involves the long-awaited Social Investment Wholesale Bank (SIWB).  Although proposed years ago and debated endlessly, Nick Hurd MP, the shadow Minister for the Third Sector, has made it abundantly clear that he will move quickly to release the funds from dormant bank accounts to such an SIWB.  There are suggestions that the remit of this institution will be more narrowly focused on facilitating other capital flows.  Although the details on the proposals are still to be released-one welcomes a speedier and more narrowly defined implementation of the broad concept.

Under nearly every possible configuration of the next Government, we can expect accelerated growth in the social finance sector.  The U.K.’s financial crisis compels this.

First Published in Third Sector in May 2010.

The value of benchmark transactions

What will finally get this social investment industry going?  Many observers seem to believe that the Social Investment Wholesale Bank (SIWB) will help.  In part, they argue that “an institution of scale” is necessary.  Why this is required eludes me.  Also, in the aftermath of the great financial meltdown, I think the arguments against scale are quite compelling.

I have a slightly different view.  What makes markets are deals, NOT structures, and transactions NOT entities.  This is especially true if the entities are just heavily Government subsidised intermediaries.  Fortunately, there are many new deals which either have happened or are happening which will become benchmark transactions and lead by example in creating the social investment space.

One in which we at Catalyst have played a role as advisor is the expected £5 million transaction for the HCT Group.  In this deal, cornerstoned by Bridges Ventures, investors are to purchase fixed rate loans and “social loans” (where interest is tied to HCT’s turnover growth).  The size of HCT within the social enterprise sector, and its long and successful track record, make this a deal other investors may key off of.

Not long before the largest and perhaps most important deal in the sector was announced, the EU 102 million financing for Triodos Bank.  Done at a time when many of the largest banks were relying on government infusions, this Dutch ethical bank was able to announce a transaction that was funded purely by investors without the need for a state subsidy, which is being used to fund Triodos’ rapidly expanding loan book.

In the coming weeks Social Finance will at long last formally launch its widely heralded “Social Impact Bond”, where the Treasury will pay to the investors some of its own savings from the reduction in prison reoffending rates expected to be caused by the programmes undertaken within the scope of the bond.  This is an important and breakthrough benchmark instrument because it connects returns and social benefits—in this case in the form of Governmental cost savings.

Finally, later this year, the Ethical Property Company will raise several million in its sixth financing from the markets (one of which was in Europe to Belgian investors).  The fact that the firm (I must disclose that I am a Non-Executive Director) has been able to routinely tap the market for capital over the past ten years sets a standard that other firms issuing, or thinking of issuing ethical shares, may hope to aspire to.

Such deals are invaluable for the sector.  Others considering similar issues may copy these formulae.  In fact, these four deals are not themselves unique but build on the work of others.  What makes these important is their size and scope within the sector.  That they have all occurred within a year of each other is a great sign of hope.

First Published in Third Sector in March 2014.

One and a half cheers for the Government’s changes on CICs

As there are only three cheers to go around I was flummoxed; do I award one or two?  Two seemed  high and unwarranted by the Government’s recent decisions (revealed in two papers summarising the results of their consultation process) to change the limits on CIC funding.  One cheer seemed churlish; failing to recognise that the Government had acted on complaints.  Thus my part score of 1.5 cheers, seemed right.

The Government has announced two core changes.  The first is to change its limit on the returns payable to equity shareholders in CICs.  These will go from 5% over the base rate to 20% total per annum with no link to interest rates.  The linkage to base was absurd and the 5% premium insufficient to reward investors who were making very high risk illiquid investments.  As base rates plummeted the available rates of return became embarrassing; the Government had to act.  Quasi-equity (QE– a debt-like instrument where returns are linked to the CIC’s performance, for example as a percentage of turnover) had been limited to 4% above base rate and this has been changed to a flat 10%–half the permitted return on equity.  Finally, the 35% cap on “maximum aggregated dividends” has been kept unchanged.  This was designed to insure that the majority of profits were re-invested in the business.

I am delighted the two changes were made.  It should make it easier for CICs to raise money.  Not only does this allow a fairer return entailed, but this will make calculating them easier.  Twenty percent strikes me as a very fair number for equity investors, given the level of risk—so well done on that score.  The 10% limit on QE is puzzling and mistaken.  First, the old differential made much more sense.  QE is not one-half less risky than equity, so why only permit half the return?  Also, QE is sometimes used as a simple substitution when straight equity is not possible.  We are currently advising the community transport company, HCT Group, on a fund-raising using QE, in part.  We could not use a CIC structure under these new guidelines because the permissible rate of return is too low to secure investment.  What a shame—an own goal in reform terms!  And what if base rates rise sharply?  Another “reform” will be needed.

Maintaining the 35% cap seems OK, but 40% or 45% would still maintain the spirit of the idea that a CIC is primarily for community benefit.  It does not mean that they will pay the maximum, just that they could.  Why does the Government persist in its refusal to trust CIC management’s and their judgement?  The fact that there were, as of 30/9/09, 3,172 CICS and that it reported that in four years only two paid a dividend, and that the total aggregated dividend in each case was less than £4,500, certainly suggests responsible behaviour.  This is taking the need for prudence too far.

Finally, there remains one elephant in the room.  Small (non-social) companies can get EIS relief or may be permissible for investment by VCTs, which benefit from a tax subsidy.  Charitable contributions are tax advantaged.  Why does the Government insist on discriminating against social enterprises and not give them at least the same benefits as traditional small companies?  When they announced CICs a few years ago they chickened out—they have done so again.  It boggles the mind.

First Published in Third Sector in January 2010.