Finance for Small and Medium-Sized Enterprises: Comparisons of Social Enterprises and Mainstream Businesses

Transcription

1 Finance for Small and Medium-Sized Enterprises: Comparisons of Social Enterprises and Mainstream Businesses A Report on the 2006 UK Survey of SME Finances Social Enterprise Booster Survey Dr Stuart Fraser Centre for Small and Medium-Sized Enterprises Warwick Business School University of Warwick

2 Acknowledgements I would like to thank Mike Young, Victoria Roberts and Andrew Lincoln for helpful comments on earlier drafts. However, I am responsible for all remaining errors. 1

3 Contents Acknowledgements Glossary 5 Executive summary 8 1. Introduction Policy context Methodology Structure of the report Background issues General issues on the financing of social enterprises Previous research on access to finance amongst SMEs and social 37 enterprises Summary Background analysis Business characteristics Owner characteristics 60 Summary 66 2

4 4. Business problems and support for social enterprises Extent of business problems Main source of financial advice Usefulness of main source of financial advice Business problems, advice and planning amongst start-ups 74 Summary Finance Use of commercial finance Types of financial products used in the last three years Friends and family finance Use of grants in the last three years The demand and supply of new finance Incidences of demand for new finance and the types of finance 95 sought Amount of new finance sought, amount supplied and finance gaps Financial rejections and discouragement Self-reported consequences of financial rejection Lending terms and conditions 111 Summary Financial relationships Market shares of the main finance providers Number of finance providers Length of relationship with main finance provider Satisfaction with main provider of finance, bank charges and methods 133 of communication 6.5 Switching Financial delinquency 141 Summary 145 3

5 7. Econometric analysis of grant dependence, the use of 147 commercial finance and sales growth 7.1 Methodology Grant dependence Use of commercial finance Sales (turnover) growth 162 Summary Conclusions and policy implications 170 References 173 Appendix A (Tables) Tables relating to Chapter Three Tables relating to Chapter Four Tables relating to Chapter Five Tables relating to Chapter Six i i xvi xxiv lxxiii Appendix B (Technical report by IFF Research Ltd.) lxxxix 4

6 Glossary Social Enterprise A social enterprise is defined by the government as 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. For the purposes of this survey, social enterprises are businesses which satisfy all of the following criteria: Their regular, everyday activities involve providing products or services in return for payment. At least some (greater than 0 per cent) of their funding is generated from trading i.e. in direct exchange for goods and services. They have a primary purpose to pursue a social or environmental goal (as opposed to being purely or mainly profit driven). They principally re-invest any profit or surplus that is made in the organisation or community to further their social or environmental goal. Are either Companies Limited by Guarantee or are Industrial & provident Societies (reflecting the sampling approach adopted by DTI 2005). Mainstream business/for profit enterprise The terms mainstream business/for profit enterprise are used in relation to businesses which pursue principally financial objectives or, at least, do not have an explicit social 5

7 mission. Any profits generated by these businesses are shared amongst its owners or re-invested in the business for the purposes of furthering its financial objectives. It should be noted that many small businesses are run to pursue the lifestyle objectives of their owners (such as a desire to be one s own boss) with turning a profit forming a secondary objective (see e.g., Fraser, 2005). However, these businesses lack the explicit social objectives associated with social enterprises. Accordingly, lifestyle businesses would come under the definition of a mainstream business/for profit enterprise. SME: Small and Medium Sized Enterprises Following the definition used by the Department of Trade and Industry (DTI) an SME is defined as a business which has less than 250 employees. UKSMEF: United Kingdom Survey of Small and Medium Sized Enterprise Finances This was the first comprehensive survey of SME finances and financial relationships in the UK which was conducted in the late summer of The Social Enterprise Finance Survey is a follow up booster survey to UKSMEF which uses the same methodology and survey instrument as the original survey. The UKSMEF report, data and survey instrument are available for download from the UK Data Archive (University of Essex): (SN 5326). Statistical significance The report frequently refers to differences in means/proportions between business groups which are statistically significant. This means that the hypothesis that the population means/proportions for the groups are identical has been tested and statistically rejected (implying that one group has a higher/lower population mean/proportion than the other group). These tests are conducted by comparing 95% 6

