BoE-Financing Social Enterprise Report

The Financing of Social Enterprises:
A Special Report by the Bank of England
Bank of England
May 2003
Domestic Finance Division

The Financing of Social Enterprises:
A Special Report by the Bank of England
May 2003
Bank of England Domestic Finance Division

Copies of this report are available from Bank of England Public Enquiries (020 7601 4878)
or the Bank of England Website www.bankofengland.co.uk
For further information please contact the authors, Hilary Brown and Emma Murphy,
at [name.name@bankofengland.co.uk].
ii
CONTENTS
EXECUTIVE SUMMARY OF KEY FINDINGS ................................................................................1
1 INTRODUCTION AND METHODOLOGY ..................................................................................5
2 IMPORTANCE OF FINANCE IN THE DEVELOPMENT OF THE SOCIAL

ENTERPRISE SECTOR ............................................................................................................8
Grant funding..................................................................................................................................................8
Potential benefits of non-grant sources of finance for social enterprises ..............................10
Other potential barriers to the development of the sector ..........................................................10
3 EXISTING RESEARCH ON THE FINANCING OF SOCIAL ENTERPRISES ................................11

How are social enterprises financed?....................................................................................................11
Do social enterprises experience difficulties in obtaining finance?..........................................12
Is there unmet demand for debt and equity finance? ....................................................................12
4 EVIDENCE FROM SURVEY OF SOCIAL ENTERPRISES – USE OF FINANCE ..........................14

Introduction ..................................................................................................................................................14
Methodology..................................................................................................................................................14
Profile of social enterprises surveyed....................................................................................................15
Demand for finance among social enterprises ..................................................................................18
Reasons for not seeking finance ............................................................................................................19
Type of finance sought ..............................................................................................................................19
Current use of debt finance ....................................................................................................................20
Terms of lending ..........................................................................................................................................22
Reason for borrowing ................................................................................................................................23
Change in demand for external finance ..............................................................................................23
Access to finance ........................................................................................................................................24
Future borrowing needs ............................................................................................................................25
Assets................................................................................................................................................................26
Additional evidence from banks on borrowing by social enterprises........................................27
Summary of key points from the research ..........................................................................................28
5 KEY THEMES EMERGING FROM CONSULTATION WITH SOCIAL ENTEPRISES

AND SUPPORT ORGANISATIONS ........................................................................................30
Grant dependency ......................................................................................................................................30
Cultural aversion to borrowing ..............................................................................................................30
iii
Lack of assets or personal investment ..................................................................................................31
Attitude of banks to social enterprises ................................................................................................31
Legal restrictions on borrowing ............................................................................................................32
Business support and investment readiness ......................................................................................33
Type of finance required ..........................................................................................................................33
Recognising social returns ......................................................................................................................34
6 SUPPLY OF DEBT FINANCE TO SOCIAL ENTERPRISES........................................................36

Methodology ................................................................................................................................................36
Mainstream banks........................................................................................................................................36
Specialist community banking units in mainstream banks ..........................................................38
Credit assessment ........................................................................................................................................39
Views on changing assessment techniques ........................................................................................41
Specialist lenders to social enterprises................................................................................................42
7 SOCIAL ENTERPRISES AND EQUITY FINANCE ....................................................................45

Methodology ................................................................................................................................................45
Characteristics of equity finance ..........................................................................................................45
Suppliers of equity finance ......................................................................................................................45
Current use of equity finance in the social enterprise sector ....................................................47
Constraints on the use of equity finance in the social enterprise sector................................47
Patient capital ..............................................................................................................................................49
Demand for patient capital ......................................................................................................................49
Supply of patient capital ..........................................................................................................................50
Share issues....................................................................................................................................................52
8 CONCLUSIONS AND RECOMMENDATIONS ..........................................................................57

Demand for debt finance..........................................................................................................................57
Supply of debt finance ..............................................................................................................................59
Equity finance ..............................................................................................................................................62
Venture capital..............................................................................................................................................62
Patient capital ..............................................................................................................................................62
Patient capital supply ................................................................................................................................62
Share issues....................................................................................................................................................63
Social auditing..............................................................................................................................................64
Annex 1 Organisations that contributed to the database of social enterprises ..................65
Annex 2 Consultees ..............................................................................................................66
iv
EXECUTIVE SUMMARY OF KEY FINDINGS
This report considers the supply of, and demand for, external finance for social enterprises
in the UK. The social enterprise sector, as defined by the Department of Trade and Industry,
is diverse and includes within it trading organisations of different sizes operating across a
range of activities and for a variety of purposes. As for any business, access to appropriate
sources of finance is a key factor in an enterprise’s development.
Demand for debt finance among social enterprises is limited both by the availability of
other, cheaper forms of funding such as grants, and by a cultural aversion to the risks
associated with borrowing. Good business support that takes into account the
distinguishing characteristics of social enterprises is necessary to make clearer the pros and
cons of various forms of external finance. The report suggests that those advising and
representing social enterprises might usefully highlight successful examples of borrowing in
appropriate circumstances and encourage social enterprises to consider the range of
available financial products.
Despite the limitations on demand, there is evidence that social enterprises, particularly
larger, more established organisations, use a range of external finance instruments supplied
by banks and other lenders such as Community Development Finance Institutions.
Borrowing is used for a variety of reasons, in particular to address cash flow difficulties (that
may arise as the result of grant payments made in arrears) or to purchase or develop assets.
Social enterprises are more likely than SMEs to have been rejected for finance, although the
majority of those rejected by one lender appear subsequently to be successful with another.
In addition, a large minority of social enterprises perceive access to external finance as a
major barrier to expansion, including some of those that have successfully accessed finance
in the past. While there is no one, clear reason to account for the higher rejection rates
among social enterprises than SMEs, this report explores possible contributory factors,
which include: lack of available security and personal financial stake; use of organisational
structures and grant funding streams with which lenders may be unfamiliar, and which may
result in lengthy arrangement times; some elements of credit and behavioural scoring;
reputational risk to the lender; and low levels of investment readiness among some
social enterprises.
There is little evidence of demand for, or supply of, conventional venture capital or business
angel finance to the social enterprise sector. Our research concludes that this is not as a
result of a market failure but is instead due to the specific characteristics of the social
enterprise sector, in particular the difficulty of providing a commercial financial return,
ownership issues and the lack of an exit strategy. Some social enterprises with appropriate
legal forms are able to access equity finance through share issues.
There is, however, evidence of demand among social enterprises for some form of ‘patient’
finance, particularly at the start-up or expansion stages. The term is variously defined to
range from ‘investment’ grants to products that are structured as debt or equity, where
investors are willing to accept lower, and in some cases uncertain, financial returns in
exchange for social outputs. Such ‘social investors’ currently include a number of grant
providers, charitable trusts, socially-motivated individuals and the public sector. Measures to
1
encourage supply of patient capital will need to be accompanied by efforts by the social
enterprise sector to promote suitable investment opportunities.
Key to tapping into a social investment market is the ability of a social enterprise to
distinguish and account for social costs and returns. Efforts to develop a method of social
auditing should be directed at meeting the needs of actual and potential investors, whilst
not placing too onerous a reporting burden on social enterprises.
Recommendations
On the basis of the evidence in the report we have identified the following measures as
potentially helpful in improving social enterprises’ access to finance.
Demand factors
● Social enterprise representative organisations and others involved in providing
support to the sector could usefully highlight successful examples of borrowing in
appropriate circumstances among their members or clients, and encourage social
enterprises to consider the range of available financial products.
● It would be helpful if the Small Business Service (SBS), devolved administrations and
Regional Development Agencies could ensure that mainstream business support
arrangements recognise the particular needs of social enterprises. Business Links and
their equivalents in the devolved administrations may need to reach beyond their
established business networks to ensure that social enterprises are aware of the
support available and feel confident about using it. This potentially has resource
implications for Business Links, including the possibility of outsourcing to specialist
agencies where appropriate.
● Public sector agencies, such as RDAs, which are seeking to promote social enterprise
activity, might expand their funding of new or existing social enterprises to support
research on the feasibility of a business idea.
● Building on existing financial awareness programmes could increase the level of

investment readiness among social enterprises. Those designing financial awareness
programmes, including the Small Business Service and the Social Enterprise
Partnership GB Ltd, could usefully involve lenders in the consultation and delivery.
● It would be helpful, in widening the awareness of alternative sources of finance for

social enterprises, such as Community Development Finance Institutions (CDFIs), if
the SBS, business support organisations, the Community Development Finance
Association (CDFA) and mainstream lenders were to provide more information and
guidance on access to these sources.
Facilitating supply
● To complement initiatives on widening awareness of possible sources of finance, and
to address the perception among social enterprises that access to finance is a barrier
to expansion, there is a parallel need to develop the sources of supply themselves. The
Government has committed to work with partners to increase the amount of money
available to CDFIs specialising in the social enterprise sector to on-lend. This could
include working with RDAs and private sector investors, to encourage take-up of the
Community Investment Tax Relief.
2
● Successful examples of joint lending between banks and CDFIs indicate that the CDFA
and mainstream lenders could usefully build on existing partnerships, particularly at a
local level, to encourage co-financing where appropriate.
● The DTI might usefully review the terms of the SFLG scheme as it applies to social
enterprises, and encourage CDFIs that lend to social enterprises to become approved
lenders under the SFLG scheme.
● It would be helpful if the DTI and the Social Enterprise Coalition were able, in
consultation with banks, to develop a clearer means of distinguishing social
enterprises from other borrowers. This would assist the banks in increasing their
understanding of social enterprise customers and in developing financial indicators
specific to the sector.
● The DTI might usefully consider establishing a brokerage service to facilitate the
arrangement of finance packages for social enterprises, operated at a local level by an
expert in the range of finance sources available to the sector.
● Banks may like to review their procedures for ensuring that broad policy intentions at
head office level related to lending to social enterprises are implemented effectively at
branch level and that incentives for local managers encourage proper consideration of
social enterprise applications.
● The British Bankers’ Association could usefully act as a source of information for
banks on social enterprises, building on the information already available on
their website.
● Grant providers, including the public sector, might usefully consider changing the
way in which grants are administered, so as not to impede the ability of social
enterprises to leverage in other forms of finance.
Patient capital for development

● If the Government wishes to expand the participation of private investors in the
financing of social enterprises, it may need to extend the availability of support, such
as subordinated matched funding, or tax relief, similar in concept to the CITR now
offered to investors in accredited CDFIs.
● Such initiatives would need to be accompanied by efforts by the social enterprise

sector, led perhaps by the Social Enterprise Coalition, to promote suitable investment
opportunities in individual social enterprises. For example, the Coalition might like to
consider working with interested parties to investigate the possibility of establishing a
‘social angels’ network to match social investors with social enterprises needing
investment, in the manner of business angel networks for traditional venture capital.
● The results of pilots, such as the Adventure Capital Fund and futurebuilders, should
provide more information on how the public sector can use innovative approaches to
fund social enterprises, which could be taken forward by Government.
3
● Promotion of successful examples of Social Investment in social enterprises should
help to encourage charities, trusts and foundations to consider investing in social
enterprises whose activities are in line with their own charitable objectives, either
directly or via specialist lenders. In addition, some large, successful social enterprises
may like to consider ways to invest in start-up or more recently established social
enterprises, similar to corporate venturing in the for-profit sector.
● In view of the regulatory and cost burden on social enterprises wishing to make a
public share offering, the Government and the Financial Services Authority might like
to review the current regulatory exemptions relating to share issues, in the light of the
particular characteristics of social enterprises.
● Current work to develop tools for social auditing should ensure that they meet the
needs of investors and provide a means of benchmarking performance.
General
● In view of the continuing developments in the social enterprise sector, the
Government might consider reviewing progress on access to finance for social
enterprises after two years.
4
1 INTRODUCTION AND METHODOLOGY
Context of the Report

1.1 The Memorandum of Understanding agreed between the Bank, HM Treasury and the
Financial Services Authority in October 1997 identifies, within the Bank’s responsibility for
the “overall stability of the financial system as a whole”, a specific responsibility for the
efficiency and effectiveness of the financial sector. This provides the basis for the Bank’s
interest and involvement in issues relating to financing arrangements for small and medium
sized enterprises (SMEs).
1.2 In addition to an annual report examining the financing environment for SMEs1 the
Bank has published a number of special reports, focusing on issues of specific interest and
concern. These include: “Smaller Exporters” (1998); “The Financing of Ethnic Minority Firms
in the United Kingdom” (1999); and “Financing of Technology-Based Small Firms” (2001).
Furthermore, following the report of the Government’s Policy Action Team 3 on Financial
Exclusion (PAT3) (1999)2, the Bank accepted a remit to assess regularly the provision of
finance to small businesses in deprived areas, which resulted in the publication of a special
report on this subject in 20003 and further analysis in subsequent annual reports4.
1.3 As part of its strategy for social enterprises launched in July 20025, the Department of
Trade and Industry (DTI) commissioned the Bank to review access to finance for social
enterprises.
“We will ask the Bank of England to review the provision of debt and equity finance to social
enterprises, including that offered by CDFIs, mainstream banks, business angels, venture capitalists
and others. Where there are gaps or barriers identified by the Bank on either the demand or the
supply side, we will take forward recommendations on how best to address them”6.
1.4 The Bank accepted this remit, which draws on, and extends, its existing work on issues
relating to SME finance. This report sets out the findings of that review.
Definition of social enterprise

1.5 For the purpose of this review the term ‘social enterprise’ is used to mean
organisations meeting the definition outlined by the DTI:
“A social enterprise is a business with primarily social objectives whose surpluses are principally
reinvested for that purpose in the business or in the community, rather than being driven by the need
to maximise profit for shareholders and owners”7.
1
See, for example, Bank of England (April 2003) Finance for Small Firms: a Tenth Report.
2
Some eighteen Policy Action Teams were formed in 1997 by the Government’s Social Exclusion Unit to
investigate aspects of social exclusion. The PAT 3 report was entitled Enterprise and Social Exclusion (1999) and
focussed on: access to finance and support services for small firm start-ups and continuing enterprises
operating in deprived areas.
3
Bank of England (2000) Finance for Small Business in Deprived Areas.
4
Bank of England (2002 and 2003).
5
DTI (2002) Social Enterprise: a Strategy for Success.
6
DTI (2002) op cit.
7
DTI (2002) op cit.
5
1.6 Within this definition, the DTI considers that a social enterprise will be pursuing one
or more of the following activities:
● Selling social or environmental goods and services (for example, recycling or childcare).
● Trading to provide (or cross-subsidise) social or environmental goods or services

(for example, the trading arms of some charities).
● Using processes or ways of working that have a significant social benefit (for example,
co-operatives, social firms and fair trade organisations).
1.7 Social enterprises, therefore, operate across a broad spectrum of activities and for
different purposes within the common objective outlined above. The purpose of this review
is not to reopen or engage in the debate on what constitutes a social enterprise but instead
to consider issues relating to access to finance for those organisations that fall within the
DTI’s definition.
1.8 As the DTI’s definition states, a social enterprise’s main objective is not to maximise
profits. It may find, therefore, that its objectives are not aligned with those of other agents in
the economy. For example, commercial finance providers are concerned with receiving a
financial return, commensurate with the risk involved. They have a responsibility to
shareholders (and their stakeholders more generally) to maximise profits and safeguard their
assets. A social enterprise will therefore have to demonstrate its financial sustainability,
rather than its social outputs, in order to access mainstream commercial finance.
1.9 The ‘double (or triple) bottom line’ of a social enterprise, incorporating financial,
social and in some cases environmental outcomes, is likely, as a matter of degree, to be
reflected in a higher cost base than that of a firm whose primary objective is long-term
profit maximisation. The social output may constitute a positive externality8 which benefits
more people than just the owners, clients or employees of the enterprise. The issue is how
the cost of those externalities is met and by whom. In some instances it may be possible for
the costs of the social activity to be met at least in part by the enterprise itself, through
cross-subsidisation from a commercial activity. In others, where the commercial and social
activities are integrated, the externalities may have to be paid for by those outside the
enterprise that have an interest in the social output.
1.10 These considerations provide the background for the analysis in this report.
Methodology and organisation of the report

