In part three of four of our new blog miniseries on shared ownership in business, guest contributor Ged Devlin - Development Manager at Power to Change - explores how social investment can support the shared ownership business model.
Following on from the recent blog on The Case for Shared Ownership: Domiciliary and Care Work by our good friends at Social Investment Business, we wanted to look at the recent success of the Equal Care Co-op’s share issue and how social investment can support shared ownership.
In the case of the Equal Care Co-op, they are looking at a multi stakeholder approach, where as well as the supported members and the worker members, the investor and advocate members’ views are also represented. As ever, this shared issue is to raise the risk capital needed. Access to appropriate finance, at the right time and on the right terms, is an ever-present issue for start-ups in the social economy.
All enterprises, no matter how young or old, the stage in their life cycle, whether large or small, need capital. Co-operatives, community businesses, employee-owned business and mutuals (an organisation owned and controlled by its members) are not exempt from this. There is a requirement for long-term finance to enable growth, research and development, sustainability and to focus on new areas of activity.
In the UK, capital finance has been a problem for many co-operatives and community businesses - particularly for those within the start-up phase. Historically, many co-operatives were funded by cash deposited by members - before high street banks could meet this need. For example, in the retail sector, members kept their savings at the local co-operative, and could withdraw them as and when needed. This type of share capital – withdrawable share capital – is unique to co-operative and community benefit society legislation and has been in existence since the mid-nineteenth century. Prior to the consolidation of the retail and consumer co-operative movement, the Practitioner’s Guide to Community Shares estimated that in the 1930s there were over 1,000 local retail co-operatives with over 7.5 million members and a collective investment of over £135 million in share capital: the equivalent of £7 billion in current terms.
Following the initial high point of withdrawable share capital, co-operatives came to rely on capital coming from retained earnings which fuelled their reserves. Retained earnings take time to build up and are unavailable at start-up stage. This tendency to accumulate and draw on reserves contributed to start-up culture, initially bypassing the shared ownership sector.
Capital is referenced in several of the co-operative values and principles, including reference that the members of co-operatives contribute equitably to, and democratically control, the capital of their co-operative. At least part of that capital is usually the common property of the co-operative. The ICA Blueprint for a Co-operative Decade refers to the issue of co-operative capital, citing a need for it to offer ‘a financial proposition which provides a return, but without destroying co-operative identity; and which enables people to access their funds when they need them. It also means exploring wider options for access to capital outside traditional membership, but without compromising on member control’.
If co-operatives are beginning to consider looking beyond their traditional membership and their own corporate saving for forms of capital, they must find ways to do so which do not compromise control by members and sustain the benefits of shared ownership, notably the potential for distributive effects. When businesses look beyond reserves, the other sources of long-term finance are debt and equity.
Although we could say that, in the past, many organisations in the co-operative and mutual sector have favoured debt over equity, there is understandably also a wariness over indebtedness. 69% of employee owned firms carry no net debt, according to the Employee Ownership Association.
In relation to employee ownership, there are a few specialist providers of finance in the UK. Existing employee owned businesses generally need working capital and finance to acquire fixed assets. As with co-operatives, growth capital that can be problematic because this necessarily means issuing equity, and conventional equity can mean surrendering some ownership.
