Social Enterprise Structures – Summary - Charlie Cattell Consultancy

INTRODUCTION

Organisations in the social enterprise sector can choose between a range of legal structures. There are a few slightly unusual structures that suit specific circumstances but the most common choice facing a new-start enterprise will be between: 

? a community interest company (‘CIC’)

? a [non-CIC] company limited by guarantee (‘CLG’)

? a [non-CIC] company limited by shares (‘CLS’)

? some form of registered charity.

This paper summarises the main differences between these options.

Social Enterprise

Note that the term ‘social enterprise’ is not defined in law and people may hold different views about what constitutes a legitimate social enterprise. So when deciding on the most appropriate structure for your social enterprise, one question to address is: who exactly are you trying to impress? Potential customers, who may be attracted to buying from a social enterprise? Social investors? Yourself and your colleagues in the enterprise? Potential grant-givers? Different stakeholders may hold different views about what features your enterprise should and should not have.

COMPANIES GENERALLY

First, a word about limited companies generally. All the first three options above and many charities are registered as limited companies, regulated under the Companies Act 2006. The written constitution of a company is called its ‘Articles of Association’. There are three primary types of limited company—

? a public limited company

? a private company limited by shares

? a private company limited by guarantee

In summary— 

? A public limited company (PLC) raises money by issuing shares to the public and is the normal structure for big corporations that are traded on a stock exchange. The structure is rare in the social enterprise sector, though it can sometimes be used for large capital-based ventures that wish to attract investment from their supporters. Successful examples include Traidcraft PLC (pioneer of the fair trade movement) which has almost five million shares in issue, most of which are held by some 5,000 individuals.

? A private company limited by shares (CLS) also issues shares, but only to people that it chooses. It cannot offer its shares to the public like a PLC. The CLS is inappropriate for purely non-profit organisations and is unlikely to qualify for much in the way of grants. The CLS is used for social enterprises that believe they can best raise funds by offering investors an equity stake – that is, investors receive part ownership of the enterprise in return for their investment (unlike someone who provides a grant or a loan).

? A company limited by guarantee is the most common form of incorporation for not-for-profit organisations of all types, including charities, and is also widely used by social enterprises and small co-operatives. Unlike the other types of company, CLGs do not issue shares at all. Instead of holding shares, each member guarantees a certain sum (usually a nominal ￡1.00) in the event of the company being wound up with outstanding debts.

Because the PLC is an extremely unusual choice for a new-start social enterprise, this paper focuses on the two types of private company, the CLG and the CLS. 

PRIVATE COMPANIES

Members of both a CLS and a CLG enjoy the benefits of limited liability, and the organisation has corporate status so it can enter into contracts and own property in its own name.

Because it has no shareholders who can take money out of the company as dividends or capital gains, the CLG will be the natural choice for virtually all not-for-profit organisations and many social enterprises. It is the only company form that can reliably hope to qualify for grant funding from most sources.

If a social enterprise believes its future lies in attracting equity capital rather than grants, the CLS may be a more appropriate option. Both types of private company may receive loans, so that’s not an influencing factor.

Objects clause

One thing that distinguishes a social enterprise from a conventional business is the inclusion of a statement of its social purpose in the company constitution: what’s known as the ‘objects clause’. While a company (other than a charity) will not generally be tightly bound by the objects clause, legally, its presence tells people about the underlying ethos of the company and it provides members and directors of the company with a moral compass against which to measure their actions. They should be able to justify all their operational decisions in the context of the company’s stated objects.

A conventional, for-profit private company will not normally have an objects clause within its Articles of Association.

CLG – EXTERNAL REGULATION

While the simple company limited by guarantee is a very common legal form for non-profit organisations and social enterprises, it is not always attractive to potential supporters because there is no statutory protection for the principles upon which the organisation was established. The members of a CLG can (in theory, at least) vote to change its constitution and switch it from ‘not-for-profit’ to ‘for-profit’, amend or remove its objects clause, or convert it from a social enterprise into a private business. This won’t happen if a majority of the members are opposed to it, of course, and there are many examples of CLG nonprofits/social enterprises that have flourished successfully for many years without compromising their principles; but it can still make some funders a little wary.

Consequently, an organisation that wishes to make a more robust statement about its social credentials, or one which is going to be heavily dependent on grant aid in the long term, is likely to consider registering additionally as a charity or as a community interest company. These are optional add-ons to the basic CLG structure which introduce external regulation of its non-profit features.