1.11 The remainder of this report is organised as follows. Given that the report’s focus is
on access to finance, Section 2 sets out in more detail the importance of financing issues in
the development of the social enterprise sector. Section 3 then briefly reviews existing
research on the financing of social enterprises. In Section 4, we seek to augment this
research by reporting the results of an original survey of 200 social enterprises and a
matched sample of 123 small and medium sized enterprises (SMEs) on their use of loan and
equity finance. This research was conducted on behalf of the Bank by Taylor Nelson Sofres, a
market research agency specialising in business finance. The Bank has also sought to gain
first hand knowledge of the sector through consultation with a range of social enterprises
8
In economics an externality is defined as a side-effect on others following from the actions of an individual or
group. For example, the employment of previously unemployed people benefits not only the employees
themselves, but also society more generally through the reduction of benefits payments.
6
and their representative organisations, in some cases facilitated by the Bank’s regional
Agents. Section 5 reports the key findings to emerge from this consultative exercise. In
Section 6, we look more closely at the supply of debt finance to social enterprises. This
section draws on written responses from banks on their lending to social enterprises,
together with a series of structured interviews with banks on their credit assessment
techniques and with a number of Community Development Finance Institutions (CDFIs) that
lend to social enterprises. In Section 7, we move on to consider the provision of equity
finance to social enterprises, drawing on a wide variety of sources. Section 8 provides a
summary of the key conclusions drawn from the evidence and sets out our recommendations
for future action.
7
2 IMPORTANCE OF FINANCE IN THE DEVELOPMENT OF THE SOCIAL
ENTERPRISE SECTOR
2.1 Not all businesses will want or need to raise external finance. In aggregate small firms
have, in recent years, become markedly less dependent on external finance. According to
survey evidence, only 39.5% of small businesses sought external finance between 1997-999
compared with 65% in the 1987-90 period10. Others are financed through internally
generated funds or the personal equity of the owner-managers. Furthermore, in recent years
the total value of small firms’ bank deposits has overtaken their bank borrowings, so small
firms are now in aggregate net creditors of banks11. However, for many businesses,
particularly those that have growth ambitions and/or limited access to internal funds, access
to appropriate external finance is a crucial factor in their viability.
2.2 According to existing research (reviewed in Section 3 below), access to finance in one
form or another is cited by social enterprise survey respondents as the main barrier to
growth. This contrasts notably with the experience of most other SMEs. In a recent survey by
NatWest Small Business Research Trust, ‘regulation and paperwork’ and ‘general economic
climate’ were the two most important problems cited by small firms; access to finance was
rated as the principal problem by only 1% of respondents12. Of course, perceived constraints
on access to finance may in fact reflect other, underlying problems relating to the ability of
an organisation to generate income from trading, or to manage the business effectively.
However, the perception that access to finance poses difficulties for social enterprises is in
itself important, because it may affect their willingness to use appropriate forms of finance
at particular stages of their development.
Grant funding
2.3 Charities and voluntary sector organisations have traditionally accessed external
finance in the form of donations from members or supporters, or as grants from government,
European funds or charitable trusts and foundations. Some social enterprises start life as
voluntary sector organisations and develop a trading activity as an additional source of
income. This often means that they have experience in applying for grant finance and
consider this to be the most appropriate form of funding. Many commentators believe that
grants are essential to enable those social enterprises operating in difficult markets or
deprived areas to deliver services. They are often thought to be particularly necessary at
start-up. Walker (1995)13 believes that “initial grant support is essential for creating viable
community businesses, particularly in areas where finance and the skills required to build
successful businesses may be scarce.” In addition, access to grants may help social
enterprises at other stages of development leverage in commercial finance. Grant support is
especially welcomed when it is efficiently administered. Recent research by Durham
University Business School14 found that social enterprise respondents gave positive feedback
on the process of applying for and managing grants from charitable trusts and foundations.
9
ESRC Centre for Business Research, Cambridge, (2000) British Enterprise in Transition 1997-1999.
10
Small Business Research Centre, University of Cambridge, (1992) The State of British Enterprise.
11
According to data published by the British Bankers’ Association.
12
NatWest SBRT Quarterly Survey of Small Business in Britain (2002 Q4).
13
Cited in Smallbone, D., Evans, M., Ekanem, I. and Butters, S. (2001) Researching Social Enterprise Centre for
Enterprise and Economic Development Research, Middlesex University.
14
Shaw, E., Shaw, J. and Wilson, M. (2002) Unsung Entrepreneurs: Entrepreneurship for Social Gain University of
Durham Business School.
8
2.4 However, although grants have the clear advantage of being non-repayable, conditions
attached to them designed to ensure that the money is used for the purpose intended may
limit the capacity of an organisation to operate and expand or to leverage in commercial
finance. In our discussions with social enterprises and their representative organisations
(reported in more detail in Section 5 below), interlocutors highlighted a number of
difficulties with grant funding that may impact on an organisation’s ability or willingness to
seek debt finance.
● Some grants, such as the European Social Fund, are designed to reimburse recipient
organisations for actual expenditure, net of any income the organisation might have
generated via the project that has been funded. As a result, the organisation has no
incentive to make a surplus and is unlikely to be able to build up reserves or an asset
base with which to secure debt finance in the future.
● Grants often impose restrictions on the use of funds. Assets bought with Government
grants, for example, cannot be used as security for borrowing, because, in the event of
default, both the Government and the lender would have a claim on the asset. This
will have clear implications for an organisation’s ability to borrow.
● Grants are usually linked to specific projects rather than to core funding. There is
often a bias towards new ‘innovative’ programmes. This can encourage ‘mission drift’,
in which organisations adapt their operations in order to meet the funders’ criteria
rather than to fulfil the original social objectives or to develop a trading activity.
● Grant funding is often committed for a relatively short time period which can make
it difficult for the organisation to convince banks and other lenders that its income
is sustainable.
● Many grants are paid in arrears leaving organisations with large cash flow difficulties,
which, in extreme cases, can threaten their sustainability15.
● The application process for grant funding can be bureaucratic, requiring many
organisations to employ a full time fundraiser. The skills required in applying for grant
finance, where the social outcomes of the proposal are of principal interest to the
funder, are very different to those required in applying for loan finance, where the
ability to repay is crucial.
2.5 The constraints associated with grant funding have been recognised by Government.
The DTI, in its Strategy for Social Enterprises, concluded that “much grant funding in the
regeneration field has been unsuitable [for social enterprises] because the funding regimes
inhibit an enterprise approach”16. Some attempts are being made to improve the way in
which public sector grants are administered; for example the Home Office is responsible for
implementing the Small Grants Action Plan, which is designed to simplify and streamline
access to Government small grants by community groups. However, although the
Government recognises that, for some social enterprises, continued subsidy may be required
in order to cover the social costs of their business, its stated aim is to “decrease grant
dependency of social enterprises”17 by facilitating access to other sources of finance.
15
In some cases advances may be available (for example, the European Social Fund operates a system of cash
advances equivalent to 30% of the first year’s funding).
16
DTI (2002) op cit.
17
DTI (2002) op cit.
9
Potential benefits of non-grant sources of finance for social enterprises
2.6 The limitations of grant finance make it all the more important that social enterprises
are able to access fully the range of other external finance products used by the generality of
businesses. The possible benefits of non-grant finance for a social enterprise include, first,
the fact that debt and equity products can be longer-term than grants, allowing the business
more time to develop its trading strategy. Second, the process of applying for, and managing,
debt or equity requires a degree of financial discipline that can help to bring efficiencies to
an organisation’s activities. In some instances grant funding can, in contrast, discourage an
organisation from making cost savings, particularly if its funding will be reduced if it makes a
surplus, as described in paragraph 2.4. Third, the range of external finance products
available provides more flexibility to businesses than does exclusive reliance on grants.
Although grants have the advantage of not being repayable, there is an implicit cost in the
requirement on the recipient to prove to funders that their money has been used for the
purpose intended. With debt finance, as long as the requirement to repay is met, the
borrower has greater latitude to use the money to develop the business as he or she
considers appropriate.
2.7 It is interesting to assess whether use of non-grant sources of finance is correlated

with growth or profits of social enterprises. The survey of social enterprises summarised in
Section 4 indicates that demand for external finance is greater among larger social
enterprises and those with a higher proportion of income from trading. In contrast, of those
social enterprises with a turnover of under £50,000, a significantly higher proportion had
never sought external finance than had done so (37% compared with 18%). Similarly, social
enterprises with a high proportion of income from trading (over 75%) were significantly
more likely to have sought external finance than not, while those with under 25% of income
from trading were more likely not to have sought external finance than to have sought it.
The 10 organisations with turnover of over £5 million had all sought external finance. These
correlations do not, however, establish whether causation runs from size to use of external
finance or vice versa. There was, moreover, little correlation between those that had sought
external finance and whether or not they had made a profit.
Other potential barriers to the development of the sector

2.8 Although, as indicated by the survey results reported in Section 4, access to finance is
perceived by social enterprises to be a major barrier to growth, it is not the only factor
restricting the development of the sector. In the Bank’s survey, 32% of social enterprises
cited problems in obtaining external finance and 25% problems in getting grants as major
barriers to expanding their trading activities. However, other problems cited included lack of
qualified staff (14%); lack of appropriate premises (16%); and lack of cash flow (10%)
(see Chart 9). A lack of qualified staff was a difficulty cited by 10% of the matched SME
sample as well, but, for this group, the main barrier to expansion was lack of demand (16%).
Most interestingly, 16% of the SMEs interviewed said that there were no barriers to
expanding their trading activities, compared with just 1% of social enterprises. Clearly,
initiatives to improve social enterprises’ access to finance would have to be accompanied by
efforts to address the other difficulties encountered by social enterprises.
10
3 EXISTING RESEARCH ON THE FINANCING OF SOCIAL ENTERPRISES
3.1 Much has been written about the role of social enterprises both in the UK and
elsewhere. In addition, a number of mapping exercises in recent years have sought to
establish a profile of the activities of the sector in the UK at a regional or local level. In
many of these, issues relating to finance are raised as key concerns among social enterprises.
How are social enterprises financed?

3.2 The Government’s definition of social enterprise is becoming widely accepted and
although there is still some debate on detail, most commentators agree that an underlying
feature must be that a social enterprise must be generating at least some of its income from
trading activity. This means that a proportion of its financing needs can be met through
payment received for goods or services.
3.3 For those organisations that do not receive all of their income from sales of goods and
services, both research and anecdote indicate that much of the shortfall is made up with
grants, largely from local, regional or central government, or from the EU, such as the
European Social Fund (ESF). As Smallbone et al (2001)18 record, “most forms of social
enterprise require grant support during the start-up and initial trading phases, although the
extent of the required support varies”. Of 80 social entrepreneurs interviewed by researchers
at the University of Durham19, 39% said they received grants from Europe, 49% from regional
and central government and 33% from the local authority. This type of funding has often
been used to finance capital expenditure. In Bristol20, 104 social economy organisations21
reported that, while just over half their current expenditure was financed from earned
income, only 2% of capital expenditure was financed from this source. The two biggest
sources of capital expenditure funding among this group were found to be ‘other statutory
agency funding’ (including, for example, grants from Arts or Sports Councils) and local
authority funding. In addition, grants from other sources, in the form of voluntary
contributions, national lottery funding and funds from charitable trusts and foundations,
together made up 26% of their income by value. Social enterprises, particularly those
emerging from the voluntary end of the spectrum, are often adept at juggling a mixture of
sources of grant finance.
3.4 Existing evidence reveals some use of non-grant finance by social enterprises. Analysis
by Conaty (2001)22, based on 40 case studies, highlights examples of the use of non-grant
financial products by social enterprises, particularly loans by CDFIs and ethical share issues.
Smallbone et al (2001)23 found that more than half the organisations studied in their
research had secured “soft” loans24 and/or some form of grant for capital investment in their
early years, and several had obtained start-up loans from banks. Of 21 organisations
interviewed in Bristol, just under half had utilised non-grant finance (not only from banks
and CDFIs, but also from members and private individuals). They tended to be “organisations
established primarily for economic rather than social reasons eg co-operatives and
community enterprises.” There is also some evidence to suggest that demand for loan
18
Smallbone, D. et al (2001) op cit.
19
Shaw, E., Shaw, J. and Wilson, M. (2002) op cit.
20
Bristol City Council and the University of the West of England, (1999) Social Economy Bristol Audit.
21
Defined as trading and non-trading organisations with social, economic or environmental benefits.
22
Conaty, P. (2001) Homeopathic Finance – Equitable Capital for Social Enterprises New Economics Foundation.
23
24
The nature of the “softness” is not described by the authors, but “soft” usually refers to below-market rates of
interest, or the inclusion of generous capital and/or interest repayment holidays.
11
finance by social enterprises is increasing. The evaluation of Aston Reinvestment Trust’s pilot
loan fund for social enterprises (2002)25 includes evidence from four other CDFIs operating
in the UK, of which two reported large increases in the volume both of enquiries and
applications for loans. The evaluation concludes that “loan finance was seen as a viable
option and a cultural shift in approaches to financing social enterprises was beginning”.
3.5 Other research indicates, however, that loans and equity are still used less extensively
than grants and reinvested earned income, particularly by small social enterprises.
Only 2 out of the 40 small voluntary26 and social enterprise organisations consulted by
London Rebuilding Society27 reported having loans or overdrafts from banks. A report by the
Merseyside Social Enterprise Initiative28 concluded that “with current short term funding
and high grant dependency of the sector, it seems very few organisations are in a position to
consider this option [of loans]”.
Do social enterprises experience difficulties in obtaining finance?

3.6 Existing research cites some examples of social enterprises applying for certain types
of external finance and having difficulty obtaining it. For example, Smallbone et al (2001)29
found that “some of the borrowers from specialist support institutions told us that they went
to them after being turned down by a bank on status grounds…Access to finance was thus
the main issue, rather than the cost of borrowing, typically associated with problems of
raising sufficient collateral to secure the loan”. Several of the organisations interviewed in
Bristol reported problems in accessing loans and credit, which was attributed partly to a lack
of knowledge among the organisations themselves, and partly to the views and requirements
of the lenders. While some of the difficulties encountered by social enterprises are likely to
be similar to those faced by ‘for-profit’ businesses (SMEs), some additional factors have been
identified by commentators. For example, Robinson, cited in Westall (2001)30, highlights the
reputational risk faced by banks investing in social enterprises, namely that enforcing
repayment by a social enterprise would generate bad publicity for the bank.
Is there unmet demand for debt and equity finance?

3.7 Here, the evidence from existing research is mixed. On the one hand, access to
finance in one form or another is cited as the main barrier to growth in all surveys of the
sector. On the other hand, some studies indicate that social enterprises are reluctant to
borrow, and that a change in attitudes among managers and trustees will be required for the
use of external finance to increase.
3.8 The reluctance to borrow appears to stem from three main factors. First, there is
apprehension over what borrowing may entail. Many organisations are concerned about
putting community assets at risk by using them as security on a loan (Bristol 2002)31.
Elsewhere, objections were raised to the terms of borrowing, especially the requirement to
pay money in interest that could be put to what is perceived to be a better use. Although
overdrafts were used by organisations surveyed in Merseyside (2002)32, the cost was
25
Roger Tym & Partners and Enterprise plc (2002) Aston Reinvestment Trust: Evaluation of the Key Loan Fund.
26
Defined as having below 10% income from trading.
27
London Rebuilding Society (2002) From Rhetoric to Reality – A Report on London Rebuilding Society’s Stakeholder
Consultation Process.
28
Northwest Development Agency (2002) Merseyside Social Enterprise Initiative.
29
30
Westall A. (2001) Value Led Market Driven IPPR.
31
Chris Wardle Associates (2002) Bristol City Council, Investing for a Dynamic Social Economy in Bristol.
32
Northwest Development Agency (2002) op cit.
12
regarded as a disadvantage (“it costs us about £10k per year, which isn’t a bad salary for
someone”). London Rebuilding Society (2002)33 found that loans were regarded as a
constraint rather than a means to facilitate expansion or capital accumulation. Second, some
research points to a lack of business experience among management and trustees, which may
mean they are not confident about assessing the costs and benefits associated with debt or
equity finance (Bristol 2002)34. This may also be linked with lack of knowledge about
non-grant sources of finance; one third of organisations surveyed in Bristol were unaware of
sources of non-grant finance to social enterprises (Bristol 2002). Third, Westall (2001)35
identifies disincentives to borrowing arising from the availability of grants. Some small social
enterprises interviewed by the London Rebuilding Society36 asked why they should borrow
when grants were readily available.
3.9 Research on the use of equity finance by the sector is extremely limited. Community
Enterprise in Strathclyde (2002)37 identifies a latent demand for some kind of equity-type
finance. It suggests that this type of finance could be supplied by both the private and
public sectors, depending on the prospective financial returns. The Development Trusts
Association (DTA) (2002)38 puts forward a case for a fund to direct long-term investments
towards asset development as a means of creating a sustainable source of income for social
enterprises. According to the DTA such a fund is perceived to be necessary in the absence of
a widely available development grant fund.
33
London Rebuilding Society (2002) op cit.
34
Chris Wardle Associates (2002) op cit.
35
Westall A. (2001) op cit.
36
London Rebuilding Society (2002) Op cit.
37
Community Enterprise in Strathclyde (2002) Sharing in Success – Patient Capital for the social economy
in Scotland.
38
Development Trusts Association (2002) Investment in Community Enterprise: modern grant making for
sustainable renewal.
13
4 EVIDENCE FROM SURVEY OF SOCIAL ENTERPRISES – USE OF FINANCE
Introduction
4.1 In view of the lack of research and data on the supply of and demand for non-grant
external finance, the Bank of England commissioned a market research agency, Taylor Nelson
Sofres (TNS), to conduct a survey on the current use of finance within the social enterprise
sector. The survey covered a broad range of topics relating to finance, including social
enterprises’ use of different types of both debt and equity. It sought to ascertain whether
social enterprises’ experience of accessing external finance differed from the experience of
the small business market in general.
Methodology
4.2 The difficulties of defining the social enterprise sector and the lack of a
comprehensive register of organisations are the main challenges facing those interested in
researching the sector. In previous work, different techniques have been used to identify
social enterprise organisations, ranging from self-definition to setting a minimum
requirement for the proportion of income from trading. As it was not the Bank’s intention to
conduct a mapping exercise, it was decided to rely on existing lists of social enterprises
compiled by other organisations. We are grateful to the organisations listed in Annex 1 for
the help they gave us in identifying a sufficient number of social enterprises from which a
meaningful sample could be extracted. From this database of around 700 organisations, TNS
selected a random sample of social enterprises for interview.
4.3 Although all the organisations in the database had been defined as a social enterprise
by at least one source, the interviewers used screening questions to ensure that all those
interviewed met two basic criteria that most analysts agree are common to all social
enterprises. To qualify for interview an organisation had to have:
● at least some income from trading, or be intending to develop some income from
trading within the next year; and
● a defined social, community or environmental objective.
4.4 Using this definition the interviewers achieved their target coverage of 200 social
enterprises. Interviews (generally with the chief financial officer or person responsible for
finances within the organisation) were conducted by telephone in November 2002.
4.5 In order to establish whether social enterprises faced different issues from those faced
by different types of business in accessing finance, a sample of ‘for-profit’ businesses was also
interviewed, referred to throughout this report as the smaller and medium-sized enterprise
(SME) sample. This comprised 123 SMEs matched by numbers employed, age and sector to
the social enterprise sample. It should be borne in mind that, by matching the SMEs with
the social enterprises interviewed, the SME sample will not necessarily be representative of
the entire SME population. Furthermore, it is impossible to say whether the social enterprise
sample is representative of the whole population, given the lack of consistent information on
the size and profile of the sector in aggregate. It is likely that, by identifying potential
interviewees from existing registers of social enterprises, our sample may be biased towards
more established organisations. This is borne out by the results, which show that only 5% of
the social enterprises interviewed had been started after 2000.
14
4.6 Where possible, responses are analysed by the characteristics of the respondents.
However, the number of respondents in sub-groups of the sample is often low, so, where
sub-samples are referred to, data should be interpreted only as indicative of behaviour.
Profile of social enterprises surveyed

Size
4.7 The size profile of the social enterprises surveyed is outlined in Table 1. It is apparent
that social enterprises range from very small organisations to large operations with a
turnover of several million pounds. Most of the respondents were small organisations,
however, with 74% having fewer than 21 employees and 28% having 5 or fewer employees39.
Some 81% had a total trading income (or turnover) in the last financial year of under
£1 million, with 28% having turnover below £50,000.
Table 1: Size of social enterprise survey respondents
Size (number of employees) Annual turnover

1-5 28% Under £50,000 28%
6-10 25% £50,000-£100,000 10%
11-20 21% £101,000-£250,000 17%
21-50 11% £251,000-£500,000 17%
51+ 13% £501,000-£1 million 9%
Don’t know 3% £1 million-£2 million 6%
£2 million-£5 million 5%
£5 million-£10 million 3%
Over £10 million 2%
Don’t know 5%
Source: TNS.
Income from trading

4.8 Respondents were asked what proportion of their income was derived from trading in
goods and services, and those with no such income, either currently or prospectively, were
excluded from the survey. Trading income was defined to exclude grants, but to include
income from contracts to provide a service on behalf of a public or private sector
organisation. The majority (56%) of social enterprise respondents received over 50% of their
income from trading, and as many as 47% received over 75% of income from trading, but
some 26% of the social enterprises received between 1% and 25% of their income from
trading. Only 7 organisations among the 200 interviewed currently had no income from
trading but were intending to develop some over the next year.
4.9 Some 65% of social enterprises said that their income from trading had increased
over the past three years, significantly more than the 45% of SMEs whose trading income
had increased. Similarly, only 9% said their trading income had decreased, compared with
18% of SMEs.
39
Employment was measured in the survey by the number of full-time equivalents.
15
Age
4.10 The social enterprises interviewed were all relatively established organisations, with
only 5% having started operations post-2000. 44% had been set up after 1989. The majority
started trading in the same decade as they were established.
Sector
4.11 Social enterprises were operating across a wide range of sectors, as outlined in
Table 2. Respondents were able to give more than one answer if they were operating in a
number of different sectors. The most common sectors were education and
environmental/recycling businesses.
Table 2: Sector of social enterprise respondents
Sector Proportion of social enterprises(a)