Many of the obstacles identified in relation to the emerging social investment market can be seen to exist in relation to co-operative enterprises and to employee-owned companies. There is a small market size, fragmented deal flows and lack of pipeline, a lack of standardised ‘off the peg’ deals, high transaction costs on products such as unsecured debt, and arguably a mismatch of supply and demand. Let’s take a look at some of the top obstacles:
- There is no shortage of capital, although making this accessible to a range of organisations is still a challenge
- There is a growing level of support and experience in accessing and using social investment by voluntary, community and social enterprises, although this is not universal
- The lack of pipeline and pre-investment support is a significant issue
- A high percentage of social investment to date has gone into secured lending, whereas demand is higher for unsecured lending
- There is a growing recognition that the binary view of grant and social investment is restrictive
- Funders looking to support social investment activities need to be clearer on their strategies better understand the market they are looking to build
- Culture around risk and taking on investment is still a barrier. We also need to focus on the lifecycle and the stage of development of the business when we talk about investment products and capital requirements
Social investment institutions have developed alternatives including quasi-equity and revenue participation, but most of these products are, ultimately, a form of debt. Indebtedness is a not a good form of risk capital, as it can be mechanistic and unforgiving. It does not always allow new, or established, enterprises to navigate the ups and downs of development. Additionally, where there are relatively high levels of profitability needed to repay debt, in some cases these could be deemed to be incompatible with the aims of the enterprise (there is, for example, the co-operative principle of limited return on capital, which can apply to both debt and equity) or tough to facilitate where a business model is marginal. Finally, dependent on the underlying assets of the enterprise, access to debt is often limited through the lack of available security.
Access to finance is a challenge facing employee-owned companies, but also one of the principal reasons why small businesses do not grow: their reluctance to take on external equity investment for fear of losing control of their business. Only 3% of small businesses have any form of external equity investment.
Historically, the co-operative movement has not favoured extrinsic investors. One of the main reasons why organisations in the wider social economy can struggle to compete with private enterprises is their lack of risk capital. The primary financial value of control to an external investor is the ability to sell the enterprise for a capital gain, which is straightforwardly incompatible with co-operative principles, and difficult to reconcile with ‘full’ employee ownership. There remains the question how much say in governance and stewardship, short of the right to sell, should be granted to external investors. The need to protect an enterprise from investors’, all too often, short terms aims has to be matched by protection for the investors from enterprise.
Taken together, these features of employee-owned companies make them more suitable for certain specialised types of financing. Employee-owned companies are, in general, less prone to volatility and fare better during economic crises, and employee engagement and participation enhances organizational performance. This could make them attractive to investors seeking to preserve their capital and earn stable, fixed returns – rather than speculative returns. Getting this demand and supply equation right is essential to increasing the supply of capital to community owned and socially responsible businesses.
The ask is for capital that is aligned to the social purpose of an organisation, money that is forgiving if things go wrong, and money that does not expect to extract value from social purpose the business serves. That is, in short, money that is long term and engaged. A type of equity is long-term, aligned with the interests of an enterprise and where there is no potential to speculate on a hypothetical futures market. This will be far more challenging to financial advisers than, say, a large charity bond, and will require a significant shift in investment practice. It is this kind of shift, however, that will free up the right kind of capital for the social economy to do what it does best: work to achieve social benefit.
This could be an opportunity for the shared ownership sector. However, this opportunity presents a challenge: identifying new business opportunities with the potential for growth and good returns for investors, which also generate significant value for all stakeholders, is extremely difficult. It is perhaps one of the most significant challenges in swift and effective development of the shared ownership sector. What are needed are the means to structure an attractive and fair deal to investors in co-operatives and employee owned enterprises, whilst, at the same time, respecting the contribution made by other members. The culture the ICA Blueprint asks for is one where people are free to invest in the things that matter to them, but don’t expect unrealistic, speculative returns. This is not an unachievable ambition, but it needs to be well-understood.
As with the opportunities that we highlighted in the domiciliary and care sector in last week’s blog, and throughout this miniseries, Social Investment Business is keen to explore the ways in which social investment can support employee-owned businesses, to help them to access to more patient, flexible capital, and to strengthen their resilience so they’re equipped with the tools and infrastructure to maximise their impact.
Ged Devlin is Development Manager at Power to Change.
Ged leads on the work of the Power to Change Foundation on their ‘Blended Finance’ Programmes. He has spent time working in the co-operative and mutual sector and helped establish new enterprises, developed existing businesses and – especially – engaged with organisations using new and innovative ideas concerning raising capital. Prior to working in the social economy, Ged worked on a variety of projects for corporate financiers and banks, before taking a break in order to study at the University of Law.