As an investment, social enterprise can be a difficult nut to crack. The truth of the matter is that, in the 21st century, no official definition for social enterprise exists in the UK. I’ve mentioned in a previous article that Social Enterprise UK has its own definition of what a social enterprise should be. According to the criteria, a social enterprise must:
- Have a clear social and/or environmental mission set out in their governing documents
- Generate the majority of their income through trade
- Reinvest the majority of their profits
- Be autonomous of state
- Be majority controlled in the interests of the social mission
- Be accountable and transparent
Now this is all very well, except, these criteria can be difficult to keep track of for your average investor. Likewise, with no official definition of social enterprise, there is nothing that prevents companies that do not meet all these criteria branding themselves as socially motivated companies. If consistency is the key, then the majority may find themselves on the wrong side of a locked door.
So, how have we combated this in the past? At SyndicateRoom, our route around this has always been the lead investor. We’ve had the benefit of working with some of the great social funds currently operating in the market and, in some cases, following their investments.
Social funds tend to work to their own criteria of a social enterprise when making investments which means that by following them, we can piggyback on the social diligence these sophisticated investors have done. WealthBriefing recently published a great article on this with specific reference to UBS. This is the route that a lot of individual investors would take as well. I wonder, however, how investors would feel about democratising the information that allows social funds to maintain their monopoly on social investments?
What does the government currently do?
To suggest that there is currently nothing in place to help socially motivated companies would be incorrect. Social entities can currently register themselves in several ways: charities, community interest companies (CICs), company limited by guarantee and a company limited by shares. Now, the issue with being limited by shares is what I’ve mentioned above: no clear definition on social enterprise, which allows for broad claims. Likewise, the former three options also all have their own limitations, not least of which is an inability to raise capital through the issuing of shares, asset locks and dividend caps. (More information on this can be found in my previous article on social impact investing.)
This has several consequences. For companies, it means that they are forced to adhere to specialist legislation and consequently may find it difficult to raise capital. Of the three former options, only CICs can actually issue shares, which means that charities and companies limited by guarantee are left solely with the debt/donation options, which can make them difficult to grow.
With regard to raising early-stage capital in the UK, private equity is still king, even if the industry has seen a slump 2016–17. While banks and lenders are still reluctant to offer loans to early-stage companies, the UK equity investment scene is still hot. Beauhurst states that the total amount invested via equity 2011–16 was £23.8bn, with an average investment size of £1.46m. On the other hand, their figures show that debt investment was £4.76bn over the same period, with a higher average of £3.92m. Looks like lenders are preferring to put larger amounts into safer bets (good on them; let’s not get into that mess again). This is a trend we can all expect to remain constant.
The Syndicate: Due diligence issue
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There have been moves to try and counter the limitations on social companies, Social Investment Tax Relief (SITR) being a great example. SITR carries all the benefits of EIS, with the added benefit of also being applicable to debt. The impact of SEIS and EIS can’t be understated – the equivalent of William of Normandy bringing a Howitzer to Hastings – it has made early-stage UK companies far more investable by mitigating risk for investors. To try and reflect this in social investment is admirable, and yet, SITR seems to be a bit like Will Smith’s third child; you have to keep reminding people that he’s real.
It is encouraging then that more and more specialists are now trying to focus on SITR. I recently became aware of Kin Capital’s work with the Bright Futures SITR Fund. Richard Hoskins (a Partner at Kin Capital) made a great point regarding the slow initial uptake of S/EIS and how it’s grown since with over £15.9bn raised since its inception in 1994. This is positive, but I do wonder – with S/EIS already in place and widely understood, is another, more complicated system needed?
The social enterprise limited by shares
So, I’ve mentioned a few problems, but very little in the way of solutions, which I’ll now try to remedy. Do I think that something needs to be done to simplify and democratise the process of social investment? Yes. Do I have all the answers? Hardly, but allow me to take a swing at it anyway.
In order to improve the social investment scene, I believe it needs to be simplified. The lack of clarity in criteria and the plethora of different structures may not do the industry any favours. Instead, how about we stop trying to separate social enterprise from standard business structures and focus on something that investors already understand? It may be time for a new structure: the social enterprise limited by shares.
I envisage that the main factors of this entity would be:
- A consistent, socially-based criteria agreed with Companies House
- Identical investment structures and remuneration structures to companies limited by shares. This includes access to SEIS and EIS tax benefits
- Identical legal structure to a company limited by shares, with the limited liability of shareholders
With regard to the criteria for companies, a good place to start would be with organisations like B Lab UK, a UK-based charity that deals in the issuing of the B Corp status to for-profit organisations: a real seal of approval without the profit incentive.
There are, of course, limitations to this model (I’m sure most of you are already mulling this over):
- SITR is non-qualifying on companies limited by shares without asset lock. This removes a key incentive for social investment (even if that key incentive is still underused)
- It’s very reliant on government legislation (we all know how inefficient that can be). Is defining social enterprise the responsibility of the government, or is it down to us, as investors, to determine what causes we wish to back?
- It’s open to abuse; companies may look for ways to meet basic criteria to encourage investors. However, is this a limitation? If it encourages companies to push more social aims then this could be a real benefit to society
- Exclusivity may be a good thing. By forcing social enterprises to prove themselves as such to bodies like B Labs UK and social funds, do we end up with much better quality social investments?
I’m sure there are other limitations and benefits that others may also recognise - but I hope I’ve covered the basics.
How would you, as investors and social companies, feel about more government intervention in the space? Do investors need a government-backed social entity that operates the same as the majority of other early-stage investments? Does removing the barriers of enforced debt and asset locking mean that we could see more being pumped into companies that promote social aims, or will we just see widespread system abuse as companies try and enforce a faux social aspect to their profit machines in order to encourage investment?
What is clear is that we, as social investors and an industry, do not currently have all the answers. However, these are discussions that we should be having. If we decide that we want greater transparency in social investing, then we need to petition for it. There is, I think, one thing we can all agree on… at present, the world could use a little more investment in social causes.