CLS – CONSTITUTIONAL RESTRICTIONS 

A private company limited by shares is inherently a for-profit enterprise: members (shareholders) can benefit from a share in the profits (dividends) and an increase in the value of their shares (capital gains). Therefore, without any refinement, a CLS will not be recognised as a social enterprise but rather as a conventional, privately-owned business.

Various methods have been developed to adapt the basic CLS structure to give it social enterprise characteristics, and these adaptations generally involve inserting special restrictive clauses into the company’s Articles of Association.

Limits on profit distribution

One of the key factors that differentiates a social enterprise from a conventional, for-profit business is what it may do with its profits. In a conventional company, 100% of the profits are available to the shareholders one way or another. Therefore one relatively straightforward constitutional amendment involves limiting the percentage of business profits that may be made available to shareholders either as a dividend or on dissolution of the company. Typically these provisions may set an upper ceiling of 50% of profits available for distribution (meaning that at least 50% must be reserved for the company’s social purposes), though that figure could be 25% or 60% or what have you.

There aren’t any rules here: it’s a matter of designing the company to suit likely future scenarios. Crudely, if the percentage of profits available to shareholders is set too low, it may be difficult to attract investors; but if it set too high, this may jeopardise its recognition as a social enterprise.

Mission lock

The organisation UnLtd (https://www.unltd.org.uk/) has developed something called a ‘mission lock’ for social enterprise share companies which they describe as having two elements, thus—

? A Social Purpose Statement written into governing documents: this means the venture’s social purpose is inserted into the objects clause of the venture’s Articles of Association. This redefines success for the venture and creates duties on its directors to make decisions in line with the social purpose.

? An Operational Commitment: a clause is included in the venture’s Articles of Association that ensures a substantial proportion of the venture’s operations are used to further the social purpose.

It may also involve a third element – entrenchment. To ensure that the first two commitments are secured in the long-term, a mission lock can be further reinforced.

The mission lock can be used by the venture itself to communicate its mission to stakeholders. It can also be used by stakeholders to hold the venture to account.

Entrenchment

The point about entrenchment is significant. Provisions which are written into a company’s Articles are protected to some extent, in that a higher than usual majority of votes is needed to amend them. However, they can be protected further, either by requiring a 100% vote of the members to alter them or – for even greater protection – by giving some external party (such as a sympathetic charity) a ‘golden share’ which gives them the power of veto over any proposed alteration to the Articles. These mechanisms may be seen as comparable to the external regulation described above for CLGs.

CLS – EXTERNAL REGULATION

A CLS cannot be registered as a charity. However, it may be registered as a CIC. A CIC CLS has statutory limits imposed on its power to distribute profits and assets to shareholders (an ‘asset lock’), it has something resembling a mission lock, and has an external regulator.

EXTERNAL REGULATION GENERALLY 

A CLS cannot be registered as a charity. However, it may be registered as a CIC. A CIC CLS has statutory limits imposed on its power to distribute profits and assets to shareholders (an ‘asset lock’), it has something resembling a mission lock, and has an external regulator.

EXTERNAL REGULATION GENERALLY

A primary issue to bear in mind is that both registered charity status and CIC status are forms of regulation. In return for submitting to a set of rules and external monitoring, certain privileges are made available. Crudely, charities are more heavily regulated and as a result, can expect greater privileges.

CICs are more lightly regulated and should expect lesser privileges. If an enterprise can get by satisfactorily without signing up for the added burdens of charity or CIC status, successfully raising the funds that it needs and enjoying good relations with its partners, then there’s probably no good reason to pursue either.

CHARITY VS. CIC

As a very brief summary—

? The charitable model is suitable for organisations that anticipate a lifetime of asking for money, in the form of donations, grants, bequests or what have you. The CIC is intended for organisations that will have primarily social purposes but will earn a significant proportion of their income from trading. CICs are often more likely to be financed through loans than grants.

? ‘Charity’ is an extremely well-recognised brand, whereas ‘CIC’ is little known outside the social enterprise sector.

? CICs may well face liabilities for taxes and business rates which charities don’t have to pay.

? CICs are better able than charities to reward their own directors financially, and generally have more freedom to be entrepreneurial.

? Founder members can far better protect their long-term stake and role within a CIC than they can within a charity.

CHARITABLE STATUS

Charities are not-for-profit organisation that are undertaking particular activities that the law has decided are in the public interest, and thus worthy of support from the public purse. A charitable company will be registered as a company limited by guarantee, as described above, but will also be registered with the Charity Commission (or OSCR in Scotland) in order to secure certain privileges. The primary reasons for seeking charitable status are usually financial.