8 confidence intervals (see below) for the estimated means/proportions across business groups. A test based on: i) comparing the confidence intervals for different business groups; and ii) inferring significance in instances where confidence intervals do not overlap, provides a conservative test of differences in means/proportions (full details from the author on request). Unless stated otherwise, the word significant is used synonymously with the phrase statistically significant. 95% Confidence interval These intervals provide a range for estimates of population means/proportions which contains the true population mean/proportion with 95% probability. A confidence interval which crosses zero leads to an inference that the corresponding population mean/proportion is zero. Narrower confidence intervals are associated with more accurate estimates. The width of the interval reflects the size of the sub-sample involved in the estimate (the larger the sample the narrower the interval) and the amount of variation, pertaining to the variable, in the population (more variation implying a wider interval). Base numbers in tables and charts The analysis in the report is weighted in order that the results are representative of the respective social enterprise and mainstream business populations. The base numbers in the tables and charts therefore represent estimates of the number of businesses in (sub)-populations as opposed to the actual numbers in (sub)-samples. 7

9 Executive Summary Background Social enterprises combine a mix of social, financial and, sometimes, environmental objectives. Consequently, in contrast to mainstream businesses social enterprises have the capacity to generate surpluses which accrue to society as a whole rather than just business owners and other shareholders. However, a social or environmental mission can lead to misalignment with the financial objectives of businesses engaged in commercial transactions with the social enterprise, such as finance providers and other resource suppliers. This misalignment has the potential to lead to resource constraints which may prevent the start-up, limit the growth or jeopardize the survival of these businesses. Until recently the social enterprise sector has received little attention from policy makers. This in part reflects the small size of the sector compared with the mainstream business population; social enterprises comprise less than 1% of the total SME population. However, it is now a central strategy of the UK Government to grow the social enterprise sector to help achieve its broader policy objectives including raising productivity, helping with the social inclusion of disadvantaged or under-represented groups such as women and ethnic minorities and improving the delivery of public services. 8

10 Objectives of the study Ensuring that social enterprises receive good business support and are able to access appropriate finance are key components of the Government s strategy. In this context, the principal aims of this report are to compare social enterprises and mainstream businesses in the following aspects: Comparisons of business problems. Comparisons of sources of financial advice and satisfaction with these sources. Comparisons of access to finance. Comparisons of sources of finance and satisfaction with these sources. In addition, grant dependency, poor financial expertise and a general lack of understanding about social enterprise have been noted in previous reports as inhibiting access to commercial finance and the expansion of the sector. Better support for social enterprises in making the transition from grant dependency to greater use of commercial finance is important if the Government s strategy of expansion for the sector is to be achieved. In this context, analysis is also presented in this report relating to: The role of increased use of commercial finance in reducing grant dependency. The role of increased use of commercial finance in enhancing growth in the social enterprise sector. The role of business support in facilitating the transition from grant dependency toward greater use of commercial finance. 9

11 Methodology The analysis in this report is conducted using two separate data-sets: The original UKSMEF carried out in 2004 which is used for the analysis of for profit SMEs (a sample consisting of 2,455 UK based businesses with fewer than 250 employees); and. The Social Enterprise Finance Survey carried out in 2006 (consisting of a sample of 1,002 UK based social enterprises formed as either Companies Limited by Guarantee (CLGs) or as Industrial & Provident Societies (IPSs) and with fewer than 250 employees). A full discussion of the UKSMEF 2004 survey is given in Fraser (2005). The Social Enterprise Finance Survey followed a similar approach. The fieldwork for this survey was conducted by telephone by IFF Research, an independent market research company, at IFF s CATI centre between 30 January and 6 March Sample was obtained from the data of an earlier survey of social enterprises conducted by IFF on behalf of the DTI (A Survey of Social Enterprises Across the UK, published July 2005). Organisations (CLGs and IPSs) had been pre-screened as social enterprises as part of this earlier research. The definition of a social enterprise used in the earlier survey was that: Their regular, everyday activities involve providing products or services in return for payment At least 25 per cent of their funding is generated from trading i.e. in direct exchange for goods and services They have a primary purpose to pursue a social or environmental goal (as opposed to being purely or mainly profit driven) They principally re-invest any profit or surplus that is made in the organisation or community to further their social or environmental goal. They were a Company Limited by Guarantee (CLG) or an Industrial and Provident Society (IPS) (reflecting the previous sampling approach adopted by DTI s 2005 survey). 10