Education 19%
Environmental/recycling 19%
Care elderly/disabled 15%
Training 14%
Childcare 13%
Media/arts 13%
Retail 10%
Other(b) 34%
Source: TNS.
(a) Social enterprises may be operating in a number of different sectors, hence the results do not sum to 100%.
(b) Other includes a wide range of activities, including ICT, consultancy, housing, catering, transport, counselling, workspace
management, leisure and design and print services.
Organisation type and legal structure

4.12 Social enterprises were asked to describe their organisational type from a list of
common terms40 (they could pick more than one category) and their legal structure. Results
are summarised in Table 3.
40
The terms used to describe organisational type were not defined by the interviewers. Broadly speaking, a
community enterprise tends to have a strong geographical focus servicing local markets and a development
trust is a community-based, multi-purpose organisation working for the regeneration of an area through
economic, environmental, cultural and social initiatives. The term social business might be used by a social
enterprise that wishes to emphasise its business activity. A social firm focuses on job creation and providing
supported employment opportunities for people with a disability or disadvantage in the labour market. A
co-operative is defined by the International Co-operative Alliance as an autonomous association of persons
united voluntarily to meet their common economic, social and cultural needs and aspirations through a
jointly-owned and democratically controlled enterprise.
16
Table 3: Organisational type and legal structure of social enterprise respondents
Type of organisation(a) Legal structure

Not-for-profit 49% Company limited by guarantee 69%
Voluntary sector 40% Company limited by share 10%
Co-operative 24% Industrial and Provident Society
(Co-operative)(b) 6%
Community enterprise 17% Industrial and Provident Society
(Society for the Benefit of the Community)(b) 4%
Trading arm of a charity 8% Sole trader 1%
Social business 6% Partnership 1%
Private company 6% Other(c) 8%
Development Trust 5% Don’t know 1%
Social firm 5%
Other 2%
Don’t know 1%
Source: TNS.
(a) These terms are commonly used to describe various organisational types within the social enterprise sector. Respondents self-defined
their organisational type from one or more of the options given, hence results do not sum to 100%.
(b) Organisations incorporated under the Industrial and Provident Societies Act and regulated by the Financial Services Authority can be
established as a bona fide co-operative or for the benefit of a designated community.
(c) Includes some respondents who described their legal structure as charity. Charities must have a separate legal form, so it is likely that
these organisations are either companies limited by guarantee, or unincorporated trusts or associations.
4.13 Social enterprise respondents were most likely to describe themselves as not-for-profit
organisations (49%) and/or voluntary sector organisations (40%). At least 50% of those
describing themselves as community enterprises, charities, social businesses, development
trusts or social firms also described themselves as not-for-profit organisations, although here
the sub-sample sizes are very small. Those describing themselves as co-operatives or private
sector companies were least likely also to use the terms ‘not-for-profit’, or ‘voluntary sector’ to
describe themselves. Overall, there were very few significant differences in the profile of
different types of organisation in terms of their age, size and sector.
4.14 As can be seen from Table 3, the great majority of social enterprises in our sample
were registered as companies limited by guarantee. Only 10% of the sample were registered
as Industrial and Provident Societies (although a much higher proportion used the term
‘co-operative’ to describe their organisation)41.
4.15 Some 60% of social enterprises interviewed said they had charitable status. A social
enterprise might choose to apply for charitable status to benefit from tax and business rates
relief and also to have a clear, social brand, with external validation from the Charity
Commission, to present to potential grant funders. Charitable status does, however, have
some disadvantages for trading organisations, notably the need to set up a separate trading
41
Two recent private members Bills have been introduced with the aim of updating and modernising Industrial
and Provident Society legislation. The Industrial and Provident Societies Act 2002 aims to provide protection
against the demutualisation of societies, while the Co-operatives & Community Benefit Societies Bill proposes
to modernise mutual law, by bringing it up to date with company legislation. This Bill also intends to give
Community Benefit Societies the right constitutionally to safeguard their assets to ensure that they are only
used to benefit the community that they were set up to help.
17
subsidiary for non-primary purpose trading42, and the need to comply with Charity
Commission requirements designed to protect assets for the beneficiaries of the charity.
4.16 The great majority of organisations describing themselves as ‘voluntary sector’ or

‘not-for-profit’ had charitable status. Whilst sample sizes restrict analysis, among community
enterprises, development trusts, social firms and social businesses the numbers of those with
charitable status were similar to those without. In contrast, some 94% of those respondents
describing themselves as co-operatives did not have charitable status43. Social enterprises
that generated 75%-100% of income from trading were significantly less likely to have
charitable status than those for which trading only constituted 1%-25% of their income. In
addition, of those social enterprises that had charitable status, a significantly higher
proportion did not use external finance than did.
Demand for finance among social enterprises

4.17 Social enterprises were asked whether they had ever sought any type of external
finance, which was defined as debt, leasing, hire purchase or equity finance from banks,
community finance lenders, business angels, venture capitalists or other lenders/investors,
including shareholders. Some 48% of the social enterprises surveyed had sought external
finance, somewhat lower than the 59% of SMEs which had sought such finance.
4.18 Demand for external finance was more prevalent among social enterprises with a
larger employee base (over 20 employees) and those with a higher trading income (above
£1 million). Social enterprises with a turnover of less than £1 million were significantly less
likely to have sought external finance than SMEs of this size.
4.19 Those social enterprises that had sought external finance also tended to have been
established for a longer period. Although the survey did not provide information on why this
might be the case, it could be that longer-established social enterprises feel more secure
about their ability to service debt, and have grown to a point where they need external
finance to meet working capital or investment requirements. Social enterprises operating in
certain sectors, such as media/arts and retail, were more likely to have sought external
finance (although here the sample sizes are small). This could be because some grants, such
as the European Regional Development Fund, are not available to retail businesses, and
because retail businesses, in particular, are more likely to generate a steady income stream
from which to repay debt. Furthermore, those social enterprises describing themselves as
co-operatives were significantly more likely to have sought external finance than those
describing themselves as voluntary sector or not-for-profit organisations. However, across all
types of social enterprise at least some of the respondents had sought finance.
42
Non-primary purpose trading occurs when the main or sole aim of the trading activity is to fund–raise and is
itself not directly related to the social aims of the charity. A charity is, however, allowed to carry out small
amounts of non-primary purpose trading itself; guidance is provided by the Charity Commission
www.charity–commission.gov.uk. The Cabinet Office Strategy Unity Report (2002) Private Action, Public Benefit
proposed that charity law be amended to allow charities to undertake all trading within the charity without the
need for a trading company.
43
Charitable status is only allowed for those Industrial and Provident Societies registered as Societies for the
Benefit of the Community, and not for those registered as co-operatives.
18
Reasons for not seeking finance
4.20 The reasons given by those that have never sought external finance differ between
social enterprises and SMEs. Responding to a list of possible reasons provided by the
interviewers, 90% of SMEs cited not needing to access finance as their main reason for not
seeking it. This is significantly different to the social enterprise sample, where only 56% gave
this as the reason. Factors also cited by social enterprises included a preference for grants
over debt finance, risk aversion by trustees or managers and not having enough income or
assets. Chart 1 summarises the responses.
Chart 1:
Reasons given for why survey respondents had not sought external finance(a)
56%
No need 90%
Prefer grant finance 35%

0%
Board members/Trustees 25%
won't take risk 8%
Not enough income 23%
2% Social Enterprises
Not enough assets 20% SMEs
2%
Executive mgmt won't take risk 20%
0%
Banks don't understand us 17%
2%
Legal restrictions 8%
prevent borrowing 0%
Other reasons 11%
6% Number of respondents: Social enterprise (SE) 102, SME 48
Source: TNS.
(a) Respondents were able to give one or more responses.
4.21 Social enterprises claiming they had not sought external finance because they had no
need for it tended to be those with a smaller employee base, a lower turnover, positive profits
in the last trading year and located in the voluntary or charitable sectors (and perhaps
therefore benefiting from alternative sources of income in the form of donations or grants).
Type of finance sought

4.22 For those social enterprises that had sought external finance, four types of financial
product were dominant: bank overdraft, term loan from a bank, term loan from a CDFI and
asset-based finance (leasing or hire purchase). The proportion of social enterprises that had
applied for a loan from a bank was very similar to the proportion of the SME sample that
had done so (Chart 2). Similarly, the proportion that had applied for asset-based finance was
similar between both samples. However, a significantly smaller proportion of those social
enterprises that had sought finance had applied for an overdraft compared with SMEs
generally. Possible reasons for this are discussed in paragraph 4.26.
4.23 A significantly higher proportion of social enterprises had applied to a CDFI for a
loan than among SMEs. Although many CDFIs target for-profit small businesses as well as, or
in some cases instead of, social enterprises, it may be that, at the present time, those that are
targeting social enterprises are better known among their potential customer base than
CDFIs are among mainstream businesses. As CDFIs do not exist everywhere in the country
19
Chart 2:
Breakdown of the financial products applied for by those respondents who had sought
external finance(a)
57%
Bank overdraft 74%
57%
Loan from bank 61%
33%
Loan from CDFI 10%
Share Issue 5%
4%
5%
Venture Capital 6%
Social Enterprises
Asset finance 27%
21% SMEs
Grants 4%
1%
Loans from local sources 6%
0%
0%
Mortgage 4%
5%
Other 7% Number of respondents: SE 96, SME 72
Source: TNS.
and often operate locally, location, which was not a matching criterion, might also explain
the difference in use of CDFIs between social enterprises and SMEs.
Current use of debt finance

4.24 Those social enterprises that said they had, on at least one occasion, applied for one
or more types of external finance (i.e. 48% of the overall sample) were then asked about
their current use of debt finance. Only 13% of these respondents currently had no debt
products at all, implying that 42% of the overall sample had at least one debt product at
the time of the survey. This compares with 51% of the SME population that had at least one
debt product.
Chart 3:
Breakdown of the debt products used by all survey respondents(a)
26%
Overdraft 41%
Leasing or HP 21%
17%
Secured loan 17%
16%
15%
Corporate credit cards 20%
9%
Unsecured loan 15% Social Enterprises
8% SMEs
Commercial Mortgage 9%
1%
Factoring/invoice discounting 3%
1% Number of respondents: SE 200, SME 123
Other loan 2%
Other type of borrowing 1%
0%
None of these 58%
49%
Source: TNS.
20
4.25 Chart 3 provides more details of the debt products used by social enterprises
(percentages are in relation to all survey respondents, including those who have never sought
external finance). As the chart illustrates, overdrafts are the most common type of debt
finance for social enterprises, used by 26% of the organisations interviewed. Use among
smaller social enterprises with a turnover of less than £1 million is slightly below the average.
Social enterprises describing themselves as co-operatives are more likely to use overdrafts
than are those describing themselves as voluntary sector or not-for-profit organisations.
4.26 While the use of most types of debt finance was similar among social enterprises and
SMEs, overdrafts were significantly less common among social enterprises than among SMEs.
Overdrafts will be particularly important for businesses in sectors with high working capital
requirements, but since the SME sample was constructed to be broadly equivalent to the
social enterprise sample in terms of sector, this is unlikely to be the explanation for the
difference in overdraft use. Other possible explanations include:
● Social enterprises appear in our survey to make more use of finance from CDFIs and
CDFIs are not able to offer overdrafts.
● Lower use of overdrafts by social enterprises corresponds with the lower demand for
overdrafts, evidenced by the lower proportion of social enterprises that had ever
sought an overdraft (Chart 2). This may indicate that the cost or nature of overdraft
finance may be unattractive to social enterprises.
● The finding that 41% of SMEs have an overdraft may not be representative of the
whole small business population. A survey conducted as part of the Competition
Commission enquiry into the provision of bank services to SMEs found that overdrafts
were held by 23% of SMEs44.
4.27 It is interesting to note that the use of leasing/hire purchase among social enterprises
was slightly higher than among the SMEs interviewed. Asset-based finance may be a useful
option for social enterprises operating in sectors where particular equipment, such as IT
hardware or vehicles, is required. The advantage is that finance is based on the asset
supplied and less on the track record or balance sheet of the social enterprise.
4.28 Those organisations surveyed that had a loan outstanding at the time of the interview
were asked who the loan was with. Compared with the SME sample, loans to social
enterprises had been obtained from a much wider spectrum of lenders (Table 4). This
included not only the range of high street banks and the former building societies but also
social banks, such as the Charity Bank, Triodos and Unity Trust, and CDFIs such as Industrial
Common Ownership Finance (ICOF) and the Local Investment Fund (LIF).
44
Competition Commission (2002) The Supply of Banking Services by Clearing Banks to Small and Medium-Sized
Enterprises Volume 2. The survey of 1,211 SMEs was carried out by BMRB on behalf of the Competition
Commission in September 2000.
21
Table 4: Providers of organisation’s most recent loan(a)
Social enterprises SMEs

Banks & Building Societies 63% 80%
Social Banks 18% 0%
CDFIs 12% 0%
Not specified 19% 12%
Don't know 0% 7%
Source: TNS.
(a) Respondents were able to name more than one provider if they had a debt package involving 2 or more providers, hence the results
will not sum to 100%.
Terms of lending
4.29 Respondents were asked about the terms of their most recent loan. Social enterprises
were more likely than SMEs to have a loan where the terms included either a capital or
interest repayment holiday (Chart 4). This does not appear to be a reflection of the greater
use by social enterprises of specialist lenders. The mainstream banks have also offered such
terms to social enterprise (and SME) respondents.
Chart 4:
Breakdown of repayment options attached to loans(a)
25%
26%
Social Enterprises
49%
19%
Capital repayment holiday offered
Interest repayment holiday offered
Neither of these offered
12%
Don't know
15%
SMEs
63%
15%
Number of respondents: SE 53, SME 41
Source: TNS.
4.30 For those firms that had a secured loan or commercial mortgage, social enterprises
had in three quarters of the cases provided a fixed charge over property or equipment,
compared with half of SMEs with secured loans or mortgages. Among both social enterprises
and SMEs it was less common to have provided a floating charge45. Although the numbers are
small and so should only be taken as an indication of behaviour, of those respondents that
45
A floating charge is a charge over the general assets of a company, which ‘floats’ over the assets until
crystallised or ‘fixed’ by some predetermined event, e.g. insolvency proceedings. A fixed charge is held over
specific assets, which the company cannot then sell without the consent of the secured creditor.
22
currently had a secured loan or commercial mortgage, a smaller proportion of social
enterprises had provided personal guarantees.
Reason for borrowing

4.31 While overdrafts tend to be used by businesses to fund working capital and cash flow
requirements, loans can be longer term and tailored in particular to capital expenditure.
Those organisations with a loan or a mortgage were asked why they had taken out their most
recent loan. The answers are summarised in Chart 5.
Chart 5:
Reasons given for most recent borrowing
To buy a building 32%

7%
To buy equipment 15%
27%
To cover cash flow difficulties 23%

15%
To expand trading activity 9%
4% SMEs
For working capital 15%
Refurbishment 6%
5%
Re-development 8%
2%
Other 4%
12%
Source: TNS.
4.32 Again, the sample sizes for this analysis are small and should only be taken as an
indication of behaviour. The most marked difference is the greater proportion of social
enterprises that said their most recent loan was to buy a building compared with SMEs,
despite the fact that the proportion of both samples holding commercial mortgages was
broadly equivalent (Chart 3). However, because respondents were asked about their most
recent loan, this may merely reflect a situation in which SMEs with mortgages had more
recently taken out loans for other purposes. SMEs were more likely than social enterprises to
have used their most recent loan to buy equipment.
4.33 It is likely that the greater use of loans for cash flow purposes among social
enterprises is connected to the payment of grant funds in arrears. Several of the CDFIs
specialising in the financing of social enterprises report that this is the main reason for
borrowing from them.
Change in demand for external finance

4.34 All those that had sought external finance were asked whether their use of external
finance had, over the past three years, increased, stayed the same or decreased. Chart 6
summarises the responses. Around half of social enterprises that had sought external finance
had increased their use of such finance over the last 3 years, compared with only 19% of the
SME sample. Furthermore, a significantly smaller proportion of social enterprises had
decreased their borrowings than among the SME sample.
23
Chart 6:
Breakdown of the change in respondents’ use of finance over the last 3 years
Social Enterprises 50% 27% 16% 7%
Increased Decreased
Stay about the same Don't know
SMEs 19% 46% 34% 1%
Source: TNS.
Access to finance
4.35 The survey indicates that social enterprises are significantly more likely to have been
rejected for external finance than SMEs, most commonly for loans and overdrafts from banks
(Chart 7). However, although on average less successful than SMEs, some 71% of social
enterprises that had sought external finance had never been rejected.
Chart 7:
Proportion of those organisations that had sought finance and been rejected
Social Enterprises 28% 71%
Have been rejected

Never been rejected
SMEs 10% 89%
Source: TNS.
4.36 While small sample sizes restrict analysis, those social enterprises that had at one time
been rejected for finance tended to be among those that made a loss in the financial year
prior to the survey. In addition, perhaps surprisingly, social enterprises reporting a larger
turnover and a larger employment base appeared to be more likely at some stage to have
24
been rejected for finance than smaller organisations. However, this may reflect that fact that
these organisations had been established longer and that their rejection had occurred some
time ago. Co-operatives were the type of organisation least likely to have been rejected.
4.37 Organisations were also asked why they thought they had been rejected. A range of
reasons were given, of which the most common (mentioned by seven social enterprises) was
the lack of collateral. Reasons given by two or more respondents included:
● No or insufficient collateral.
● Bank was too cautious.
● Bank would not lend to a social enterprise / a non-profit organisation.
● Banks not interested in social enterprises / in a small business.
● No track record.
● Bank did not believe our business plan.
4.38 This list should be interpreted with caution, given the small number of respondents.
However, as discussed in Section 5 below, the reasons given reflect commonly held
perceptions among social enterprises. Section 6 below discusses further possible reasons for
rejection, based on the views of lenders.
4.39 Those social enterprises that had been rejected were then asked whether they had
tried other lenders. Some 20 out of the 27 social enterprises that had been rejected had
subsequently applied elsewhere, of which 16 were eventually successful. Among SMEs, of
the 7 that had been rejected, 4 applied elsewhere and were successful. Thus, while the great
majority of social enterprises that had sought external finance had been successful, social
enterprises were more likely than SMEs to have had to shop around.
Future borrowing needs

4.40 A significantly higher proportion of social enterprises than SMEs were looking to
expand their trading activities in the next three years (84% compared with 63%). Those
social enterprises looking to expand said grants or retained surpluses were much more
important than debt or equity in financing such growth. Chart 8 summarises the findings.
4.41 Consistent with the findings of other research (Section 3), a large minority of social
enterprises thought that problems in obtaining external finance would be a major barrier to
expanding trading activity. Some 32% of social enterprises identified this as a constraint
compared with only 7% of SMEs (Chart 9). Of these 64 social enterprises, 31 had not
sought external finance in the past, 25 had successfully sought finance and never been
rejected and 8 had at some stage been rejected for external finance. It does not appear to
be the case, therefore, that the perception that access to external finance is a barrier to
expansion is correlated with having experienced difficulties in obtaining it in the past.
Section 5 below attempts to explore in more detail the reasons for this perception.
25
Chart 8:
Breakdown of the means with which respondents aim to finance trading expansion(a)
Grants 76%
19%
Retained surplus 57%

