CIC profit distribution eased

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New rules could 'open the investment floodgates' for Community Interest Companies

Isabelle de Grave, Pioneers Post, 11 Dec 13

Since their inception in 2004, Community Interest Companies (CICs), the bespoke legal form for social enterprises in the UK, have endured in a climate of financial difficulty, and high failure rates, indicated yesterdays report from the CIC regulator. But, two key changes to restrictive caps imposed on CICs could be fundamental to future CIC success.

This year the Office of the Regulator of Community Interest Companies in the UK expects to dissolve close to 1,000 community interest companies (CICs). Most will have been trading less than three years and many will cite lack of investment as the reason for failure. This is according to the response of the CIC Regulator to a recent consultation on changes to the dividend and interest caps for CICs, which was published this week. Operating at the intersection of business and social change, a CIC is a limited company carrying on a social activity. CICs seek to generate surpluses to support their activities, maintain their assets, make their contribution to the community and in some cases make a return to investors. Some CICs may also depend on grants or donations to achieve these ends.

Until now, CICs have been suffering from a cumbersome double cap on returns to investors that has discouraged investment and those wishing to take up the form, concludes the report. The changes now put forward will be implemented in 2014, and will affect more than 8,000 CICs now on the public register, as well as those set up in the future.

  • For CICs permitted to attract private investment, there will no longer be an upper limit on the amount paid to individual shareholders. But the asset lock, which requires the majority of capital to be used to fulfill the company's social purpose will be retained, leaving 35% of profits to be freely distributed. This leaves "the combination of social mission and business purpose hardwired into the legal form," says Stephen Lloyd, senior counsel at lawyers Bates Wells Braithwaite, widely credited as the inventor of the CIC.
  • There will also be an increase from 10% to 20% in the cap on performance-related loans, which support CICs without share capital by linking the return to the lender to the performance of the business.

"These are very positive changes for CICs, designed to give them greater flexibility and become a model of choice for many social entrepreneurs," says the CIC Regulator Sara Burgess.

Floodgates, CICs and social finance

Currently around 22% of CICs are limited by shares. Within this group, 12% have adopted a legal form that allows them to pay dividends to private investors. But investor's earnings have until now been restricted by a 20% cap on the maximum dividend per share. The other 10% of CICs also limited by shares will not benefit from the new rule, as they are only allowed to make dividend payments to asset locked bodies including other CICs, and charities.

Removing the dividend cap is expected to bring about a gradual change in the way that CICs permitted to work with private investors are regarded by both entrepreneurs and the investment community. "Fundamentally, up until now, the CIC share structure has been impotent," says John Mulkerrin, co-founder of the CIC Association. "This is going to open the floodgates of retail social investment," he says. Tempering the expectation for an investment surge, "floodgates, CICs and social finance is a very optimistic view," says Lloyd. "It is nice to think of, but unlikely at this stage."

But there are hopes that it could become a 'best practice' model for social entrepreneurs and social mission organisations. "It gives them much more accountability. If we can provide a model that encourages people to move in that direction, I would love them to become the model for social purpose," says Burgess. "It could inspire a high street revolution in CIC and social enterprise development," says Gareth Hart, business adviser at Iridescent Ideas, explaining that many of the social entrepreneurs he works with were put off the form by the existing restrictions.

More deals

The maximum interest rate for performance related loans, where the return to the lender is linked to the performance of the business has been increased from 10% to 20%, which is expected to create benefits across the CIC spectrum, particularly for the 78% of CICs that are limited by guarantee. These CICs, which have no share capital and so cannot derive profit from shares, should now be better positioned to access finance through deals with social investors, according to Burgess. The cap increase means profit making CICs can attract social investors willing to structure 'quasi-equity investments' explains Mike Baker, director of operations and head of credit at Big Issue Invest, the social investment arm of the Big Issue.

These equity-type investments seek a return from a royalty on turnover or profit and are often applicable to companies limited by guarantee. But "to date if the most you could earn from an equity-type of investment in a CIC limited by guarantee was 10% there wasn't a lot of upside," he says. "Raising the cap to 20% is going to make performance related loans a more viable option." Stephen Lloyd believes there is "a real opportunity now for CICs to be a key part of driving forward the social enterprise market in this country". However, Baker warns that the recently announced changes are unlikey to lead to financial benefits across the board. "The changes would likely be most beneficial to CICs that have established a track record, proved themselves, and proved a model that can produce a return for investors, rather than early stage CICs," he says.

Burgess also acknowledges that the evolution of the CIC towards a social enterprise model that is capable of attracting investment could present a challenge for the CIC regulator in terms of making sure that the social mission remains the core purpose of the organisation. "We anticipate that the model will become more interesting to entrepreneurs and investors and are aware of the challenges this might pose in terms of maintaining the integrity of the model," Burgess says. "If the floodgates do open we need to make sure the companies are registering for the right reasons, and that we make sure they are being vigilant about the social purpose."

The model needs fine-tuning says Lloyd, but the new rules and resulting evolution of the CIC demonstrates its unique ability to develop and reinvent itself. The CIC has always benefitted from being plugged into company law, which enters the model into a constant process of renewal. "Governments reform company law on a regular basis, because it's seen as crucial to having an efficient business sector," Lloyd says. As a part of this process CICs are well placed to remain agile and up to date.

Lloyd also points out that the budgetary constraints that followed the recession in the UK, have encouraged the government to look to new players to provide public services. The CIC has been a model of choice for organisations "spinning out" of public sector bodies into the social enterprise landscape. "A well financed CIC sector is a crucial player in that space," Lloyd says.

CICs fit for export

As CICs have developed in the UK, and responded to challenges faced by the public sector, the model has begun to gain traction overseas. The CIC is currently being emulated in Nova Scotia, British Columbia and Australia. "Fundamentally, it is fit for export," says Lloyd, but fine-tuning both in the UK and abroad will be key to maximising the CIC's potential and appropriateness in different countries. "We do a lot of business with CICs now, and I think they are something for the future," says Baker. "No legal form should have a monopoly," says Lloyd, but the CIC is well poised to energise the social enterprise space in the UK and capture the attention of governments across the globe.

The new legislation is expected to be debated in Parliament in June 2014 and it is hoped that the changes will take effect in October.