12 For the present survey, the second of these criteria was relaxed to a simple requirement that some of their funding be generated from trading any amount over 0%. Indeed a substantial 19% of social enterprises fall into the category of having a trading income of less than 25% of total income. The trading income percentage was checked and recorded as part of the interview to ensure the exclusion of organisations with no trading income. As in UKSMEF 2004, quotas were set in the Social Enterprise Finance Survey fieldwork to ensure adequate coverage by size, sector and region. The analysis in this report is then weighted so that the results, for both social and for profit enterprises, are representative of the respective business populations. The weights for the UKSMEF data-set were obtained using SME Statistics (2002) which was the most up to date sampling frame available at the time the sample was structured in May, The weights for the social enterprise data-set were obtained from DTI (2005). However, it is important to bear in mind that the latter study, and indeed the social enterprises in this report, cover only CLGs and IPSs. This may lead to under-estimates of the size of the social enterprise sector. Also, since owners of CLGs and IPSs have limited liability for business debts, the social enterprises used in this report may appear riskier than the sample of mainstream business (of which two-thirds are sole traders which have unlimited liability). In order to control for the issue of limited liability, the key comparisons of access to finance in this report include looking at social enterprises against the sub-sample of mainstream companies. Key conclusions Grant dependence The analysis presented in the report supports previous evidence that social enterprises are heavily dependent on grant finance and use less commercial finance than mainstream businesses. For example: The percentage of social enterprises using commercial finance (65.5%) is significantly lower than the figure amongst for profit enterprises (79.8%). 11

13 Social enterprises are significantly more likely to use grants than mainstream businesses (71.7% versus 6.3%). And grant awards in the last three years account for, on average, 28.6% of annual current income amongst social enterprises which used grants, a significantly higher percentage than amongst mainstream businesses which used grants (9.7%). In the past, it has been argued that social enterprises face higher barriers to obtaining commercial finance than mainstream businesses leading to grant dependence (see e.g., Bank of England, 2003). These barriers may arise because of: A misalignment between the mission of social enterprises and the financial objectives of mainstream finance providers leading to moral hazard issues. A lack of understanding of social enterprises amongst mainstream finance providers. A lack of financial acumen amongst social enterprises. Financial relationships Moral hazard issues and a lack of financial acumen may make social enterprises appear riskier to finance providers leading to financial constraints. However the analysis in the report offers no indication that social enterprises are either riskier or less well understood by mainstream finance providers. Indeed: Social enterprises are less financially delinquent than mainstream businesses: they are significantly less likely to exceed their agreed overdraft limit than mainstream businesses (14.0% versus 25.9% of businesses respectively); and similar percentages of social enterprises and mainstream businesses missed term loan repayments (3.0% and 3.6% respectively). A significantly higher percentage of social enterprises are very satisfied with the level of understanding of their business shown by their main bank compared to mainstream businesses (39.1% versus 30.6%). 12