60%
Bank borrowing 33%

Raised from members 12% SMEs

0%
Leasing 10%
6%
Equity Investment 7%
8%
Source: TNS.
Chart 9:
Breakdown of the major barriers respondents see to expanding their trading activity(a)
Problems obtaining external finance 32%

7%
Problems in accessing grants 26%

1%
14%
Lack of qualified staff
10%
Lack of appropriate premises 16% Social Enterprises

2% SMEs
Lack of money/cash flow 10%
8%
4%
Lack of demand 16%
4%
The economy/market 6%
Source: TNS.
4.42 Asked whether they would be looking to expand their activities further if external
finance were more readily available, 64% of those social enterprises intending to expand said
they would. Even 42% of those social enterprises not currently looking to expand said they
would be prepared to do so if external finance were more readily available.
Assets
4.43 We were aware of concerns that the borrowing capacity of social enterprises might be
more constrained than that of SMEs, either because they had fewer assets to use as security
or because there were restrictions on the use of their assets. In fact, only a very small
proportion of social enterprises reported holding no assets at all (4%). The main assets held
26
were land or buildings owned (33%) or held on a long lease of over 20 years (29%), vehicles
(39%) and equipment (90%). This was similar to the SME sample, except that SMEs were less
likely to have land or buildings held on a long lease and more likely to have vehicles.
4.44 However, a significantly higher proportion of social enterprises said that there were
restrictions on the use or sale of their assets. Some 26% of those with assets reported such
restrictions, compared with 3% of SMEs, and a further 17% of social enterprises said that
there would be restrictions in some cases (against 3% of SMEs). The main restrictions cited
were:
● Asset cannot be sold or can only be sold to certain types of organisation.
● Significant restriction on use to which asset can be put.
● If asset is sold all or some of the profit will be due to someone else.
● The assets have to be used for charitable purposes.
● The organisation needs permission to sell the asset.
Additional evidence from banks on borrowing by social enterprises

4.45 In a separate exercise, banks were sent a list of 213 organisations compiled from
contacts within the social enterprise sector. For reasons of confidentiality this was not the
same set of social enterprises that participated in the Bank’s survey, although there may be
some overlap. The selection was random in terms of key characteristics of the organisations.
Eight banks were able to identify their own customers from the list. Information was
provided to the Bank in a way that protected customer confidentiality. The aim of the
exercise was to gain additional information on the terms and average values of loans to social
enterprises, and not in any way to establish the total amount of bank lending to the sector.
4.46 The main findings from this exercise are summarised below:
● From the list of 213 social enterprises, 163 were customers of the banks that supplied
information. Banks reported a total of £14.8 million held on deposit by these
organisations.
● Some banks were able to identify the size of their social enterprise customers, as
defined by turnover through their accounts. This revealed a very large range in the
sample in terms of size, from very small organisations with turnover of under £10,000
to large enterprises with multi-million pound turnover. For this reason a comparison
with published small business statistics is inappropriate. There was some indication,
consistent with the findings outlined in paragraph 4.18, that larger organisations were
more likely to have outstanding debt.
● Banks identified 35 customers with agreed overdraft facilities and 26 with outstanding
overdrafts at the time of the survey. The total value of outstanding overdrafts was
£1.3 million, of which around 60% of the total value of agreed overdrafts had been
drawn down. Average facilities varied from £20,000 to £105,000, while average
overdrafts outstanding varied between £2,000 and £63,000.
27
● Some 25 organisations had outstanding business loans, with a total value of
£14.0 million. Banks have indicated that this includes a few very large loans to large
social enterprises. Approximately 75% of loans by value had a residual maturity of over
10 years, which suggests most of them are commercial mortgages. The majority of
lending was at least partially secured.
● Banks supplied us with average margins on the overdrafts and loans identified. These
ranged between 2% and 4% over base. On average this is broadly in line with average
margins on small business lending, although, as noted above, this sample is not
exclusively composed of small social enterprises. Other data show that average total
interest rates on loans and overdrafts to all private non-financial corporations were
5.84% and 6.67% respectively in January 200346. These comparisons, though inexact,
do not suggest that the social enterprises in this sample are paying excessively high
rates for their borrowing.
Summary of key points from the research

● Around 40% of those social enterprises interviewed had some borrowing at the time
of interview.
● A smaller proportion of social enterprises than SMEs had ever sought external
finance. However, over the last three years, a substantially greater proportion of social
enterprises than SMEs had increased their use of external finance.
● Of those social enterprises that had not sought external finance, the primary reason was
that they did not need it. However, the proportion of social enterprise respondents that
said they did not need external finance was considerably lower than the proportion of
SMEs that gave this as a reason. Other reasons given by social enterprises included a
preference for grants and some risk aversion among management and trustees.
● Around 3 in 10 social enterprises that had applied for external finance had been
rejected – significantly higher than for SMEs.
● Ultimately, however, the majority of these subsequently obtained external finance by

going elsewhere.
● Social enterprises were almost twice as likely as SMEs to have negotiated loans with
capital or interest repayment holidays.
● Social enterprises made less use of overdraft finance than SMEs, although overdrafts
were still their most commonly held product.
● The majority of social enterprises were looking to expand their trading activities in
the next three years.
● Grants or retained surpluses were seen as the main sources of funding for expansion.
46
Bank of England (February 2003) Monetary and Financial Statistics. Private non-financial corporations
(PNFCs) are those which exist to produce goods and provide non-financial services. They are mainly public
limited companies, private companies and partnerships where these are distinct from their owners and not
owned by government.
28
● Problems in obtaining external finance were cited more often by social enterprises as
a major barrier to expanding trading activity than any other barrier, and such
problems were thought to be a constraint by a much greater proportion of social
enterprises than SMEs generally. This perception was not related to whether or not
the social enterprise had been rejected for finance in the past.
● Social enterprises appear to be paying broadly the same rates of interest as other
businesses in the economy.
29
5 KEY THEMES EMERGING FROM CONSULTATION WITH SOCIAL
ENTERPRISES AND SUPPORT ORGANISATIONS
5.1 In order to supplement the evidence provided by the survey reported in Section 4, we
also met a range of social enterprises and their representative organisations around the
country to discuss their views on finance for the sector. The outcome of these consultations
is summarised in this section.
Grant dependency
5.2 The survey found that a high proportion of respondents had some form of borrowing,
but that 76% of those social enterprises planning to expand their trading activities intended
to finance that expansion through grants, a higher proportion than for other types of
finance (Chart 8). As noted in Section 4, the sample of survey respondents comprised
relatively established, small to medium sized organisations, with 56% receiving more than
half their income from trading activity. Our discussions with social enterprises around the
country suggest that the use of grants is even more pronounced among smaller
organisations, particularly those that have their roots in the voluntary sector, many of whom
have not yet generated sufficient income from trading to cover the cost of their social
activities. While grants were usually considered to be an important means of financing an
organisation at start-up, and were, of course, cheaper than any external finance, there was
recognition among consultees that, in some cases, grants were restricting the organisation’s
ability to develop as an enterprise. However, for many, particularly those working with
disadvantaged groups or in difficult markets, grants continued to play a part in financing
ongoing social costs.
5.3 It was agreed that the transition from grant funding to debt finance was difficult. The
information required by grant funders, both in an application for funding and in terms of
the ongoing monitoring requirement, is based on the social outputs that the organisation is
able to deliver, such as jobs created for certain groups, or services provided in deprived
communities. Social enterprises report that some grant funders tend not to be interested in
any efficiency savings an organisation might make, and indeed, as mentioned above, in some
cases retaining funds to plough back into the business is actively discouraged. Lenders will
require an applicant to focus on its ability to repay debt, so social outputs will be much less
relevant than evidence of financial sustainability.
Cultural aversion to borrowing

5.4 It requires a fundamental change in mindset among the management and board of
the organisation itself to consider borrowing money, as opposed to receiving funding that is
not repayable (but which may be subject to other constraints). Many social enterprises told
us that their trustees were reluctant to consider borrowing as long as ‘risk-free’ money was
available in the form of grants. If the advantages of grants are thought to outweigh the
constraints that accompany them (outlined in Section 2 above), managers of social
enterprises will naturally tend to choose grants, and demand for loan finance will remain
relatively weak.
5.5 Among some social enterprises, particularly those providing services in deprived
communities that the private sector perceive to be unprofitable, there was an attitude that
they should not have to borrow, and that they ought instead to be compensated for their
activity through grants or public sector funding. In the view of these social enterprises,
30
payment of interest on a loan was considered to absorb funds that should more
appropriately be used to finance the core activity of the organisation or its staff costs.
5.6 Connected with this is the perceived risk that the organisation would be taking by
borrowing money. Among some social enterprises, particularly those with a strong
community presence and support, the fear of putting the organisation at risk of failure by
going into debt is strong. Where the decision to borrow resides with volunteer trustees who
are not necessarily very close to the daily running of the business, this concern may be
particularly acute.
Lack of assets or personal investment

5.7 There was a definite perception among social enterprises that a lack of assets for use
as security was a constraint on their ability to access bank finance. Many social enterprises,
particularly those in the early stage of development, did not have assets that could be used
as security. As discussed in Section 2, those that did have assets were sometimes constrained
in how those assets could be used, particularly if they have been transferred from the public
sector or purchased with grant finance.
5.8 Banks lending to SMEs generally expect to see some personal financial investment by
the entrepreneur. However, social entrepreneurs would normally not expect to invest their
own capital in a business, the primary purpose of which is not financial gain, although some
do. Lack of personal capital to invest in the enterprise was viewed by social enterprises as a
barrier in accessing finance. Many social enterprises would argue that this commitment is
demonstrated in other ways, for example by the amount of voluntary time and resources put
into the organisation (‘sweat equity’).
5.9 Similarly there was much unease among individuals running social enterprises that
borrowing from banks would require them to provide personal guarantees against loans. This
was considered to be an unreasonable request where the guarantor would not stand to make
substantial financial gain from the activities of the social enterprise (although, as the Bank’s
survey showed, some do provide such a guarantee).
Attitude of banks to social enterprises

5.10 A common criticism voiced by social enterprises was that “banks do not understand
the sector”. The lack of understanding was attributed in part to the fact that banks are
commercial organisations with obligations to depositors and shareholders, so their
motivations are very different from those of social enterprises. Other reasons given for the
perceived lack of understanding by banks related to the way in which social enterprises are
structured and to their funding streams, which, as discussed in Section 2, can be complex.
Banks with some specialism in lending to social enterprises were considered by some
interlocutors to be more flexible and receptive to the needs of the sector. CDFIs were more
likely than banks to be seen as supportive and to ‘put the time in’ to develop business plans.
They were also thought by some to be more likely to work with the social enterprise in the
event of it running into difficulties. Some social enterprises felt that banks had moved away
from traditional face-to-face relationship management and that this disadvantaged social
enterprises.
31
Legal restrictions on borrowing
5.11 Part of the reluctance to borrow among many social enterprises was attributed to
restrictions on the borrowing powers of certain types of organisational entity, and to the
belief that trustees will be personally liable for the loan. Restrictions on borrowing may exist
as a result of clauses in an organisation’s constitution designed to ring-fence its assets for
the social purpose for which it was established. In addition, the law limits the conditions in
which a charity may borrow. There appears, however, to be some confusion as to when such
constraints apply, and, in particular, in what circumstances individual trustees are liable.
Box A summarises the legal position.
Box A: Legal restrictions on charities’ powers to borrow

Many charities have a power to borrow set out in their governing document. Charities that
are not companies can usually rely on powers defined in legislation or implied by law.
Further guidance is available from the Charity Commission1. Before land can be
mortgaged, charities must obtain Charity Commission clearance under section 38 of the
Charities Act 1993, unless the mortgage is for the limited purpose of securing the
repayment of a loan to the charity and (usually) independent qualified advice has been
obtained. The advice must include whether the terms are reasonable, whether the loan is
necessary for the purposes the trustees have in mind and whether the charity will be able
to repay the loan.
Trustees’ liabilities
Charity trustees have a duty to act prudently and lawfully in administering the financial
affairs of a charity (and must act solely in furtherance of their given objectives and not
some other purpose). The legal position of charity trustees in an insolvency varies
according to how the charity is constituted:
● Unincorporated charities. Where the trustees have properly incurred a liability, but the
charity does not have sufficient assets to meet the liability, the trustees may have to
meet the shortfall personally, unless they have contracted out of that liability.
● Charitable Companies. Where a charity has been incorporated under the Companies
Act, the company itself is normally liable for the debts which the directors have
incurred on its behalf. Charitable companies are normally limited by guarantee and
the members of the company will have no liability for the debts of the company
beyond the – usually nominal – amount of their guarantee. However, if the company
goes into liquidation, the question arises whether the trustees have allowed the
charity to continue to operate at a time when they knew, or ought to have known,
that the liquidation was inevitable. If that is the case any trustee may be held
directly liable to creditors for any liabilities of the company.
● Furthermore, the trustees of any charity may be personally liable if their charity
suffers a loss as a result of their negligence, recklessness or deliberate wrongdoing
or by trustees applying monies of the charity for purposes other than set out in the
charity's objectives. However, incidences of such liability are rare.
1
www.charity-commission.gov.uk.
32
Business support and investment readiness
5.12 Investment-readiness was perceived to be generally weak by those advising social
enterprises, and even by some social enterprises themselves. The need to develop financial
and business skills among management and trustees was regarded as of particular
importance for social enterprises, as distinct from SMEs generally, because many managers
and trustees come from the voluntary sector and may not have previous business experience.
Provision of good quality business support for social enterprises should improve their ability
to access external finance.
5.13 It was clear from our consultations that good business support based on an
understanding of the social enterprise sector was considered very important, both to help
social enterprises develop a sustainable income from trading activity and to improve
investment-readiness. Many consultees did not consider support for social enterprises
among mainstream public sector business support organisations to be very satisfactory,
perhaps understandably given the size of the sector relative to the for-profit business sector,
although there are examples of successful initiatives in some areas. There is also some
evidence that social enterprises may not be very plugged into business networks47, which
may limit the penetration of the sector by mainstream support providers. Traditionally,
support for social enterprises has been provided from within the sector, for example to
co-operatives through a network of co-operative development agencies. The Government’s
Small Business Service (SBS) has made a commitment that Business Link Operators should
specifically consider the needs of social enterprises when formulating their business plans,
which could involve using specialist agencies from within the sector. One of the key training
needs perceived by consultees was to help social enterprises develop business plans that
finance providers would understand. This is one of the aims of a pilot financial awareness
training programme for social enterprises currently being developed by the SBS, to be
delivered through a partnership of Community Development Finance Association (CDFA)48
members. In some cases it was felt that, in addition to training, grant funding was necessary
in order to research the feasibility of a social enterprise business idea.
5.14 Some consultees felt that mentoring by successful social entrepreneurs would be a
good way of sharing experience among social enterprises themselves. The Cat’s Pyjamas is an
example of a successful practitioner-led training programme set up to enable other social
enterprises to benefit from the experience of the Liverpool-based Furniture Resource Centre.
Type of finance required

5.15 Some interlocutors had borrowed from banks and CDFIs. Borrowing was often for
working capital, particularly in order to bridge the gap before grant payments were received,
or to purchase assets, where the loan may have formed part of a larger fund raised from
grants and other sources.
5.16 However, among consultees, particularly at the smaller end of the spectrum of social
enterprises, it did not appear that demand for loan finance was very well developed. There
was a perception among some that the potential supply of loan finance was currently in
excess of likely demand. For the reasons outlined above, this was to a large extent attributed
to a lack of investment readiness in the sector, to risk aversion among trustees and to the
availability of grants. Some suggested that social enterprises needed a different kind of
47
For example, see Roger Tym & Partners and Enterprise plc (2002) Aston Reinvestment Trust: Evaluation of the
Key Loan Fund.
48
The CDFA is the trade association for Community Development Finance Institutions in the UK.
33
financial product from those that banks and CDFIs generally provide, which could align the
incentives of the investor and the investee, and in which returns to the investor could be
part social, part financial. The raises the issue of the need for ‘patient’ capital, which is
discussed at more length in Section 7.
Recognising social returns

5.17 In our consultations with social enterprises, it was clear that, alongside the wish to be
taken seriously as businesses by banks and others, there was a desire for the social benefits
and positive externalities of their activity to be taken into account when decisions on
finance were being made. For example, those social enterprises employing homeless or
long-term unemployed people referred to the saving to the public purse, as measured by the
benefit payments that would otherwise be made to their employees. We encountered
differences of views among consultees in relation to how the costs of their socially beneficial
activities should be met. Some social enterprises subsidise at least some of these costs
themselves with income from commercial trading activity, for example rents from managed
workspace. However, this is harder to achieve for social enterprises whose social activity
forms an integral part of the trading activity, e.g. those employing disabled people to make a
product. Some consultees felt that lenders ought to take into account the social as well as
financial returns. Others were of the opinion that grant providers or the public sector
should meet the costs of the socially beneficial activity so that any financial returns from the
enterprise could be maximised, which in turn would support demand for loan finance.
5.18 Some social enterprises produce social accounts (Box B). This is a transparent way
for a social enterprise to demonstrate the impact of its activities to stakeholders and
investors.
Box B: Social Accounting

