Local wealth retention should be a cornerstone of a Big Society, says ResPublica's Winston Mak
Amid the threats of soaring energy
prices and global climate change, this is the time to go ahead with ‘Energy
Localism’
– community sustainable energy projects – which can stimulate local green
growth and motivate a ‘Big Society’. Unless you are lucky enough to have a
hidden goldmine in your community, it is often the financiers, not any business
angels, who can give an energy project the green light. A legal structure or company
model often carries too many implications.
No doubt that any community
organisation has to be incorporated with a legal form before it can seek
financing. For enterprises with social missions (e.g. social enterprises), the
government recognised in the early noughties that traditional legal forms pose
an obstacle to raising finance. Traditional vehicles like companies limited by
guarantee and charities are not allowed to raise equity which is often
essential for a distributed generation project that needs substantial
investment. Their weak brand makes financiers wary and increases the cost of
funds. Introduced in the previous decade, some ‘tailor-made’ legal vehicles
such as community interest companies (CIC), society for the benefit of the
community (BenComm) and bona fide co-operative (Co-op) under the umbrella of
industrial and provident society (IPS) are increasingly adopted by community
enterprises. Are these new models really a blessing for social entrepreneurs
when raising finance and tackling local sustainability agenda? The
answer is not that straight forward. It depends on the ‘bankability’ or
robustness of a community energy project.
Bankers desire stable and predictable
cash-flows at known risk. Equity funders require maximised returns to equity at
known risk with a pathway to exit or repayment within a determined horizon, say
5-15 years. If you benefit from the government’s feed-in tariff and renewable
heat incentive, your project will be awarded a higher score on bankers’ desks.
But the scale of a local energy project that is typically smaller than large
infrastructural projects remains a stumbling block due to the transaction cost
being relatively prohibitive. It seems that a CIC or BenComm, though featuring
social responsibility, “asset lock” and democratic governance, has not gained a
clear edge over other competing proposals in the City.
Community financiers are
looking for ‘robust’ energy projects which can offer competitive returns in the
commercial market whilst pursuing broader community benefits. To them,
an investment decision is more about the “substance” than the “legal form” of
the enterprise. For instance, even
if there is no “asset lock” in a company’s structure, funders will look for clear
policies regarding social objectives, power to borrow, dividends,
directors’ remuneration, shareholding and dissolution
in their governing documents, which reflect the distinctive
profile of a community renewable energy enterprise. In
some cases, funders may negotiate with the borrowers to set up a quasi “asset
lock” arrangement or a minority stake in their article. In the case of Co-ops,
they only lend to those with at least 51% of shares controlled by employees. Thus,
in fact, socially responsible financiers do look for the ‘substances’ which
characterise such new models as CIC and BenComm, rather than simply the
‘certificates’ from the FSA or Companies House.
Well, legal structures do matter in
terms of asset allocation – a determinant of the forecast rate of returns, in
the considerations of financiers. Particularly in the context of
community-owned energy projects, a Co-op allowed to distribute
all profits can, in theory, attract more private capitals
than BenComm and CIC. Both categories of
IPS guarantee community engagement, one-member-one-vote governance and to pay
interest on shares, but BenComm lures less capitals as all surplus from
business is not allowed to go for dividends. In CIC, no more than 35% of
surplus is distributable and the dividend per share limited to the Bank of
England base lending rate 5%. These
restrictions render CIC difficult to invest because the performance-related
income is too low in the eyes of financiers. If a CIC is mainly supported by
grants from local authority, the payback period is unattractive in the market. Therefore,
Co-op
tends to dominate in community
energy.
However, as I have already mentioned
in my previous blog, “Building a Co-operative Economy”, a co-op model is not as perfect as it seems. The trouble with the
Co-op status currently available is that a legal ceiling of £20,000 per-unit
investment in this vehicle means that a community energy co-op, which needs
millions of pounds of investment, must achieve very large size by number of
members. There may be a trade-off with the economies of scale enabled by much
larger investment units for many other traditional plc models. This is
obviously a ‘dead loop’ in company law that results in such financing
conundrum. Isn’t it justifiable that we need a new hybrid company model which
assimilates the features of plc into the existing co-op structure?
Don’t forget that all companies except
charities are liable to corporate tax. So when Downing Street is mulling over
any new company models, the mentality that has to be changed is that to fuel
local economic growth, more money should stay locally rather than go to the
taxman, unless the tax from social enterprises stay in the purse of local
authority (which is not the case today). Unlike traditional companies, a new
hybrid company model needs the capability to retain wealth for communities.
Local wealth retention should be a cornerstone of a Big Society.
A version of this blog first appeared in EG Magazine
(Volume 17, Issue 3) by the Global to
Local Foundation in January 2012.
As part of our mutuals and
co-operatives series, ResPublica will be hosting an expert panel to discuss the
above issues. 'Community Energy – Beyond the Big Six with Co-operative Solutions' will take place on Wednesday 11th July 2012.