14 Access to commercial finance In this context, social enterprises do not appear to experience poorer access to commercial finance than mainstream businesses: There are no significant differences in the size of finance gaps - the difference in the amount of finance sought and the amount received - between social enterprises and mainstream businesses (these gaps averaging 15.4% and 11.4% respectively as a percentage of the amount of finance sought). There are no significant differences in rejection rates; 9.6% of social enterprises experienced outright rejection compared with 11.6% of mainstream businesses. There are no significant differences in the loan margins paid by social enterprises and mainstream businesses respectively (averaging around percentage points over base amongst both groups). Regarding collateral requirements, social enterprises required relatively less collateral than mainstream businesses ( 2.60 versus 4.40 per 1 of borrowing). This suggests that grant dependence may be due to predominantly demand side factors such as debt aversion or a lack of awareness about sources of commercial finance. However, this does not imply that there is an absence of issues for finances in the social enterprise sector, some of which may stem from the supply-side. For example, the report finds the following issue (which could contribute to grant dependence): Smaller social enterprises (1-9 employee size-band) are significantly more likely to feel discouraged from applying for finance than their mainstream counterparts (14.8% versus 4.6%). This suggests there is a higher perception amongst smaller social enterprises that they will be denied finance compared to similar mainstream businesses. In view of the earlier finding that social enterprises are less financially delinquent than mainstream businesses, it is possible that these discouraged businesses are capable of keeping up with loan repayments but, for some reason, decide that finance providers are likely to turn down their applications. This finding, along with the finding that social 13

15 enterprises are in fact no more likely than mainstream businesses to have their applications turned down, suggests that finance providers and policy makers need to get the message across to social enterprises that their commercial finance applications will be judged on merit and will not be rejected out of hand. Grant dependence, the use of commercial finance and sales growth In a static environment, grant dependence (for whatever reason) could be seen as a side-issue, so long as the business is able to access the finance it needs from one source or another. However, it is Government policy to expand the social enterprise sector which will place increasing pressure on the sources of finance traditionally used in the sector. In this context, reducing grant dependence and increasing the use of commercial finance may be important in that there is a larger pool of commercial funds relative to grant sources. Also, a greater use of commercial finance may engender a more entrepreneurial approach leading to higher growth and improved performance in the social enterprise sector. In relation to these issues the report tests the hypotheses that: An increase in the use of commercial finance reduces grant dependence amongst social enterprises. A reduction in grant dependence increases the use of commercial finance amongst social enterprises. An increase in the use of commercial finance enhances the growth of social enterprises. Business support: i) helps to reduce grant dependence; ii) facilitates an increase in the use of commercial finance; and iii) enhances the growth of social enterprises. Regarding the first hypotheses, there is strong evidence that an increase in the use of commercial finance reduces grant dependence. This supports current policies designed to increase the amount of funding available to Community Development Finance Institutions (CDFIs) for on-lending to social enterprises. Also support and advice from 14

16 financial advisers and various government initiatives appears to be effective in assisting the transition away from grant dependence. However, there is no evidence that a reduction in grant funding would increase the use of commercial finance indeed reducing the availability of grant funding is not part of the current policy framework. More importantly, in terms of the current policy framework, there is no evidence that an increase in the use of commercial finance leads to enhanced growth in the social enterprise sector. In fact, to the contrary, greater use of commercial finance is associated with lower growth. This result may be biased because the use of commercial finance encompasses debt finance alone (due to data constraints) debt finance is less usually associated with high growth businesses than equity finance. Also, the only growth measure used in the analysis relates to sales growth (again, due to the available data). Future work may usefully look at the roles of both debt and equity finance in relation to a wider range of growth measures. Summary of other findings The remainder of this Executive Summary is given over to a brief summary of the contents of each chapter in the report. Detailed summaries of statistically significant findings from each chapter can be found at the end of the respective chapters. Chapter Two: Background issues This chapter sets out some background issues in regard of access to finance amongst social enterprises. In particular, in the past it has been argued that the supply of commercial finance to social enterprises may be curtailed by a misalignment between the financial objectives of mainstream finance providers and the primarily social objectives of social enterprises. This misalignment can lead to problems of moral hazard and raises questions about the financial skills of social entrepreneurs. In addition, the availability of grant finance and an aversion to debt may curtail the demand for commercial finance amongst social enterprises. Better financial advice and specialist lenders to social enterprises may have an important role in improving access to finance and performance amongst social enterprises. 15