Traidcraft, the UK’s largest fair trade organisation, has been publishing independently
audited social accounts since 1993, based on the auditing standards produced by The
Institute for Social and Ethical Accountability. It measures its social impact against
benchmarks agreed with stakeholders. The three core strands of Traidcraft’s strategy under
which it reports indicators of performance are: direct impact on poverty, influence on
others to trade, work and legislate to the advantage of the poor and sustainability of the
Traidcraft organisation.
The Furniture Resource Centre (FRC) Group is a Liverpool based social enterprise that
provides low-income households with furniture and recycles bulky household waste,
whilst employing and training long-term unemployed people. In March 2003, the Group
was awarded the ACCA/AccountAbility award for Best Social Report over private sector
organisations including GlaxoSmithKline and BP. It will publish its 5th set of social
accounts in September 2003. Through these social and environmental audits the
FRC Group tries to measure not only its social impact but also assess its influence on
policy makers and the environment. They are also used as a tool to aid strategic
management decisions, improve stakeholder engagement and increasingly play an
important role in bids for contracts.
34
5.19 There is, however, no one universally accepted method of social accounting;
Pearce (2003)49 lists eight different models in the UK alone. The process of social
accounting is evolving as it is used in different contexts, and co-ordinated efforts are taking
place, for example by the Social Enterprise Partnership (GB) Ltd50, to develop methods that
enable social enterprises both to prove their social impact and improve their performance.
Social returns are difficult to quantify in a way that facilitates comparison with other
businesses, both in the for-profit and non-profit-distributing sectors. In addition, the social
enterprise sector is extremely diverse and hence benchmarks within organisational types or
sectors may be more appropriate in some instances than across all social enterprise
organisations. The New Economics Foundation is currently adapting for the UK the concept
of Social Return on Investment (SROI), developed in the US, which aims to capture those
returns that are capable of monetisation (for example, reduction in welfare spend or
increase in taxes raised through increasing employment). Such an approach is intended to
enable organisations that may create little economic value but large social returns to provide
clear information to funders about the value created by grants or investments. The DTI has
said that “it is not the Government’s intention to make social auditing mandatory”51 but that
it is keen to see developed a better range of accredited tools, techniques and benchmarks to
measure and evaluate outcomes.
49
Pearce, J (2003) Social Enterprise in Anytown Calouste Gulbenkian Foundation.
50
This is a partnership consisting of Social Firms UK, the Development Trusts Association, Co-operatives UK,
the New Economics Foundation and Social Enterprise London, funded by the European Social Fund under the
‘Equal’ programme.
51
DTI (2002) op cit.
35
6 SUPPLY OF DEBT FINANCE TO SOCIAL ENTERPRISES
Methodology
6.1 The two preceding Sections have focused largely on factors relevant to the demand for
external finance, notably debt finance, by social enterprises. In this section, we turn in more
detail to the supply side. In order to assess the major influences on the supply of debt
finance to social enterprises, a written questionnaire was sent to those banks that provide
the majority of finance to small firms in the UK and to those banks specialising in the social
enterprise sector. This was followed by a series of structured interviews with credit policy
analysts, and, where appropriate, specialist community banking teams. Similar discussions
were held with specialist non-bank lenders to the sector. The first part of this section is
based on information from six ‘mainstream’ banks52. The second part reports evidence from
social banks and CDFIs53.
Mainstream banks
Bank lending policies
6.2 Banks manage their small business lending in different ways. All have centralised
credit teams that set policy and design credit assessment systems. However, the extent to
which decision-making authority over lending resides with a local manager differs between
the banks, and according to the size and age of the business. Policies vary from managerial
discretion using credit scoring as an aide, to referral of all applications to a central unit. In
most (though not all) cases, the judgement of the individual lending manager remains an
important factor in the decision process.
6.3 For most loans to small businesses, banks will make use of automated credit or
behavioural scoring systems designed to establish the businesses’ likelihood of default. For
small loans, the score is likely to be the primary decision-maker. However, the closer the
application is to the upper limit for the scorecard, the more likely it is that the score will be
used as a decision aid to a manager who will make the final decision.
6.4 As part of research conducted in 200254 the Bank considered the main criteria on
which local managers made lending decisions in the small business sector. Interviews with
19 bank managers employed by one major high street bank suggested that credit history,
past account management, the applicant’s willingness to invest his/her own money in the
business (particularly for start-ups) and evidence of repayment capacity based on a
business plan were judged to be the most important factors in assessing loan applications
by SMEs (Chart 10).
52
RBS NatWest, Lloyds TSB, Barclays, Halifax Bank of Scotland, HSBC and the Co-operative Bank.
53
Triodos Bank, Unity Trust Bank and Charity Bank, London Rebuilding Society, Industrial Common
Ownership Finance, Black Country Reinvestment Society, Social Investment Scotland, Local Investment Fund
and Aston Reinvestment Trust.
54
Brown, H. (2002) Finance for Small Businesses in Deprived Communities in Finance for Small Firms – a Ninth Report
Bank of England.
36
Chart 10:
Factors in assessing loan applications
Applications from established businesses Size of Loan
Start-up applications Age

References
Experience of applicant
Sector of business
Evidence of repayment capacity based on business plan
Availability of appropriate security
Credit history
Past account management
Whether applicant is an existing customer of this bank
Access to other sources of finance
Applicants' use of personal capital
100% 80% 60% 40% 20% 0%

Percentage of managers rating the factor as very important or essential
Source: Bank of England (2002).
6.5 These results have been confirmed through the structured interviews conducted as
part of the current review. Key criteria identified were the quality of the people running the
business; the track record (for existing businesses); the ability of the business to repay the
loan; and the financial contribution made by the owners of the business. These factors are
assessed through a combination of credit and/or behavioural scoring and discussions with
the applicant, although, as discussed above, the processes can differ between banks. One
bank, for example, makes extensive use of behavioural scoring in assessing applications from
existing customers, so that the decision whether or not to lend is based largely on the
business’ past account management.
6.6 Lending to start-ups is always more difficult than lending to established businesses for
the simple fact that there is no information on the performance of the proposed business.
For new businesses, therefore, the skills and experience of the entrepreneur become very
important, as does, for some banks, an analysis of the sector in which the business proposes
to operate. Three banks said that personal bank account behaviour of the entreprenuer is
used, in some situations, as a leading indicator of how the business’ finances would be
managed.
Banks’ policies on collateral and personal guarantees

6.7 All banks were keen to stress that they did not lend simply on the basis of security. It is
more important for both the customer and the bank to be sure that the business is going to
be sustainable and has the capacity to repay. Security, where it is available, provides an
additional safeguard to the bank. It cannot, however, substitute for a bad lending proposition.
6.8 Banks differ in their practice of taking security. Three banks said that it was standard
practice to take security on a business loan if it was available. Others lend unsecured up to a
certain amount but above these limits would generally ask for some security. The increased
use of credit scoring may be reducing banks’ reliance on collateral, to the extent that
Barclays Bank had indicated that 85% of borrowing applications (in numbers) from its small
37
business customers are now determined irrespective of whether security is available55.
Ram, Smallbone and Deakins (2002)56 found that, in practice, credit scoring was supporting
unsecured discretionary levels of lending of up to £35,000.
6.9 The Small Firms Loan Guarantee (SFLG) scheme is designed to assist banks in lending
to small businesses. Recent revisions to the scheme extended the number of sectors eligible
for the guarantee to include, notably, retail businesses. There remains, however, a scheme
requirement deriving from the Industrial Development Act 1982 that, to be eligible for the
guarantee, businesses must be receiving more than 50% of their income from commercial
activity. This may limit its use among those social enterprises for whom grants and donations
remain a significant part of their income.
6.10 From the consultation it appears to be fairly widespread practice for banks to ask for
directors’ guarantees on loans to limited companies, including (or perhaps especially) for
loans that are otherwise unsecured. Several banks said that a guarantee indicated personal
commitment to the business and was, therefore, viewed in similar terms to the owner putting
his or her own capital into the business. This practice was not universal, and again, there are
indications that increased use of scoring systems may be reducing banks’ recourse to
directors’ guarantees. It was acknowledged in the interviews that the requirement to provide
a personal guarantee might create difficulties for those people setting up social enterprises,
for whom financial gain is not the motivating factor.
Specialist community banking units in mainstream banks

6.11 In three out of the six mainstream banks interviewed, no special provision is made for
dealing with applications for finance from social enterprises as compared with applications
from other types of business. The remaining three banks have central units specialising in
community banking, including social enterprises, but also other types of organisation, such
as, for example, local authorities, housing associations or CDFIs. There are two different
models for these units. One model is designed to provide an advisory and educational
service within the bank, and to fulfil an external outreach role, rather than to replace the
normal lending channels. Under this model lending applications from social enterprises
would be dealt with in the same way as for SMEs, as described above. The role of the
specialist unit is to provide the local or central decision-maker with additional information
on the organisation or the social enterprise sector more generally, particularly in instances
where a standard credit assessment has not generated a clear positive or negative answer.
This model is used by many banks for other specialist areas, such as agriculture, technology
and the professions. In the second model, all applications from social enterprises are passed
to the specialist team to process. Banks advocating this approach believe that each
application should be assessed on a case by case basis, potentially using different techniques
to those used elsewhere in the bank. The success of both these models relies on the central
unit having a sufficiently high profile among the banks’ branches to ensure that applications
from social enterprises are referred to them. The system also relies on the local manager
recognising the applicant as a social enterprise and associating it with the work of the
specialist unit.
55
Bank of England (2003) Finance for Small Firms – a Tenth Report.
56
Ram M, Smallbone D, and Deakins D, (2002) Ethnic minority businesses in the UK: access to finance and business
support British Bankers’ Association.
38
6.12 The establishment of these specialist units is relatively new and their impact has yet
to be assessed. Their success will depend on their profile both within their own organisation
and within the social enterprise sector. One bank with a specialist team said that, currently,
deal flow was low. At the moment, the impression of some in the social enterprise sector is
that interest and good intention at head office are not necessarily reflected in greater
appetite for lending at branch level. However, the creation of these specialist teams is an
indication that some banks consider the social enterprise sector to be sufficiently important
to dedicate resources to it as part of a broader community banking agenda.
Credit assessment
6.13 The following issues were raised by banks in the course of the consultation as reasons why
social enterprises may find it harder than other businesses to fulfil credit assessment criteria.
No personal equity
6.14 The majority of banks confirmed that the lack of a personal financial stake by the
social entrepreneur in his or her enterprise could make it more difficult to pass conventional
assessment criteria. Some banks did, however, say that recourse to personal guarantees for
small amounts of lending was increasingly rare, as they were difficult and costly to put in
place and to enforce.
Understanding legal and organisational structures

6.15 Social enterprises often maintain that banks find it difficult to understand their
structures and to identify the way in which surpluses are used and accounted for. While
some banks admitted this could be an issue, others felt that it was no more complicated than
lending to charities or other types of business, and was not, in itself, a reason why social
enterprises might find it more difficult to borrow.
Box C: Key features of a Community Interest Company (CIC)

The CIC was proposed by the ‘Private Action, Public Benefit’1 report as a new form of
company. The aim is to create a strong identity for social enterprise that can be easily
understood by investors and others. CICs will be easy to establish, with the flexibility and
certainty of the company form. They will be registered as companies in the usual way, but
with an additional requirement to demonstrate that they will operate for the community
interest. The CIC form has some special features to ensure that it will use its assets and
profits for the benefit of the community. A CIC will report to an independent regulator on
how it is delivering on that commitment, and on how it involves stakeholders in its
activities. A CIC structured as a company limited by shares will be able to issue modified
preference shares.
A technical consultation is underway, details of which can be found on

http://www.dti.gov.uk/cics/.
1
Cabinet Office Strategy Unity Report (2002) Private Action, Public Benefit.
39
6.16 An associated difficulty raised by banks in connection with lending to charities as well
as to social enterprises is establishing the form of governance. In the case of a conventional
SME, it is usually very clear who has taken out the loan and who makes decisions about the
business. However, in an organisation governed by a board of trustees or similar body
comprised of volunteers (perhaps with a relatively high turnover and little or no personal
financial stake in the enterprise) it may be more difficult to identify who is responsible for
running the business and repayment of the loan.
Reputational risk
6.17 A number of banks said that, in addition to the usual risks associated with lending,
providing debt finance to social enterprises can also entail significant reputational risk. This
is the risk that, in the event of the social enterprise running into difficulties, the bank would
be seen as responsible for its closure, should it call in the loans or realise any security
pledged. Where a social enterprise has strong community support, this could generate
extremely bad publicity for the bank.
Arrangement time
6.18 Banks identified two main reasons why loans to social enterprises may take longer to
arrange than for other types of business. First, social enterprises that are based on member
or community involvement may need to consult their members and trustees at meetings that
might take place infrequently. In such cases, a large number of people have to agree to
taking on a loan on the terms proposed. Second, it is more common with social enterprises
than with conventional SMEs that an application for a bank loan may form only part of a
larger package of finance, comprising a range of funding sources. Sometimes one source of
finance may be dependent on the commitment of another, and co-ordinating both the
timing of the package and the demands of a number of different funders can take time. This
could, potentially, discourage a bank manager from becoming involved, particularly if he or
she is incentivised on the basis of the number or value of products sold.
Financial expertise within social enterprises

6.19 Most banks felt that, in general, financial expertise among social enterprises was weak.
Where the social enterprise has been established to meet social rather than financial
objectives, the financial side of the operation may not necessarily be seen as a priority. In
addition, those with expertise in applying for grant finance will be more familiar with writing
a plan based around social, rather than financial, outcomes. One bank said that initial
applications from social enterprises were often as much as 95% geared towards the social
objectives and 5% about the financial position of the business. This concern about
investment readiness mirrored, to some extent, views expressed to us from within the social
enterprise sector.
Terms and use of grant finance

6.20 Social enterprises that are largely grant-funded are likely to experience irregular large
receipts through their accounts. One bank said their account behaviour analysis indicated
that regular payments in and out of an account are correlated with low rates of default, so
that a grant-funded organisation would be rated as having a higher risk of default than
organisations with a more even flow of trading income and expenditure.
40
Peer group comparisons
6.21 Behavioural scoring systems include comparisons of the applicant’s account
behaviour against that of other businesses in the same sector. As banks are unable easily to
identify their social enterprise customers, social enterprises are likely to be assessed against
for-profit businesses. One bank identified the difficulty of assessing an application from a
social enterprise that is deliberately seeking to fill a market gap by providing services at
below-market prices to under-served groups or communities. A comparison with primarily
commercial businesses operating in a similar sector may identify the social enterprise as a
‘weak’ performer, because selling at below-market price will depress its income relative to
outgoings. Similarly any social enterprise with a higher cost base (for example if it achieves
its social objectives by purchasing more expensive inputs or employing a less productive
workforce) may also appear to be a ‘weak’ performer relative to its peers.
Public sector contracts

6.22 In assessing a business plan banks will consider the sources of income, and where
these are grants or contracts, the number and committed length of the agreements. Longer
contracts and a diverse range of clients are viewed favourably. Many social enterprises, as a
result of the sectors in which they operate or the objectives they are established to meet, are
contracted to provide a service on behalf of the public sector, with the result that they may
only have one customer, who in some cases dictates the price the enterprise is able to charge.
Limited company status

6.23 One bank said that their credit scoring systems identified incorporated small
businesses as having a higher probability of default than sole traders or partnerships. As
noted above (Table 3 on page 17), 89% of the social enterprises surveyed were incorporated
as limited companies or Industrial and Provident Societies. This contrasts with the business
sector as a whole, in which 77% of enterprises are unincorporated57. This will only be one
factor among the range of criteria on which a loan application is assessed, but means that,
for this bank at least, all other things being equal, a limited company will be judged as
higher risk than a sole trader or partnership.
View on changing assessment techniques

6.24 Clearly, banks are commercial businesses with responsibilities to depositors and
shareholders. They have designed credit assessment techniques that for the generality of
businesses identify viable, profitable lending prospects. One bank interviewed said that it
was through their financial expertise that banks could provide the most ‘value-added’ service
to social enterprises, by helping them establish whether a loan is the right option, based on
their experience of lending to other businesses.
6.25 However, the results of the survey summarised in Section 4 above show that
applications from social enterprises that are rejected are often later accepted by another
lender. This could indicate that what is perceived to be a bad lending proposition by one
lender can later be reassessed as a good one by a different lender. It may be that this is the
result of efforts on behalf of the applicant to improve or revise their proposal, perhaps on
the basis of feedback about the reasons for rejection. It may also be that lending techniques
employed by some banks are better suited to assessing applications from social enterprises
than others, or that practice differs within a single bank. For example, successful examples of
57
Source: Small Business Service (2001) www.sbs.gov.uk.
41
lending by banks to social enterprises have sometimes occurred as a result of the personal
interest and commitment of an individual bank manager or specialist unit.
6.26 The objective of a specialist unit within a mainstream bank is to build up greater expertise
and thereby overcome some of the barriers to finance considered above. Such expertise should
facilitate banks’ understanding of the range of funding streams available to social enterprises and
enable them to take into account income from subsidies and grants where commercial income
streams are subdued due to difficult markets. An alternative, or complementary, technique
currently being explored by some banks to reach higher-risk business customers is to work
through, or in partnership with, CDFIs and specialist banks. These relationships are managed in
different ways. Banks are major funders of CDFIs, and some are testing the commercial viability of
CDFIs by providing loan finance, as opposed to donations; for example Barclays has lent to Aston
Reinvestment Trust. NatWest has a network of regional Community Finance Funds, capitalised
through its Community Bond, which invest in local projects that are not yet bankable. Bank of
Scotland has provided seed funding to The Big Issue to develop BIGinvest, a wholesale
intermediary that will lend to CDFIs and large social enterprises. In other cases the provision of
finance or a guarantee to a social enterprise by a CDFI or social bank enables the enterprise to
leverage in additional finance from mainstream banks.
Specialist lenders to social enterprises

6.27 We spoke to three ‘social’ banks that have objectives to support in some way social or
environmental businesses58 and to six CDFIs59. These lenders may differ in their target
customers and methods of operating, which may reflect whether they themselves operate as a
commercial business, non-profit-distributing organisation or charity. However, they have a
number of characteristics in common that distinguish them from the mainstream banks.
● They take explicit account of social or environmental criteria in judging whether or

not to lend to an organisation (although an application will not be approved on social
grounds, if, on financial terms, it appears not to be viable).
● Less use is made of credit scoring systems than in mainstream banks, and decisions
are taken on a more bespoke basis. More time is spent working with organisations to
understand their operations and to mould applications into a form that meets the
lenders’ criteria.
● Some specialist lenders have developed innovative methods of taking security. Instead of
asking for personal guarantees from trustees, specialist lenders may take account of the
time and effort invested in the enterprise by key staff or the extent to which local
resources can be drawn upon in the event of the enterprise running into difficulties.
Triodos Bank, for example, might take usual commercial security, but have also pioneered
alternative forms where this is not available, such as using the support of a network of
stakeholders associated with the borrower to provide a community of guarantors.
● The higher costs of treating each application on a more individual basis are offset
against the savings of not having a branch network, and by specialising in a few niche
markets. Despite the lack of a branch network, these institutions say they maintain a
close association with their customer base, either through common social objectives
or geographically (in the case of some CDFIs).
58
Triodos Bank, Unity Trust Bank and Charity Bank.
59
London Rebuilding Society, Industrial Common Ownership Finance, Black Country Reinvestment Society,
Social Investment Scotland, Local Investment Fund and Aston Reinvestment Trust.
42
● Specialist lenders aim for more flexibility to structure finance around the needs of
individual organisations, and to customise products to meet the needs of their
customers. In many cases, they work with other finance providers (including
mainstream banks) to help social enterprises obtain an appropriate package of finance.
● Specialising allows them to develop an understanding of the social enterprise sector, in

particular of the complex grant funding streams used by many of their customers, of the
markets in which social enterprises work and of the motivation of the social entrepreneur,
especially inasmuch as their own objectives mirror those of their customers.
6.28 This specialised understanding and more hands-on service is considered by these
organisations as important in managing the key risks in lending to the sector, which one
social bank summarised as the need for improved financial skills in some social enterprises
and the greater uncertainty of income, in cases where social enterprises are operating in
difficult markets or are reliant on a single funding stream. Specialist lenders identified
similar factors to those raised by the mainstream banks with regard to the difficulties of
lending to social enterprises. The importance of understanding the governance structures in
social enterprises and the relationship between management, trustees and volunteers were
seen as key, as was knowledge of grant funding streams.
6.29 Among CDFIs, several interlocutors reported difficulties generating demand for loan
finance. These tended to be newly established CDFIs and/or those targetting smaller, less
developed social enterprises. Here, contacts reported that demand was low, and could only
be stimulated by considerable support and development work. Many of those consulted
thought that one of the key barriers to social enterprises accessing external loan finance was
a lack of good business support. Currently, much of the support that is provided is similar in
nature to that supplied to the mainstream business sector and not tailored to the specific
needs of social enterprises. Two CDFIs thought that their most important objective was to
help organisations move away from grant dependency towards self-sustainability. Access to
debt finance was thought to be one of the tools to help social enterprises achieve this, but it
needed to be accompanied by support and training in business and financial management
and in adequate referral networks.
6.30 One other interesting point made by CDFIs is that they regard lending to social
enterprises as relatively low-risk. In a survey conducted last year, UK CDFIs lending to social
enterprises reported default rates of 0.8% (compared with 12.2% reported by CDFI lending
to SMEs) and loss rates of 1.0% (compared with 8.4%)60. The authors point out that
measures of portfolio quality are not defined on a consistent basis across CDFIs and policies
for write-offs and provisioning against bad debts vary. However, the data suggest that, among
the clients of CDFIs, social enterprises constitute a lower risk than SME borrowers. This
concurs with anecdotal evidence from the wider charity sector, in which it is rare for an
organisation to fail, largely as a result of the voluntary resources and level of community or
stakeholder support on which such an organisation can draw. In part the authors attribute
the lower default rates among social enterprises to the fact that SME lending includes more
loans to start-up businesses, which are generally considered to be higher risk. It might also
suggest that bank penetration of the social enterprise sector is lower than their penetration
of the small business sector, with the result that CDFIs receive better quality applications
60
Ainger, B., Brocklehurst, R. and Forster, S. (2002) Feasibility Study into a Wholesale Intermediary for Community
Development Finance Institutions. Default rates were defined as the value of the outstanding balance of loans in
default as percentage of total value of loans outstanding. Loss rates were defined as total losses since the CDFI’s
inception divided by cumulative financing since inception.
43
from social enterprises than from SMEs. Some interlocutors believe it indicates that the risks
in lending to social enterprises can be effectively managed through the specialist
understanding and additional support that CDFIs are able to provide.
6.31 It should be noted, however, that the number of CDFIs in the UK is still small, and
geographic coverage remains patchy. The recently established trade association for CDFIs,
the Community Development Finance Association, currently has 26 lending members, of
which six have a bespoke social enterprise fund and a further seven lend to social
enterprises as part of a wider, small business portfolio. The scale of lending activity is
further constrained by the size of individual funds. For example, Industrial Common
Ownership Finance, one of the largest UK CDFIs with national coverage, has a fund of
around £4 million, raised mainly through public share issues and bank borrowing.
6.32 The Government’s Phoenix Fund, established to promote enterprise in disadvantaged

communities, has recently been allocated a further £50 million over the next three years, of
which around half is to provide funding for CDFIs61. The Government has also introduced a
tax incentive, the Community Investment Tax Relief, designed to encourage investment by
individuals and corporates in CDFIs (Box D).
Box D: Community Investment Tax Relief