Here follows a summary of the advantages and disadvantages of charitable status.

Benefits of charitable status

? Charities can access sources of funding which are unavailable to non-charities – in particular, charities can seek funds from a wider range of grant-giving trusts, and are likely to have more success in raising money from the private sector and the general public.

? Charities generally pay less tax than non-charities - particularly Corporation Tax, Capital Gains Tax, Stamp Duty Land Tax on property transfers - and can reclaim the tax from some donations given to them. They are not generally exempt from VAT. Businesses get tax benefits from charitable donations.

? Charities can use Gift Aid to claim back the income tax that individual donors have paid on the money they donate to the charity. Businesses don’t pay tax on profits that they donate to charity.

? Charities are eligible for statutory relief on Business Rates for property occupied (minimum 80% reduction).

? Charities enjoy a positive public image in many quarters.

Disadvantages of charitable status

? Charities are restricted in what they are permitted to do: they may only engage in activities which are legally recognised as charitable, which doesn’t include everything within the not-for-profit or social enterprise sectors.

? Charities are restricted in the type and scale of trading activities they are permitted to undertake (although we can use subsidiary trading companies to get round this problem).

? Registered charities must report to and are subject to the jurisdiction of the Charity Commission which can wield significant power over a charity’s affairs – including making trustees liable for losses to the charity in some circumstances.

? As a charity is a form of public trust, it cannot be owned by anyone in the way that a private company may be; and no-one (for example, a founder) can guarantee any long-term protection for their role or status within the organisation.

? Charities are subject to the Charity Commission’s strict interpretation of trust law, which requires that trustees (i.e. the management committee or board of directors) should not benefit unduly from the activities of the charity. The default legal position is that a minority of the trustees may be paid for doing occasional bits of work for the charity, but an employee cannot serve as a trustee unless the constitution specifically allows for this. It can be possible to persuade the Charity Commission to approve the inclusion of such a power though it cannot be guaranteed.

? In the eyes of some people, ‘charity’ may be associated with paternalistic practices, well-meaning amateurism, handouts etc.

? Registering as a charity is a one-way process – a charity cannot decide to de-register later if the advantages haven’t proved as useful as hoped (although in rare cases it may be possible to convert to a CIC).

To register or not?

(1) The motivation for registering or not often comes down to money—

? Where do you expect to acquire your funds in the long term? Do you need the fundraising advantages that charities enjoy? You may not, especially if generating income through selling a service rather than relying on grants and donations, or if financed exclusively by public authorities.

? Will you be making large profits, so that relief from Corporation Tax will be a major financial incentive?

? Do you need the guaranteed relief from Business Rates that charities enjoy in order to remain viable? The answers to these questions will largely indicate whether or not charitable status is likely to be beneficial.

(2) Another fundamental question is—

? Does your organisation actually qualify for charitable status? Not all organisations, however worthy, fall within the legal definition of charity (which is not as broad as is commonly believed).

(3) Where one or a few individuals have been instrumental in developing the ideas or services that an organisation is to put into practice, they will often identify strongly with those ideas and services and wish to ensure they have a long-term role within the organisation. A charity, as a public trust, is not a suitable structure to protect the interests of any individual. Committed founder members, therefore, need to ask themselves—

? Are we happy to hand over our ‘baby’ to a group of independent trustees, and effectively relinquish any guaranteed stake or role within the organisation in the longer term?

Alternative charity structure.

The charitable company – where an organisation is registered with both Companies House and the Charity Commission – has long been the ‘gold standard’ structure for a charity. Since 2013, an alternative has been available, the Charitable Incorporated Organisation. If you’d like to read a comparison of these two legal formats, please ask for my briefing paper.

CIC STATUS

The community interest company, or CIC, is a relatively new regulatory regime that can only be applied to organisations that are registered as companies (whether limited by guarantee or by shares).

Essentially, CIC status offers a degree of regulation for social enterprises that is less stringent than that applying to charities, but still protects the CIC’s assets in the hope that this will reassure its founders and potential funders and supporters. CICs are regulated by the CIC Regulator, an officer within Companies House.

The key features of CIC status are –

? CIC status is an overlay on one of the existing forms of limited company. An organisation registers as a company limited by guarantee, or as a company limited by shares (public or private) and – either simultaneously or at a later date – applies to the CIC Regulator for CIC status. (This is comparable to the situation of charitable companies, which are regulated both by Companies House and the Charity Commission.)

