What mighty charity investors could mean for social enterprise
Recent scrutiny of UK law has brought about the potential for changes to help grow the social investment market. Luke Fletcher, a partner at the law firm Bates Wells Braithwaite, explains why a new statutory power of social investment proposed by the Law Commission is an exciting prospect for charities, social enterprise and the future of social investment.
The trouble with a social investment made by a charity is that it is often neither fish nor fowl. It is not a grant and neither is it a traditional investment.
This can make legal categorisation difficult. When it comes to accepting higher social impact for lower risk-adjusted returns, I have seen eminent lawyers who are new to the idea think about it for a moment and say 'charities cannot do it'. Usually, it is possible to persuade to the contrary but the often intuitive legal reaction that it is impossible or somehow questionable illustrates the legal dilemma.
The result is that charity trustees often shrink back from social investment, even when it is the best way of advancing charitable objects and benefiting the public.
Against this backdrop, the Law Commission has provisionally proposed a new statutory power for charities to make social investments.
If the proposal is implemented, it will provide charities with a new power that should be beyond argument or dispute.
In April 2012, I made a submission to Lord Hodgson when he was conducting his Charity Law Review which argued for a statutory power. I argued that charities were a different sort of beast to other types of fiduciary investors - as charities exist for public benefit and can take informed risks with capital, where investment is likely to advance charitable purposes in some way – and this should be recognised in statute.
The paper ‘Ten Reforms to Grow the Social Investment Market’, authored by Stephen Lloyd and I in July 2012, repeated the argument. Thankfully, Lord Hodgson agreed. It seems that the Law Commission now agrees too...
A New Statutory Power
The proposal is for a power and not a duty. If the proposal is implemented, it will provide charities with a new power that should be beyond argument or dispute. It would remove the risk of challenge to which the Charity Commission's guidance on ‘Charities and Investment Matters’, known as ‘CC14’, is currently subject.
The proposals appear to have been warmly welcomed by the Charity Law Association and other interested charity lawyers.
A Platform to Innovate
To date, the most creative foundations have exercised leadership and have relied upon their own expertise, analysis and advice to show what is possible in social investment. This has meant finding new ways to advance charitable objects, often using hybrid financing instruments and financing techniques, such as revenue participation agreements, royalty agreements, conditional loans and repayable grants.
A power like this will be useful for foundations supporting and incubating pre-revenue social start-ups...
With the Law Commission's proposals, charities should be able to point to a clear statutory power as a platform from which to deploy these innovative approaches. The new power should embolden charity trustees to take informed risks where the 'mission benefit' - the benefit to the charitable objects - and the financial benefit justify an investment.
The proposed power that would extend not only to situations where some return on capital is expected but also to situations where only all or part of the capital is expected to be returned. This is a critical distinction as, in many social investment contexts, return on capital is hard to achieve and may not be expected. As a result, the proposed power is likely to apply in many more contexts than many people have realised.
A power like this will be useful for foundations supporting and incubating pre-revenue social start-ups and smaller social enterprises with some trading income and uncertain prospects. It will help those foundations who want to address the social enterprise investment readiness conundrum.
The Law Commission proposals are not perfect.
Ideally, the law on 'private benefit' would be clarified so that private benefit must be 'reasonable and proportionate' in investment contexts, where a charity is effectively acquiring something of value in a commercial exchange. There is a tendency at the moment for private benefit to be disregarded in mainstream investment contexts, such as investment on listed markets via established investment managers earning good fees, and for only minimal private benefit to be allowed in unlisted markets, such as investment by charities into social enterprises, which can cause trustees to feel less confident about social investing.
If a power is enacted, it will only be as good as the tax guidance from HMRC which underpins it. If Parliament creates a statutory power, HMRC will need to act to support it through the tax code.
Legal Leap Forwards
If the Law Commission confirms its proposals for a new statutory power, it will be a big legal leap forwards and should lead to the spread of innovative approaches to financing good things already being deployed by foundations. I never thought I would say it but... ...all power to the Law Commission!