Community Investment Tax Relief (CITR) is available to individuals and corporate bodies
investing in accredited Community Development Finance Institutions (CDFIs), which then
in turn provide finance to qualifying profit-distributing enterprises, social enterprises or
community projects. CITR will enable an accredited CDFI to offer tax relief as an incentive
to investors willing to provide it with patient capital for at least five years. These funds can
then be on-lent by the CDFI to borrowers within its target market.
The design of CITR draws a distinction between loans made by CDFIs to profit-distributing
small and medium-sized enterprises (SMEs) and those to “community projects”. The latter
category includes both non-competitive, non-commercial activity as well as commercial
activity that is small-scale and purely local in nature. Many social enterprises will therefore
be included within the scope of that description and thus benefit from the greater
flexibility permitted in CDFI transactions with community projects. In particular, when
using funds raised under CITR, an accredited CDFI:
● may make a loan of up to £250,000 to a community project, compared with a limit

of £100,000 for loans to profit-distributing SMEs;
● is not required to apply the European Commission Hurdle Rate as a minimum

interest rate when making loans to community projects, which it must do when
lending to profit-distributing SMEs;
● may make an equity investment of up to £250,000 in a community project, but may

not make equity investments in profit-distributing SMEs.
Full details of CITR may be found at www.sbs.gov.uk/finance/citr.php.
61
www.sbs.gov.uk/finance/phoenix_cdfi_r3.php.
44
7 SOCIAL ENTERPRISES AND EQUITY FINANCE
Methodology
7.1 The information and evidence summarised in this Section is drawn from a wide
variety of sources. As well as academic and other research papers, evidence from the survey
commissioned by the Bank is also used. However, given the limited current use of equity
finance by the social enterprise sector, primary evidence is extremely scarce. The Bank
therefore consulted with individual social enterprises and their representative organisations
in order to explore both the actual and potential demand for equity finance. We also spoke
to a range of suppliers of equity and quasi-equity products.
7.2 Lack of access to equity finance is perceived by many in the social enterprise sector as
a key barrier to growth and development. However, we have encountered a great deal of
confusion and misunderstanding about what constitutes equity finance.
Characteristics of equity finance

7.3 Equity is traditionally regarded as an appropriate form of finance for a small business
with substantial growth potential, but lacking (in the early stages of growth) both the assets
and track record generally needed to access debt finance.
7.4 Equity investors can be active or passive. Passive investors, such as many smaller
shareholders, are those willing to provide capital and take little part in the management of
the company. Active investors, such as venture capital providers, expect to play a hands-on
role in the running of the company.
7.5 Equity investors in small businesses include venture capital funds, business angels,
and larger corporates. Given the risk premium attached to equity finance, investors aim for a
higher ultimate return than debt finance. A realistic exit strategy and the subsequent
realisation of any capital gain are essential to all equity investors, especially providers of
private equity capital.
Suppliers of equity finance

Commercial venture capital funds
7.6 In recent years a small number of venture capital funds have announced their
intention to apply fully commercial venture capital techniques to the ‘social’ sector, widely
defined. Judgement of what constitutes ‘social’ for these funds can be fairly fluid but in
general the output of the firms must generate positive social externalities. As with traditional
venture capital, however, the funds’ main priority is to invest in businesses that will generate
substantial financial returns. Discussions with potential providers suggested that in order to
generate both the deal flow and commercial returns necessary, their funds would have to
target for-profit companies located in the wider ‘social’ sector (for example environmental
businesses, organics, care and education). This sector, broadly defined, was perceived as
having good growth potential and government support. In contrast, the social enterprise
sector, as defined by the Government’s Strategy, was considered to have limited appeal to
venture capital funds, both because returns were thought unlikely to compensate fully for
risks and because of opaque exit routes. And, as expanded upon in paragraph 7.19, there is
also a perception within the sector that demand for venture capital finance is likely to be
constrained by the degree of control required by venture capital firms.
45
Box E: A case study of a ‘social’ venture capital firm – Foursome Investments Ltd
Foursome is a venture capital firm that invests in British, European and North American
socially responsible businesses. They require the enterprises in which they invest to be
profitable and each project is evaluated against a number of financial criteria, including
return on investment, a well-developed and achievable business plan together with a
realistic exit strategy. However, Foursome also requires their potential investments to
generate a social and environmental return that is complementary to the financial return.
To achieve this aim, Foursome make equity investments of up to $1 million in projects
relating to the environment, education, technology and culture.
Foursome has made investments in a small number of social enterprises, but these have
been structured as long-term debt instruments. They have therefore concentrated on
social enterprises with commercial models and secure cash flows with which to service
repayments. Social enterprises more generally are unlikely to form a central part of
Foursome’s core business.
Business angels
7.7 The typical business angel is a high net worth individual willing to invest risk capital
in smaller unquoted companies. According to recent research, business angels make on
average one investment each year, close to their home or office, tend to invest in high-tech
and manufacturing businesses and are prepared to wait three to five years for an exit62.
Although reliable information on the activities of business angels is scarce, the National
Business Angel Network believes it to be unlikely that business angels are involved in making
extensive ‘social’ investments. Furthermore, although some social enterprises have benefited
from financial investment by individual supporters, the Bank came across no evidence within
the sector of widespread involvement by business angels.
Bridges Community Ventures

7.8 Bridges Community Ventures (BCV) is a community development venture capital
company, which makes equity investments in growth companies located in the bottom 25%
of deprived wards in England. It has £40 million under management63 and is aiming to make
40-45 investments over the next few years. BCV looks to acquire either ordinary shares or
some preference shares in return for an investment but does not provide senior debt64. It
invests on a smaller scale than most commercial venture capital funds, concentrating on
investments below £2 million. BCV is targeting an internal rate of return of around 10-15%,
which is lower than the benchmark of most commercial venture capital funds. So far BCV
has invested in traditional SMEs. BCV told us that many of the applications received from
the social enterprise sector are difficult for a venture capital fund to invest in because of the
lack of growth opportunities and exit routes.
62
Gullander, (2001) The Business Angel and Incubator as tools in the development of the SME.
63
Of this £40 million, the Government provides £20 million and £20 million is provided by commercial sector
organisations.
64
Senior debt is the element of a financial package that consists of secured bank lending. It is called senior
because the lender has higher priority than those who provide equity or mezzanine finance.
46
Regional Venture Capital Funds
7.9 In order to overcome the so-called ‘equity-gap’ at the lower end of the SME market,
the Government has initiated the Regional Venture Capital Funds (RVCFs) programme.
RVCFs aim to provide risk capital in amounts of up to £500,000 to SMEs which demonstrate
growth potential. But the funds are intended to generate commercial returns, so it is likely
that many social enterprises will not be able to access finance from these sources.
Friends and family

7.10 Investments by family and friends are one of the most common sources of finance for
start-ups, and often the most accessible for small firms. Our consultations suggest that this
source of funding does not play an important role in the social enterprise sector. Even though
friends and family may accept lower financial returns, the danger of putting money from friends
and family at risk for a relatively low return appears to dissuade most social entrepreneurs.
Current use of equity finance in the social enterprise sector

7.11 It is apparent from this brief consideration of potential sources of equity finance that
most equity investors are not currently targeting social enterprises. Demand for equity from
such enterprises is also limited. Our discussions indicated that many social enterprises are
unfamiliar with the concept of equity investment and lack knowledge about the differences
between debt and equity financing and about the types of organisation that equity
investment would benefit. This was reiterated by the survey reported in Section 4, which
showed that of the 96 social enterprises that had sought external finance, only ten had tried
to raise finance through either venture capital or a share issue. This was a similar proportion
to those SMEs that had sought equity finance.
7.12 Of the 39 social enterprises surveyed whose legal structure enabled them easily to
access equity finance, 15 reported that they had some form of equity investment. Only four
of these firms had successfully issued shares and another four said they had raised equity
from an individual investor or business angel. However, further investigation confirmed that
at least one of these investments was in fact a long-term loan and another an investment
made by one of the directors of the enterprise. Just one firm had obtained finance from a
traditional venture capital fund and another two firms reported having some form of social
venture capital investment. Of the four social enterprises that had issued shares, three had
imposed some form of restrictions on distributions to shareholders. Although the sample
sizes for this analysis are very small and so the results should not be interpreted as
representative, they concur with other evidence and anecdote suggesting that the use in
particular of purely commercial equity investment by social enterprises is very low.
Constraints on the use of equity finance in the social enterprise sector

7.13 In this section, we consider in more detail the main factors limiting the use of equity
finance by social enterprises.
Financial returns
7.14 As noted above, perhaps the most fundamental barrier to the social enterprise sector
raising equity finance is the unfavourable risk-reward relationship. For most social
enterprises, financial returns are of secondary importance to meeting social and
environmental objectives. Any surplus is more likely to be distributed as profit-sharing to
members, recycled to support the enterprise’s social objectives or used to benefit the wider
community, rather than to provide a direct return on share capital.
47
Exit strategy
7.15 An exit strategy and the subsequent realisation of any capital gain are essential
components of any deal for most equity investors. Traditional equity investors, such as
venture capitalists, seek either to sell a stake in a firm on a liquid stock market or to exit via
a trade sale to either a private individual, another venture capital fund or an outside firm. In
the social enterprise sector, such an exit strategy may undermine the social objectives of the
original owners of the social enterprise.
Legal structures
7.16 A social enterprise can also be limited in its potential use of equity finance by its
group or legal structure. For example, a company limited by guarantee (CLG), which our
survey shows to be by far the most popular form of incorporation for social enterprises, is
prohibited from issuing any shares. That said, legal structures can be modified to enable
social enterprises to access equity finance. Community Enterprise in Strathclyde65 shows how
a CLG can incorporate equity financing into their business model. The securities of a CLG
would have to be structured as loan capital or a bond issue rather than equity in the strict
sense, but it would be possible to incorporate ‘equity-type’ features in such securities.
Another simpler method is for the CLG to spin off a wholly-owned subsidiary, structured as a
company limited by shares. This provides a vehicle for the introduction of an equity-type
investment and could be tailored towards the exact needs and preferences of both the
investor and holding company. However, this method may raise some difficult Capital Gains
Tax questions.
7.17 Although a CLG can modify its structure to facilitate equity investment, there is no
evidence to suggest the options identified above are currently widely in use in the sector.
This probably reflects their cost and complexity, especially for small-scale social enterprises.
7.18 An Industrial and Provident Society, due to its maximum shareholding of £20,000
and the fact that the voting rights are distributed equally amongst the members, regardless
of the number of shares held, is unlikely to attract venture capital. However, it can issue
shares, loan stock and other securities to raise capital (paragraph 7.34). Significant sums
have been raised by some IPSs such as housing associations through the issue of debenture
stock66.
Ceding control
7.19 Venture capitalists and, to a lesser extent perhaps, business angels generally want
some degree of control over the management of the companies in which they invest, in order
to protect their investment. In our discussions, the possibility of an outside investor
‘watering down’ social objectives in order to maximise financial returns was a real fear for
social enterprises.
Due Diligence
7.20 Investing equity capital involves a costly due diligence process and ongoing
monitoring of the investment. Continuing audit requirements can also be high and there are
often sophisticated management reporting requirements to be met.
65
Community Enterprise in Strathclyde (2002) Sharing in Success – Patient Capital for the social economy in
Scotland.
66
Debenture stock is usually used in the UK to describe a secured company bond and is a form of long-term
borrowing.
48
Patient capital
7.21 For all the reasons detailed above, the use of private equity finance by social
enterprises is very limited. This reflects both limitations on the supply of equity finance and
some strong constraints on demand. In the Bank’s discussions with social enterprises and
their representative bodies, we encountered a strongly-held view that the sector really
needed access to some form of ‘patient capital’ rather than equity finance per se. For
example, the co-operative sector is investigating methods of delivering long-term finance to
facilitate the creation and growth of co-operatives. Overall ‘patient capital’ was thought to
be crucial to enable social enterprises to develop their business capacity and sustainability.
7.22 ‘Patient capital’ is a term used quite widely in the social enterprise sector but there is
no single, widely accepted definition. The main characteristics of such finance are:
● It is long term in nature, enabling it to be used both for start-up and subsequent
development funding.
● If structured as debt, it could have capital and interest payment holidays, perhaps to
the extent of deferring all capital repayments until the end of the loan. Alternatively, it
could be structured as a zero interest loan, analogous to a recoverable grant.
● If structured as equity or quasi-equity, it would involve little ceding of control and

would not require an explicit exit strategy.
● However structured, the financial returns would be sub-market, in return for social
gains.
7.23 Some commentators, such as the New Economics Foundation67, also use the term
patient capital to include ‘social venture capital’. In the US, this term covers a broad
spectrum of different models, but in the UK the provision of social venture capital has
been limited. So far, it has been linked to the introduction of ‘hands on’ financial expertise
to fast growing charities (that may or may not be trading) rather than to investments in
social enterprises. Although social venture capital is a fluid concept, social venture
capitalists both raise funds and place funds on the basis of active monitoring and
measurable performance-related criteria.
Demand for patient capital

7.24 Demand for this type of finance is evidenced in applications for development capital.
Bridges Community Ventures, for example, has received a number of applications from social
enterprises requiring both start-up finance and development capital intended to build
business capacity and long-term sustainability. The Adventure Capital Fund (Box H),
which provides a mixture of grants and long-term loans rather than equity, received
38 applications amounting in total to £11.5 million to part-fund projects worth a total of
£45 million, despite very short application periods and minimal advertising. Amounts sought
ranged from £28,000 to £800,000. The ‘soft’ terms of the finance offered mean that this
should not be interpreted as an indicator of demand for loan finance, but rather of demand
for a patient form of capital investment, whereby the investor’s interests are aligned with
those of the enterprise, and repayment is dependent on the success of the venture.
67
Conaty, P., with Mayo, E. and Sattar, D., (2000) Social Venture Capital in the UK New Economics Foundation.
49
7.25 Patient capital may be particularly suitable to social enterprises unable to finance
their start-up or expansion with loans because the planned growth may be out of proportion
to their current asset base (so debt finance would result in very high gearing), or because
they are unlikely to generate sufficient income in the short term (i.e. under 3 years) to
service the debt and at the same time deliver on their social objectives.
Supply of patient capital

7.26 Although there are currently few examples of patient capital in the UK, there are
signs that some investors are prepared to accept sub-market financial returns in exchange
for explicit social gains.
7.27 NOP surveys68 commissioned by Triodos Bank point to a growing desire among
potential investors for at least part of their savings to be used to benefit society and the
environment, even if that entails sub-market financial returns. This may lead to the
emergence of more individual ‘social angels’ who are looking to invest in social enterprises.
If this is the case, matching networks, similar to that run by Triodos Bank until last year,
may be necessary to help social angels find suitable investments and also to build a
secondary market.
7.28 The development of ethical or socially responsible investment69 (SRI) funds may
indicate that this willingness to take into account social returns extends also to some
institutional funds. However, as discussed in paragraph 5.19 above, social returns can be
extremely difficult to quantify. Even when crude measures are used, such as the number of
jobs created, they are rarely robust enough to stand up to investment committees or audit
requirements. Therefore, institutional funds are only likely to make investments of this kind
if there is considerable pressure from their members to do so.
Programme Related Investments or Social Investments