? It is not possible for an organisation to be both a CIC and a charity.

? A company must pass a ‘community interest test’ to register as a CIC, though this is not particularly demanding.

? The CIC is an ‘asset-locked’ body: it may not give its income or assets away, to members or to others, except to another asset-locked body (i.e. another CIC or a charity).

? CICs are subject to fewer rules than charities but do not at present have the financial benefits of charitable status, in terms of tax exemptions, rates relief and so on.

? As with charitable status, it is not possible to de-register. If a CIC is wound up its assets must go to another asset-locked body.

? A CIC which is a company limited by shares may pay dividends, but only up to prescribed limits.

? It is permissible and indeed normal for a CIC to pay its own directors (unlike a charity). Excessive salaries could, of course, be seen as a breach of the asset lock – a means of getting money intended for community benefit into the pockets of individuals. CICs are therefore required to “consider whether the particular level of remuneration paid to directors is justified in terms of the benefit to the community resulting from it”.

The Regulator has prescribed powers of enforcement that can be used if there are believed to be ‘matters of concern’ and intervention in the affairs of a CIC is ‘necessary to maintain confidence in CICs’. These powers include removing directors and confiscating assets. Without any power of intervention, regulation would be effectively meaningless; but the Regulator stresses that these powers will only be used when really necessary and there has been little evidence as yet of the Regulator interfering in the affairs of CICs. 

Benefits and disadvantages of CIC status

This degree of regulation and the lock on assets should, it was hoped, make a CIC more attractive than an unregulated company when it comes to awarding grants or contracts and so on. However, there is little evidence that funding bodies are favouring CICs over non-charitable, non-CIC companies. Most grant-givers who have historically favoured charities continue to do so and many do not treat CICs as their equals when it comes to eligibility for funds.

A CIC that is structured as a company limited by shares can claim social enterprise status but the very presence of shares will make many potential funders and supporters wary – shares have not traditionally been associated with the concept of ‘not-for-profit’ as they indicate at least some profit motive, even if there is a limit on the profits that can be distributed. Consequently, CICs limited by shares have found a lot of funding doors closed to them and a CIC limited by shares structure will normally only be selected if there is a very specific reason for wanting to issue shares to members/investors, and the company hopes to be self-financing without the need to regularly seek grant aid. I have a more detailed briefing paper on CICs which explains how shareholding is dealt within a CIC.

As a brand, CIC remains relatively unrecognised outside of the social enterprise sector. A survey of CICs reported, “principal reasons given for choosing the CIC form were those relating to demonstrating social purpose and distinction from the charity sector rather than ready recognition of the legal principles or the ability to raise finance”. Consequently, it is hard to identify many tangible benefits conferred by CIC status at present (though see the section on SITR that follows). However, registering as a CIC does make a very public and robust statement about the company’s long-term commitment to social outcomes, and the protection given over assets and income could be attractive to those founding a social enterprise and wanting to avoid its future subversion for private gain by individuals.

Social Investment Tax Relief

This scheme offers tax relief (income tax and capital gains tax) to people who invest in social enterprises and commenced in 2014. One thing the Government had to do, of course, was come up with a definition of social enterprise and they have decided that tax relief will only be available to investors in registered charities, Community Interest Companies and Community Benefit Societies. 

Thus we can identify at least one tangible advantage for a CIC over a regular company – it will be able to make use of Social Investment Tax Relief. The investment can take the form of a loan or the purchase of shares, so CICs limited both by shares and by guarantee may take advantage.

CONVERTING

A final consideration is the capacity of a company to convert to something else.

? A CLG is a very flexible vehicle that may, at some future date, convert to a CIC or a charity, if it is eligible.

? A CLS may apply for CIC status at some point in the future by changing its Articles of Association.

? A CIC limited by guarantee may convert to a charity if it is eligible, but it can never revert to being ‘just’ a CLG.

? A CIC limited by shares can’t convert to anything else.

? A charitable company is unlikely ever to be able to convert to any non-charitable structure. It is technically possible for a charity to convert to a CIC with the permission of the Charity Commission but the process comes with a convoluted legal safeguard. All the historic assets of the charity (money, property, equipment) have to be retained as a charitable trust held within the CIC, like a little charitable bubble containing everything that the charity owned before the conversion. The CIC is then a corporate trustee for that property. (A charitable company may convert to a CIO but that’s another form of registered charity.)

FURTHER INFORMATION 

If you would like to discuss the particular needs of your organisation, please contact me directly or look at my website: https://www.charliecattell.net/