Legal Structures and Raising Capital

20th April 2018

Different forms of capital

All social enterprises need capital to have enough to cover day to day bills (working capital), to buy and replace equipment, to buy property or to pay for equipment, staff, stock to enable expansion.

There are several forms of capital used in the social enterprise sector. The most common are:-

Grants – do not need to be paid back but usually for specific things. This can be tricky if the organisation requires capital for several elements (say staff, equipment, stock) as each may require different grants with different grant conditions. Grant turnaround times can be lengthy and only certain types of organisations may be eligible.

Grants are becoming increasingly competitive and often have stringent monitoring and evaluation regulation which means that organisations could face mission drift becoming unreactive to the changing needs of the people and communities that they serve. Additionally grant funding doesn’t always fit well with schemes that predominantly trade as part of its community benefit/delivery, and there are also limited funders who would support this.

Crowdfunding – donations which do not need to be paid back but can normally be used for anything once secured. Taps into new money from potential supporters of the project. Crowdfunding donations is normally only successful for amounts under £15k. Crowdfunding loans or shares can raise much higher sums.

Loans – need to be paid back with interest but can normally be used for anything once secured. Traditional forms of loan finance usually require security (which is not always available for social enterprises) but there has been a mushrooming of social investment funds over the last decade. The social investment sector is awash with money to lend, but not enough demand.

Even though social investors are more sympathetic than traditional lenders there is still less flexibility than interest/dividend payments which are agreed at an AGM by the organisation itself depending on its performance.

Bonds/Loan Stock - long term patient capital, which can be transferable (bonds) or not (loanstock). In the social enterprise sector interest/dividend on shares is normally low. Interest only payments for the period of the bond/loanstock which helps with cashflow followed by the repayment of the full amount on the completion of the term, which creates a cashflow problem. Can normally be used for anything once secured. Provides no ownership and voting rights for supporters in the social enterprise.

Equity (shares) – long term patient capital, which can be transferable (in which case it can be maintained) or withdrawable (in which case it can be replaced). In the social enterprise sector interest/dividend on shares is normally low. Can normally be used for anything once secured. Shares provide ownership and voting rights for supporters in the social enterprise.

Community Shares (equity) – traditionally equity has come from external investors who own the business on the basis of one share, one vote, own the entire wealth of the business between them and can take as much profit from the business as they see fit. Community equity comes form the community benefiting the business, is based on one member one vote, creates a growing community owned asset as the shares don’t increase in value and have a limit on the amount of profit which can be taken from the business.

Comparison of pros and cons from the point of view of raising capital and in particular community shares of being a society in comparison to all other structures as listed above:-

  • Company limited by guarantee – some grants, crowdfunding, some loans, 
  • CIO – grants, crowdfunding. Loans can be tricky because of ease of cancellation by the Charity Commission
  • Charitable Company Limited by Guarantee – all forms of grants, crowdfunding, loans (but heavily regulated)
  • Community Interest Companies – many grants, crowdfunding, loans, equity in the share capital form (but can’t be sold to the public)
  • Societies - some grants, crowdfunding, loans, community equity

Asset lock

An asset lock is a legal clause that prevents the assets of an asset locked body being distributed for private gain rather than the community purposes of the asset locked body.

An asset lock applies to the net assets of the organisation (not any particular piece of property). So the asset lock does not prevent the organisation buying and selling property or securing a loan or mortgage on its assets. But upon a solvent dissolution of an organisation after all debts, loans or shares have been repaid any assets left over must go to some other asset locked body.

There are three types of asset locked bodies: all forms of charity, Community Interest Companies and Community Benefit Societies (in which an asset lock is an option).

The advantages of being an asset locked body are that it clearly brands you as being for community purpose. Adopting an unbreakable lock on the assets of the organisation for community benefit demonstrates clearly to funders and the community that the organisation exists for community benefit. And, of course, the asset lock secures the assets of the organisation will always be used for community benefit.

The main disadvantage of being an asset locked body is that assets cannot be distributed among members if the business is wound up. Because the asset lock cannot be legally broken it restricts conversions of legal form to other forms of asset locked bodies. For Societies, a consequence of the strength of the asset locked clauses is that an asset locked non-charitable Community Benefit Society cannot amend its Rules to become a charitable Community Benefit Society as this would mean amending the asset lock clauses. Finally the asset lock prevents the organisation from distributing to a non-asset locked body, no matter how worthy.

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