7.29 Another potential source of patient finance for social enterprises is ‘Programme
Related Investment’ (PRI) or ‘Social Investment’ by charities. The Charity Commission has
set out the following criteria that an investment (other than a straight grant) must meet for
it to qualify as a social investment:
● The money or other resources provided will advance charitable objectives and, more
specifically, will be made to those organisations whose objectives concur with those of
the charity.
● Any private benefit derived from the investment will be purely incidental. If it does
arise it is a necessary but incidental consequence of a decision by the charity trustees
to further their charitable purpose.
● Any private benefit is not excessive and will be heavily outweighed by public benefit.
● Trustees need to monitor the use of their investment to ensure it continues to be used
as a good means to further the objectives of the charity.
68
NOP World Polls – September to October 2002.
69
Socially responsible investment attempts to combine investors’ financial objectives with a commitment to
social concerns.
50
Box F: Example of PRI
A charity established to assist people with disabilities to find employment might, for
example, choose to purchase shares in a commercial organisation run by and only
employing people with disabilities. The subsequent success of the company will deliver
benefits to all shareholders. However, these private benefits are incidental to the public
benefit deriving from the investment as long as the company’s employment policy remains
unchanged. The more successful the company, the more people with disabilities it is able
to employ and train1.
1
Example taken from The Charity Commission Useful Guidelines – Charities and Social Investment.
7.30 Charities can support enterprise that enables the charity to achieve its charitable
objectives. In the past this has usually been by way of grants, rather than investments as
envisaged by the terms PRI or Social Investment, but the same principles apply. In 2000, the
Social Investment Taskforce70 encouraged the Charity Commission to issue guidance in order
to address any concerns that charities might have in relation to PRI. Since then, charities
and charitable trusts have gradually used the concept to make limited debt and equity-type
investments in social enterprises (Box G), although they face some potential difficulties in
doing so. Equity-based social investments can become extremely complex. The distinction
between directly furthering the charity’s objectives and the investee company’s overall
business objectives can blur as the company grows and diversifies. In the example above, the
employment policy of the company could change as it matures and it might choose to
employ non-disabled people. A charity with specific objectives could face a dilemma in
ring-fencing any equity stake for the pursuit of their defined objectives. The value of the
investments can also be difficult to determine. This may lead to difficulties when accounting
for social investments in the charity’s annual accounts. Trustees must monitor how their
investment is used to ensure that it continues to fulfil the charity’s objectives and if the
charitable objectives are no longer being achieved they must withdraw.
7.31 Social investments can also be extremely time consuming for a charity, which may not
have the relevant skills to evaluate and monitor their investments. There may, therefore, be
potential for charities to delegate the administration of PRI to specialist intermediaries such
as CDFIs, the Charity Bank or social venture capitalists. These intermediaries will probably
have the relevant skills and long-term experience in the loan market and the perspective to
consider the overall financial health of a company rather than its individual projects. For
many charities, therefore, it may be more cost-effective to make large-scale investments in an
intermediary, rather than a range of small investments in individual social enterprises. If they
invest through an intermediary they must still be satisfied that the activities being
supported will achieve the objectives of the charity.
70
Social Investment Taskforce (2000) Enterprising Communities: Wealth beyond Welfare.
51
Box G: A case Study of PRI in action – Venturesome
Venturesome is a risk capital vehicle established and funded by the Charities Aid
Foundation (CAF). It is positioned between grant providers on the one hand, and debt
financiers on the other, and the basic idea is to employ “mezzanine” financing
mechanisms, commonly available in the commercial sector, in the voluntary and
community sector.
Venturesome supports capital projects, either property/asset based or social capital; it

does not fund on-going, recurrent costs. It aims to make CAF’s grant money “work harder”
by recycling funds and concentrates on underwriting, unsecured lending and participating
in share issues. Its current fund (£2 million) is quite small but Venturesome can act as a
facilitator, bringing different investors together. Its underwriting activity provides a safety
net intended to aid charities to proceed with projects and raise further finance.
Venturesome has made two equity investments in social enterprises with a specific
charitable purpose. But it does not regard social enterprises as a sector likely to supplant
charities as its main market. This is in line with CAF’s mission and also partly because
most social enterprises have commercial outputs that introduce a larger element of market
risk than applies to charities.
Government or local authority providers

7.32 Government and local authorities are, of course, major suppliers of grant finance to
the social enterprise sector. There is therefore a potential role for the public sector to apply
the concept of patient capital to its social investment strategy. Such investments could take
many different forms including long terms loans and recoverable grants. Work being piloted
is attempting to develop some of these options; for example through the Adventure Capital
Fund (Box H below) and futurebuilders – a one-off, £125 million investment fund specifically
to assist voluntary and community sector organisations in delivering public services. The
design of futurebuilders is being led by HM Treasury with the close involvement of the
voluntary and community sector71.
Share issues
7.33 Share issues to social investors can also provide some social enterprises with an
equity-based form of patient capital. One method is to initiate an alternative public offering
(APO). An APO is an ‘ethical’ share issue, offering social investors the opportunity to invest
in a social enterprise whilst remaining off-market. These may be appropriate for social
enterprises registered as Plcs that have reached a certain level of growth and financial
maturity. APOs enable members of the public and some financial institutions to invest in a
firm without the same amount of control that venture capital and large-scale business angel
financing generally involves. The exact structures of the deals will vary depending on the
social enterprises’ individual needs. In general, however, consultees defined some generic
characteristics. These include a genuine intention to pay dividends, sufficient liquidity and
ease of valuation.
71
See HM Treasury (2002) The Role of the Voluntary and Community Sector in Service Delivery: A Cross Cutting
Review and (2003) futurebuilders: An investment fund for voluntary and community sector public service delivery -
proposals for consultation
52
Box H: A case study of the Adventure Capital Fund
The Adventure Capital Fund was launched in December 2002 in order to pilot a range of
alternative approaches to financial investment in community enterprises. The aim is to
accelerate enterprise growth amongst community enterprises and create sustainable
institutions that contribute to long-term community renewal. The project has been
developed as a partnership between the Home Office’s Active Community Unit, the office
of the Deputy Prime Minister’s Neighbourhood Renewal Unit, the Local Investment Fund,
the Development Trusts Association, the Scarman Trust, and the New Economics
Foundation, all of whom, apart from the NRU, are represented on the Investment Panel.
The intention is to test a range of new financial products for the sector, taking the form of
either grants or loans that are tailored to the specific needs of each client. Repayments
will be made from a combination of financial and social returns to be delivered by the
community enterprise over a period of years.
The project has received £2 million capital funding from the Active Community Unit
(ACU) for investments, £400,000 from the Neighbourhood Renewal Unit (NRU) to meet
operational and evaluation costs and to enable a programme of business support to be
made available to successful applicants, and over £300,000 committed by four Regional
Development Agencies for additional development grants or bursaries to bring projects to
a state of ‘investment readiness’.
The Fund received 38 applications and was over-subscribed five times. Some ten
enterprises have been selected across a wide range of sectors, and at different stages of
development, but each aiming to make a major difference in their communities whilst
improving their long-term sustainability. The programme is being closely evaluated to
establish the effectiveness of this form of investment in helping community enterprises to
develop their capacity to deliver real social benefits through reinvestment of surpluses.
7.34 An Industrial and Provident Society (IPS) can also issue shares, although the current
maximum shareholding of each member is restricted to £20,000, unless the shareholder is
another IPS. This maximum shareholding is due to be revisited if the proposals set out in the
recent Cabinet Office report72 are taken forward. Members of an IPS rarely realise capital
gains on their shares but a payment of interest or dividend on share capital is still possible,
although it can be no more than is required to attract and maintain the investment. Share
issues by an IPS to supporters or members can take many forms73 and the IPS can be a useful
structure for social enterprises that are either starting up or wishing to expand and that
intend to raise ‘equity’ from members or supporters. In some circumstances Enterprise
Investment Scheme tax relief is available to investors in such shares. IPS share issues are
often on a much smaller scale than APOs and generally face a lighter touch regulatory
regime than other public offers of shares. However, in certain circumstances, they still can
face some of the regulatory hurdles and cost issues detailed below. Whilst an IPS can issue
preference shares there is an absence of guidance on this issue from the FSA.
72
Cabinet Office Strategy Unity Report (2002) op cit.
73
The governing document of an IPS must state what shares the society is issuing and what limitations apply
to them.
53
Box I: A case study of an IPS share issue – Hesket Newmarket Brewery Ltd
Hesket Newmarket Brewery Ltd is registered as an Industrial and Provident Society
community co-operative and is a microbrewery established to serve a small village in rural
Cumbria. In 1999, 58 villagers and well-wishers agreed to buy the brewery to maintain a
key part of the local economy. Each member of the co-operative invested £1,500 each and
bought shares to raise the £87,500 needed to cover the purchase price and initial working
capital, so each has an equal stake and one vote. These shares were withdrawable and
non-transferable and so avoided the necessity and expense of a full prospectus. It was
estimated that this exemption saved approximately £10,000 on start-up costs.
The majority of the brewery’s sales are direct to individual pubs in Cumbria and
North East and the brewery is gradually investing to upgrade its plant and improve beer
quality. Investment is being met from new shareholders and a Rural Recovery Fund grant.
If the co-operative makes a profit, members receive a dividend on their shareholding and
in 2000 this amounted to £25 (or the equivalent amount in beer). In 2001 the effects of
Foot and Mouth meant that there was no dividend. The success of the co-operative has
helped to support other businesses in the village, notably the pub and adjacent guest
house.
7.35 The issuance of preference shares is an option available to a company limited by

shares (CLS). The proposed CIC form will be capable of being structured as either a CLS or
CLG, and those that use the CLS structure will be able to issue preference shares, subject to
a cap on dividends. Preference shares are a flexible option for social enterprises because the
rights attaching to them can be tailored specifically to suit a particular social enterprise. For
example, a social enterprise can issue preference shares that have a specified rate of
dividend or confer specified voting rights.
Current use of share issues in the social enterprise sector

7.36 As mentioned above, share issuance by social enterprises is limited because the
predominant legal structure within the sector (CLG) cannot issue shares. However, in 2002,
a limited number of social enterprises, such as Traidcraft Plc, initiated APOs and some
enterprises with CLS legal structures issued preference shares.
7.37 All IPSs must issue shares to members. In many cases these are just nominal
shareholdings. However there are examples of IPSs who have used share issues as a
mechanism to raise substantial amounts of capital, such as some CDFIs and Baywind Energy
Co-operative Ltd.
7.38 APOs may gain in popularity over the next few years if social enterprises reach the
size necessary to launch them. The investors are currently drawn from known and limited
constituents, such as the customer bases of ethical banks and individual enterprises’
supporters. Given the need to price the share issue transparently, APOs are likely to be
concentrated in the more commercial social enterprise sectors, such as social housing,
renewable energy and fair trade and organics.
54
Constraints on share issues
7.39 APOs are regulated through the same mechanisms as ordinary share issues. The social
enterprise needs to draw up a prospectus, as governed by prospectus regulations74, and all
financial promotions are governed by the Financial Services and Markets Act 2000. This
means the costs associated with APOs are high75 and can only be covered by raising a
suitably large amount of share capital. Prospectus regulations do exempt the issues of
securities by charities and some other social purpose non-profit distributing organisations
and where the issue is considered relatively small scale76.
7.40 Transferable share issues via an IPS can also face regulatory constraints, although this
depends on the exact nature of the issue, which means the costs can become high if a
company wishes only to raise smaller amounts of capital. However, specific exemptions from
the FSMA and prospectus regulations do apply to most withdrawable share issues77, the most
common form of IPS share issue.
7.41 These ‘social’ share issues are intended to provide long term investments but both
individual investors and institutions still need to be able to sell or redeem their investment
if necessary. Lack of secondary market liquidity is often cited as a major barrier to this type
of investment. To improve liquidity, enterprises undertaking APOs generally offer a matched
bargaining process. Triodos Bank undertakes such a process for The Ethical Property
Company, whereby they match investors that wish to sell with those that wish to buy. In the
past this process has taken up to 2-3 months, which reinforces the fact that these stocks are
not generally tradable on a daily basis. An alternative strategy for those social enterprises
that are able to afford it would be for them to buy back shares at some point in the future.
The Ethical Property Company, for example, has established a ring-fenced fund that has the
ability to buy from existing shareholders, or sell to new shareholders, as necessary to meet
demand78.
7.42 These liquidity constraints will be an obstacle for many fund managers, although the
development of matched bargaining has made this less of a concern to individual investors.
Fund managers also face specific difficulties in supporting unlisted companies, including:
● Funds can only invest a certain proportion of their total fund in unlisted investments
and are restricted to certain asset classes.
● The companies in which the funds are investing are often relatively small.
● There is a large exposures risk associated with owning a large percentage of a small
company.
● Unlisted companies cannot offer the reassurance of brokers’ reports or adherence to

stock exchange rules and a large proportion of management time is involved.
74
The Public Offers of Securities Regulations 1995 (S.I. 1995/1737).
75
It has been estimated an APO costs from approximately £250,000.
76
Small scale is defined as an offer to 50 or fewer recipients or where the total consideration payable is less
than ECU 40,000 (approximately £30,000).
77
A withdrawable share issue involves shares that, similar to deposits, can be withdrawn on demand. The
individual IPS may include a notice period in their governing document.
78
The Observer, Doing the right thing can pay good dividends too (9 March 2003).
55
7.43 Financial returns from companies making these share issues are likely to be low but
augmented by social gains. Thus, APOs are only likely to be attractive in the limited market
of SRI funds and individual social investors, whilst IPS share issues are more attractive to
local or national communities of interest.
Box J: A case study of an APO – The Ethical Property Company Plc

The Ethical Property Company Plc buys properties and develops them as centres that
bring charities, community groups and ethical businesses together under one roof. These
groups benefit from reasonable rents, flexible tenancy terms and office space and facilities
designed to meet their needs. In order to expand its activities the company undertook its
first share issue in 1999, which raised £1.32 million and was over-subscribed. The share
price increased from £1.00 at the time of the first share issue to £1.05 in June 2002, as
traded on the matched bargain market run by Triodos Bank. The company has declared
net dividends of 3 per cent per share after basic rate tax over the three years since the
issue, and augments this by offering its shareholders a social and environmental return.
The Ethical Property Company shares have remained unlisted and in 2002 it initiated
another share issue that raised £4.2 million in total. It was also fully subscribed and has
enabled the company to leverage in further loan finance from banks. To date, the Ethical
Property Company has approximately 1200 shareholders who have invested from £300 to
£500,000 each. There are several shareholders with holdings of over 100,000 shares,
including two of the company’s directors and two SRI funds.
56
8 CONCLUSIONS AND RECOMMENDATIONS
8.1 The Bank was asked to address the question of access to debt and equity finance for
social enterprises. This report has sought to provide evidence on the current demand for
and supply of commercial finance for social enterprises in the UK and has also considered
potential sources of sub-commercial finance, which may be necessary to account for the
social benefit of social enterprises’ activity.
8.2 The evidence presented in the report demonstrates the complexity of the issues
around finance for the social enterprise sector. As the Bank’s survey shows, the ‘sector’ is
composed of a diverse range of organisations, ranging from multi-million pound enterprises
with an established trading history to small voluntary sector organisations that are
developing a trading strategy in order to secure a more sustainable income stream. Social
enterprises, like all businesses, need access to a range of financial products appropriate to
their activity and stage of development. Our research shows that, while a substantial number
of social enterprises do access debt finance on commercial terms, there are hurdles on both
the demand and supply side that might make it more difficult for social enterprises than
other types of business to do so.
8.3 The remainder of this Section draws together the evidence presented in the report
and puts forward a number of recommendations to facilitate access to debt and equity
finance for social enterprises, highlighted in the text.
Demand for debt finance

8.4 The Bank’s survey (detailed in Section 4) found that fewer social enterprises than
SMEs had sought external finance, and further consultation with social enterprises and their
representative organisations indicated that demand for external finance was constrained by
a number of factors. Similarly some banks and CDFIs reported difficulties in generating
demand. While some social enterprises, like other types of business, may have no need to
borrow, and others may lack the income stream or the collateral to access and service debt,
demand for debt finance among social enterprises is further constrained by the availability
of cheaper sources of funding, such as grants, and in some cases, by a cultural aversion to
the risks and costs associated with borrowing. The evidence suggests that, among some
social enterprises, the case for considering the full range of financial products available has
still to be made. For those social enterprises that are able to service debt, non-grant sources
of finance may prove to be a more flexible and efficient way of funding their operations.
8.5 In addition to the issue of demand for debt finance, evidence from lenders and
support organisations suggests that levels of investment readiness vary among social
enterprises. Investment readiness encompasses the ability of the social enterprise both to
service debt from its trading income and also to present its business activity in a way that
lenders will recognise and understand. These issues are by no means unique to the social
enterprise sector. However, they may be of particular importance to social enterprises whose
management and trustees have not had previous business experience.
8.6 A number of initiatives could help to generate demand for non-grant sources of
finance and improve investment readiness among social enterprises, some of which were
identified by the DTI in its Strategy for Social Enterprise79.
79
DTI (2002) op cit.
57
Role models
8.7 First, social enterprise representative organisations and others involved in
providing support to the sector might usefully highlight successful examples of
borrowing in appropriate circumstances among their members or clients, and
encourage social enterprises to consider the range of available financial products.
Such role models from within the social enterprise sector would actively demonstrate the
advantages of borrowing, alongside or in place of grants, to finance a trading activity.
Business support
8.8 Second, good business support, tailored to the needs of social enterprises, is
necessary, both to increase investment readiness and to build demand for non-grant finance.
The Government is already committed to ensuring that social enterprises are properly
supported by Business Links and that interventions designed to support the mainstream
business sector are available to social enterprises. Evidence from consultations around the
country suggests that more effort may be needed by Regional Development Agencies
(RDAs) and Business Links to ensure that good policy intentions are reflected in local
practice. Business Links may need to reach beyond their established business networks
to ensure that social enterprises are aware of the support available and feel confident
about using it. This potentially has resource implications for Business Links, including
the possibility of outsourcing to specialist agencies where appropriate.
8.9 For some social enterprises, the business activity may not be sufficiently developed to
enable the enterprise to service a loan. In such cases business support needs to concentrate
on building up an enterprise’s trading activity or encouraging it to seek other, cheaper,
sources of funding. In addition, lack of reserves or personal capital may make it difficult for a
social enterprise to finance a feasibility study of a new business idea. Public sector
agencies, such as RDAs, which are seeking to promote social enterprise activity, might
expand their funding of new or existing social enterprises to support research on the
feasibility of a business idea, similar in aim to ‘proof of concept’ funding available to
university spin-outs. In others cases, the social enterprise may lack the financial skills to
present its business case effectively to a potential lender. Building on existing financial
awareness programmes could increase the level of investment readiness among social
enterprises. Those designing financial awareness programmes, including the Small
Business Service and the Social Enterprise Partnership GB Ltd, could usefully involve
lenders in the consultation and delivery.
Specialist finance providers

8.10 Third, those social enterprises that are capable of borrowing need to feel that debt
finance is both appropriate and available to them. Banks interested in lending to social
enterprises will need to address the perception among some social enterprises that banks
do not lend to them. While supply on its own is unlikely to generate demand for debt finance
among social enterprises due to the constraints on demand cited above, social banks and
specialist CDFIs are well placed to develop the market for loan finance, particularly among less
investment-ready organisations, and to design products that meet the needs of their customer
base. It would be helpful, in widening the awareness of alternative sources of finance for
social enterprises, such as CDFIs, if the DTI, SBS, business support organisations, the
CDFA and lenders were to provide more information and guidance on access to these
sources. For example, the Social Economy Bristol Development Project has published a guide to
sources of loan finance for social enterprises80.
80
Bristol Area Community Enterprise Network A Guide to Loans for Social Enterprise.
58
8.11 To complement initiatives on widening awareness of possible sources of finance,
there is a parallel need to develop the sources of supply themselves. Previous Bank of
England reports have highlighted the important role of CDFIs in supporting ‘near bankable’
businesses and social enterprises81. Currently, however, there are only a small number of
CDFIs that lend to social enterprises and geographic coverage remains patchy. In addition,
many CDFIs spend considerable time working to develop the business plan of their clients,
the cost of which service cannot be recouped solely through interest rates charged. The
Government has committed to work with partners to increase the amount of money
available to CDFIs specialising in the social enterprise sector to on-lend82. This could
include working with RDAs and private sector investors, to encourage take up of the
Community Investment Tax Relief. In addition the CDFA and mainstream lenders could
usefully build on existing partnerships between banks and CDFIs, particularly at local
level, to encourage co-financing of social enterprises where appropriate.
Supply of debt finance

8.12 Despite the limitations on demand, our research indicates that a substantial minority
(around 40%) of social enterprises, particularly larger, more established organisations,
currently use a range of financial products supplied by banks and other lenders. Borrowing
tends to be used to meet cash flow requirements (that sometimes arise as a result of grant
payments made in arrears) or to purchase or develop assets.
8.13 Nevertheless, social enterprises are more likely than other SMEs to have been rejected
for finance (though many are subsequently successful with another lender) and access to
finance is perceived by a large minority (32%) of social enterprises to be a barrier to expansion.
This review has not found any one reason for the higher rejection rates, but it appears that a
number of factors may contribute. These include a lack of available security and personal
financial stake, elements of credit and behavioural scoring techniques, use of organisational
structures and grant funding streams with which lenders may be unfamiliar, and which may
result in lengthy arrangement lead times, reputational risk to the lender83, and the level of
investment readiness within the sector. Methods of improving investment readiness have been
discussed above; the following paragraphs seek to address the other constraints identified.
Security
8.14 Banks do not lend on the basis of security alone, but a majority said that they take
security if it is available, particularly for larger amounts. The vast majority of social
enterprises in our survey had some assets, although 43% said that there were some
restrictions on their use or sale, and it is likely that smaller, younger social enterprises will
be less likely to have assets. Furthermore, the director of a social enterprise may be less
willing (or able) than a private entrepreneur to provide a personal guarantee to banks or to
invest his or her own capital in the enterprise. Finally the Small Firms Loan Guarantee
scheme is not available to organisations receiving 50% or less of their income from
commercial activity.
81
Bank of England (2000) Finance for Small Businesses in Deprived Communities and (2000) Finance for Small
Firms – a Ninth Report.
82
DTI (2002) op cit.
83
This is the risk that, in the event of the social enterprise running into difficulties, the bank would be seen as
responsible for its closure, should it call in the loans or realise any security pledged.
59
8.15 The DTI might usefully review the terms of the SFLG scheme as it applies to
social enterprises, and encourage CDFIs that lend to social enterprises to become
approved lenders under the SFLG, perhaps as part of the current consultation
announced in the Budget on improving access to growth capital for small businesses84.
Peer group analysis

8.16 Aspects of traditional credit assessment techniques designed to identify good lending
propositions across the generality of the business sector may identify some social enterprises
as ‘weak performers’ when performance is judged against other, primarily commercial
businesses operating in the same sector. If banks were able to identify their social enterprise
customers, there would eventually be scope for them to analyse behavioural trends within
the sector itself, thereby establishing indicators of default risk specific to social enterprises.
The Government’s proposed new form of company for social enterprises, the Community
Interest Company, if it is widely adopted, would provide a marker by which banks and others
could identify those social enterprises that choose this form. It will be important to ensure,
however, that social enterprises that do not choose the CIC form are not disadvantaged. In
order to carry out this type of statistical analysis, a large amount of historic data is required,
so this should be viewed as a long-term solution.
8.17 It would be helpful if the DTI and the Social Enterprise Coalition85 were able, in
consultation with banks, to develop a clearer means of distinguishing social
enterprises from other borrowers. This would assist the banks in increasing their
understanding of social enterprise customers and in developing financial indicators
specific to the sector. In the short term, banks interested in exploring this market
could begin to assemble peer group data on identified social enterprise customers.
Arranging finance packages

8.18 Of those social enterprises that use debt finance, many do so as part of a package of
funding, involving grant and debt money raised from a variety of sources. The difficulty of
co-ordinating the requirements of all these funders is one of the main reasons why loans to
social enterprises can take a long time to arrange. One solution has been to combine
regional grants, and the required matched funding, into one pot to provide loans and grants
to social enterprises, as in the South Yorkshire Key Fund86. Assistance in arranging a finance
package involving grants and commercial lenders is currently provided in some instances on
an informal basis by a specialist lender, such as a CDFI. However, such a service can be
costly to provide and is not universally available.
8.19 The DTI might usefully consider establishing a brokerage service to facilitate the
arrangement of finance packages for social enterprises, operated at a local level by an
expert in the range of finance sources available to the sector.
84
HM Treasury and Small Business Service(2003) Bridging the finance gap: a consultation on improving access to
growth capital for small businesses.
85
The Social Enterprise Coalition UK was formed in 2001 to provide a co-ordinated voice for the social
enterprise sector in the UK.
86
See http://www.sykeyfund.org.uk.
60
Helping lenders to understand social enterprises
8.20 Banks may like to review their procedures for ensuring that broad policy
intentions at head office level related to lending to social enterprises are implemented
effectively at branch level and that incentives for local managers (by portfolio value or
cross-selling) encourage proper consideration of social enterprise applications. There
is a need to educate local branch staff to recognise and understand social enterprises, or to
know where to find information and expertise within the bank. The British Bankers’
Association’s website87 contains a section on Understanding Social Enterprise which should
provide a useful resource to bank managers dealing with social enterprise customers. The
British Bankers’ Association could usefully act as a source of information for banks on
social enterprises, building on the information already available on their website.
Improving grant regimes

8.21 Some features of grant finance may limit the capacity of a social enterprise to operate
efficiently or to leverage in commercial finance. First, making grant payments up front that
are currently paid in arrears would improve the cash flow of many social enterprises,
and remove the need to borrow against the promise of future grant receipts, which many
perceive to be an unnecessary expense. This issue was acknowledged in HM Treasury’s recent
cross-cutting review88. Some evidence suggests that regular grant income payments, rather
than lump sums, might improve social enterprises’ behavioural scores (although in other
circumstances lump sums may be necessary to meet large up-front costs at the beginning of
a new project). Second, while it is important that organisations are not encouraged to
overestimate projected costs in grant applications, it would be extremely helpful to social
enterprises if surpluses generated through efficiency gains could be retained within
the organisation. Although in the short term such measures could have the effect of
decreasing demand for debt finance, by encouraging enterprise activity and operational
efficiency they should help organisations become more investment-ready. Third, we
encountered several examples of cases in which social enterprises have been unable to
borrow against assets purchased with grant money, because of the grant funder’s concern to
ensure that the assets are retained for the purpose for which they were intended. Where
feasible, removing restrictions on using assets purchased with grant money as
collateral would give social enterprises more flexibility to make maximum use of their
assets. To this end, the Government has committed to ensuring the rules and flexibilities on
clawback are fully understood and implemented89.
8.22 It is intended that the ‘asset lock’ included in the terms of the proposed Community
Interest Company should not preclude those assets from being used as collateral for loan
finance. In view of the difficulties encountered with existing grant regimes, we would
encourage the DTI to consult with lenders to ensure that, in practice, this would be
the case.
87
www.bba.org.uk.
88
HM Treasury (2002) The Role of the Voluntary and Community Sector in Service Delivery: A Cross Cutting
Review (2002).
89
DTI (2002) op cit.
61
Equity finance
8.23 Businesses need access to different types of finance at different stages in their
development. Our research indicates that social enterprises tend to borrow to cover cash
flow difficulties and to buy and develop assets, but some evidence from the Bank’s survey
suggests that they are not borrowing to finance expansion of their trading activities.
Furthermore, access to both grant and non-grant sources of finance is perceived to be a
major barrier to expansion. This may reflect underlying problems relating to the ability of
the enterprise to generate sufficient income from trading or to manage the business activity
efficiently. However, it is also likely to be the case that a social enterprise that channels
surpluses into subsidising its social activity will have less capacity to leverage in debt finance
for development than an SME. In addition, where primarily commercial businesses might be
able to accumulate larger reserves, or use personal capital, investment by family and friends
and, in a small minority of cases, venture capital to finance development, these options may
be less available to social enterprises.
Venture capital
8.24 There is little evidence of demand for, or supply of, either conventional venture
capital or business angel finance in the social enterprise sector. Our research concludes that
this is not as a result of a market failure but is instead due to the specific characteristics of
the social enterprises, in particular the difficulty of providing a commercial financial return
and an exit strategy, and of addressing issues of ownership.
Patient capital
8.25 There is, however, evidence of demand for some form of ‘patient capital’ among social
enterprises, particularly at the start-up or expansion stages. As with SMEs at similar stages
of development, these enterprises need an alternative to straightforward debt because the
timing and cost of repayments associated with excessive gearing make the enterprise
particularly vulnerable to temporary trading difficulties. Patient capital is often referred to
in the social enterprise sector as an alternative to private equity finance, where part of the
expected returns will be social rather than financial. It is defined in many ways, from
‘investment’ grants to products that are structured as debt or equity. For the purposes of
this report we have defined patient capital as long term finance for development, with soft
terms, including little ceding of control and sub-market financial returns, in return for
social gains.
Patient capital supply

8.26 Supply of patient capital appears to be limited at the moment to a number of grant
providers, charitable trusts, socially-motivated individuals and government-funded pilots.
Such social investors are characterised by their willingness to accept lower and, in some
cases, uncertain financial returns in exchange for social gains. Sub-market returns represent,
in effect, a subsidy to account for the positive externalities generated by the social
enterprise. With their current scale, CDFIs can rarely meet the demand for long-term patient
capital because they are constrained to supply more conventional interest-bearing, repayable
loan finance to ensure the sustainability of their fund. However, with sufficient, subsidised
capital their specialist knowledge of the sector would make CDFIs well placed to deliver
patient finance to social enterprises.
62
8.27 It may be that some of the demand for patient capital could be met if the difficulties
currently associated with grants, detailed in Section 2, were overcome, thus enabling social
enterprises to build up reserves and have greater flexibility in managing their assets. In
addition, the results of pilots, such as the Adventure Capital Fund and futurebuilders,
should provide more information on how the public sector can use innovative
approaches to fund social enterprises, which could be taken forward by Government.
8.28 Promotion of successful examples of Social Investment in social enterprises

should help to encourage charities, trusts and foundations to consider investing in
social enterprises whose activities are in line with their own charitable objectives,
either directly or via specialist lenders. In addition, some large successful social
enterprises may like to consider ways to invest in start-up or more recently established
social enterprises, similar to corporate venturing in the for-profit sector.
8.29 If the Government wishes to expand the participation of private investors in the
financing of social enterprises, it may need to extend the availability of support, for
example through subordinated matched funding, or tax relief on investment in social
enterprises, similar in concept to the CITR now offered to investors in accredited
CDFIs. This would require a system of accreditation and would be subject to EU State Aid
rules.
8.30 Such initiatives would need to be accompanied by efforts by the social

enterprise sector, led perhaps by the Social Enterprise Coalition, to promote suitable
investment opportunities in individual social enterprises. For example, the Coalition
might like to consider working with interested parties to investigate the possibility of
establishing a ‘social angels’ network to match social investors with social enterprises
needing investment, in the manner of business angel networks for traditional venture
capital. The terms of the investment would depend both on the needs of the social
enterprise and the requirements of the investor.
Share issues
8.31 Share issues, via a public offering or the issuance of preference shares, provide a
means for social enterprises with an appropriate legal form to tap into the social investment
market. However, the burden and high cost of regulation means that a public offering is only
appropriate for social enterprises that are aiming to raise substantial amounts of capital. In
view of these constraints on social enterprises wishing to make a public share offering,
the Government and the Financial Services Authority might like to review the current
regulatory exemptions relating to share issues, in the light of the particular
characteristics of social enterprises. Although social investors might be motivated by the
long term and not concerned about exit possibilities at the outset, some form of exit route
will be important to attract a wider pool of potential investors. In the short term, in order
for investors in social enterprises to redeem their capital, those social enterprises that
issue shares will themselves have to offer exit routes, such as share buy-backs or
matched bargaining services. In the longer-term, as the extent of share issuance
increases, there may be the opportunity for the sector to develop a more substantial
secondary market.
63
Social auditing
8.32 The absence of a recognised set of standards in social auditing makes it harder for
social enterprises to demonstrate social gains to potential funders. Social auditing should
enable a social enterprise to identify not only the costs incurred as a result of its social
objective but also the returns generated. Doing so could help it to secure grant funding or
social investment for the social activity, which should, in turn, make it easier to secure
commercial funding for its business activity. Interest in this area is growing and the Social
Enterprise Partnership (GB) Limited and others are developing techniques and benchmarks
that may need to take into account the different size and activities of social enterprises.
There may be a tension between the need to recognise the diversity in the sector and to
develop an approach that enables investors to benchmark achievements. In addition, there
may be a need to increase awareness of social auditing amongst those that finance social
enterprises through loans or grants.
8.33 Those developing methods of social auditing should ensure that they meet the
needs of actual and potential investors. In addition, to encourage take-up of social
auditing among social enterprises, methodologies should be accessible and not overly
onerous.
64
ANNEX 1
ORGANISATIONS THAT CONTRIBUTED TO THE DATABASE OF SOCIAL ENTERPRISES

We are grateful to the following organisations that provided the Bank with names of social
enterprises to form the database from which the Bank’s survey was conducted.
Bristol Area Community Enterprise Network

Charity Bank
Co-Active Ltd
Community Action Network
Co-operative Union
Development Trusts Association
Department of Trade and Industry
New Economics Foundation
Social Enterprise East Midlands (SEEM)
Social Enterprise London
Social Firms UK
The Guild
Yorkshire and Humberside Regional Forum
65
ANNEX 2
CONSULTEES
We are grateful to the following organisations that contributed to our round-table
discussions and sector-wide consultations. Please note that, for reasons of confidentiality, the
Bank’s survey respondents are not included in this list.
Angier Griffin Consultants ASDAN

Aspire Group Aston Reinvestment Trust
Baker Brown Associates Bank of Scotland
Barclays Bank Bates, Wells and Braithwaite
Black Country Reinvestment Society Bolton Business Ventures
Bolton Metropolitan Borough Council Bootstrap Enterprises
Bridges Community Ventures Bristol Area Community Enterprise Network
Bristol City Council Burness
Business Initiative Business Link
Buxton Volunteer Bureau Cambridge Co-operative Development Agency
Catalyst Fund Management and Research Ltd. CDFA
Chamber Business Enterprises Charity Bank
Clydesdale and Yorkshire Bank CO3
Coin Street Community Builders Community Action Network
Community Enterprise in Strathclyde Community Loan Fund for the North East
Community Loan Fund NW Co-operative & Mutual Solutions Ltd.
Co-operative Action Co-operative Bank
Co-operative Union Cumbria Rock Sculpture
David Carrington Day Chocolate Company
Department of Trade and Industry Development Trusts Association
Ealing Community Transport Easington Action Team for Jobs
East Midlands Development Agency Economic Partnerships
Eldonians Emmaus Cambridge
Emmaus North West Partnership Esmee Fairbairn Foundation
Essential Trading Co-operative Ltd. Expanding Horizons
Faith in the City Finance Wales
Foursome Investments Ltd. Fsquared
Future Furniture Glossop Volunteer Bureau
Goodwin Centre Groundwork Trust
66
Hartcliffe and Withywood Ventures Henderson Global Investors
High Peak and Dales Primary Care Trust HM Treasury
Homes for Change Hoxton Bibliotech
HSBC Bank IMBY
Impact Sheffield Impetus Trust
Industrial Common Ownership Finance Judge Institute of Management
Kibble Centre Knowsley Pathways
Leek College/Honeycomb Project Liverpool City Council Social Economy Team
Lloyds TSB Local 41 Consultancy
Local Investment Fund London Development Agency
London Rebuilding Society Manchester Enterprises
Manor and Castle Development Trust Marketwise Strategies
McKinsey & Company Mersey Network for Europe
National Business Angels Network National Council for Voluntary Organisations
New Economics Foundation Newcastle City Council
North West Development Agency Northern Rock Foundation
NW E-Net One London
One NorthEast Parker Communications Consultancy
Peak District Farm Holidays Peak District Rural Deprivation Forum
PENTRA Piccadilly Gardens Ltd.
Poptel Project North East
R.A.S.C.A.L.S RBS NatWest
Reclaim Recycle IT
Respect, London Salford Community Ventures
SCEDU School for Social Entrepreneurs
Shaw Project Sheffield Hallam University
Sheffield Rebuild SMART
SME Solutions Social Enterprise East Midlands
Social Enterprise Network Social Firms UK
Social Investment Scotland South Yorkshire Investment Fund
St Peters Hospice Staffordshire Moorlands CVS
Staffordshire Moorlands District Council Team Fostering North East
The Arts Factory The Big Issue
The Charity Commission The Churches Regional
Commission in the North East
The Enterprise Fund The Ethical Property Company plc.
The Guild The Princes Trust
67
Traidcraft Ltd. TREND
Trinity Community Partnership Triodos Bank
Tyne and Wear Enterprise Trust Ltd. UK Social Enterprise Coalition
Unicorn Grocery Ltd. Unity Trust Bank
Uniun Enterprise Trust Limited University of Northumbria
UnLtd Venturesome
VIRSA Wandsworth Youth Enterprise Centre
Welsh Development Agency World in Need
Wrigleys Solicitors Yorkshire and Humber Regional Forum
68
ISBN 1 85730 123 4
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The Financing of Social Enterprises:

A Special Report by the Bank of England

Domestic Finance Division

Bank of England Domestic Finance Division

EXECUTIVE SUMMARY OF KEY FINDINGS ................................................................................1

1 INTRODUCTION AND METHODOLOGY ..................................................................................5

2 IMPORTANCE OF FINANCE IN THE DEVELOPMENT OF THE SOCIAL

3 EXISTING RESEARCH ON THE FINANCING OF SOCIAL ENTERPRISES ................................11

4 EVIDENCE FROM SURVEY OF SOCIAL ENTERPRISES – USE OF FINANCE ..........................14

5 KEY THEMES EMERGING FROM CONSULTATION WITH SOCIAL ENTEPRISES

6 SUPPLY OF DEBT FINANCE TO SOCIAL ENTERPRISES........................................................36

7 SOCIAL ENTERPRISES AND EQUITY FINANCE ....................................................................45

8 CONCLUSIONS AND RECOMMENDATIONS ..........................................................................57

Annex 1 Organisations that contributed to the database of social enterprises ..................65

Annex 2 Consultees ..............................................................................................................66

● Building on existing financial awareness programmes could increase the level of

● It would be helpful, in widening the awareness of alternative sources of finance for

Patient capital for development

● Such initiatives would need to be accompanied by efforts by the social enterprise

Context of the Report

Definition of social enterprise

● Trading to provide (or cross-subsidise) social or environmental goods or services

Methodology and organisation of the report

2.7 It is interesting to assess whether use of non-grant sources of finance is correlated

Other potential barriers to the development of the sector

How are social enterprises financed?

Do social enterprises experience difficulties in obtaining finance?

Is there unmet demand for debt and equity finance?

● a defined social, community or environmental objective.

Profile of social enterprises surveyed

Table 1: Size of social enterprise survey respondents

Size (number of employees) Annual turnover

Income from trading

Table 2: Sector of social enterprise respondents

Sector Proportion of social enterprises(a)

Organisation type and legal structure

Type of organisation(a) Legal structure

4.16 The great majority of organisations describing themselves as ‘voluntary sector’ or

Demand for finance among social enterprises

Prefer grant finance 35%

Type of finance sought

Current use of debt finance

Social enterprises SMEs

Reason for borrowing

To buy a building 32%

To cover cash flow difficulties 23%

Change in demand for external finance

Social Enterprises 50% 27% 16% 7%

SMEs 19% 46% 34% 1%

Number of respondents: SE 96, SME 72

Social Enterprises 28% 71%

Have been rejected

SMEs 10% 89%

Number of respondents: SE 96, SME 72

● Bank was too cautious.

● Bank would not lend to a social enterprise / a non-profit organisation.

● Banks not interested in social enterprises / in a small business.

● Bank did not believe our business plan.

Future borrowing needs

Retained surplus 57%

Bank borrowing 33%

Raised from members 12% SMEs

Problems obtaining external finance 32%

Problems in accessing grants 26%