17 Chapter Three: Background analysis This chapter also sets out comparisons of business and owner characteristics between social enterprises and mainstream businesses which could explain differences in access to finance between the two types of business. 1 Business characteristics Analysis of business and owner risk characteristics in this survey indicates that social enterprises employ relatively more people than mainstream businesses (only 3.8% of social enterprises have no employees versus 61.1% of mainstream businesses). Also social enterprises are not significantly smaller than for profit enterprises in terms of turnover or business assets. Social enterprises are less profitable than for profit enterprises (their return on assets is 70 pence per 1 of business assets versus 2 per 1 amongst mainstream businesses). However, there are relatively as many high growth businesses amongst social enterprises as there are in the mainstream business population. Regarding business age, social enterprises are older, with an average age of 27.2 years, and hence less risky in this aspect than mainstream businesses (which have an average age of 18.5 years). In contrast in aggregate, and across size and sector comparisons, social enterprises tend to be situated in more deprived areas than mainstream businesses which may hinder their access to finance. Owner characteristics Looking at personal characteristics, owners of social enterprises have higher levels of academic qualifications than their mainstream counterparts (e.g., 23.6% have a postgraduate qualification versus 9.6% of mainstream business owners). However mainstream business owners have more business experience than social enterprise owners (20.2 years versus 16.1 years). In this regard mainstream businesses may appear to be less risky than social enterprises. Almost one half of social enterprises are majority female owned, as against one quarter of for profit enterprises. This may reflect the role of social enterprises in helping with the social inclusion of disadvantaged groups 1 For a fuller description of the social enterprise sector, see DTI (2005) and DTI (2006). 16

18 or simply traditional tendencies amongst females to engage in social work activities. In any case, female ownership should have no effect per se on credit assessments and previous evidence supports this argument. Chapter Four: Business problems and financial advice for social enterprises The principal aim of this chapter is to examine the view that social enterprises encounter greater financial problems than mainstream businesses due to a lack of appropriate financial advice. The analysis of self-reported business problems suggests that social enterprises suffer greater problems than mainstream businesses with respect to production and finance but less extreme problems with red tape. Both social enterprises and mainstream businesses show similar patterns of using financial advice although social enterprises are less likely to be reliant on advice from a bank manager. The financial advice received is similarly helpful for both types of business according to their owners. However, whereas financial advice appears to be effective in reducing the probability of serious financial problems, and increasing incidences of few financial problems, amongst mainstream businesses this advice appears to be less effective for social enterprises. This suggests there may be a lack of appropriate financial advice for social enterprises relative to mainstream businesses. Chapter Five: Finance The analysis of access to finance in this chapter shows that social enterprises are less likely to use commercial finance (65.5% versus 79.8% of mainstream businesses) and are much more reliant on grants than mainstream businesses (71.7% using grants versus 6.3% of mainstream businesses). However, there is no evidence that social enterprises experience (commercial) finance gaps which are bigger than those experienced by mainstream businesses. Also there is no evidence that social enterprises are any more likely to experience rejection than mainstream businesses, and relatively few businesses fell into serious financial difficulties as a consequence of rejection in both business groups. 17

19 Further, lending terms and conditions do not appear to be significantly more stringent for social enterprises than mainstream businesses. In one aspect social enterprises do appear to experience tougher lending terms than mainstream businesses. Specifically, social enterprises have shorter loan maturities relative to loan size (0.2 years per 1,000 of borrowing versus 0.5 years amongst mainstream businesses). This difference does not appear to be due to variations in the purposes for which loans are used. Instead, this may reflect attempts by finance providers to mitigate moral hazard issues, which arise due to a misalignment between their financial objectives and the social mission of the business, by closer monitoring of social enterprises. Chapter Six: Financial relationships The analysis of financial relationships does not support the view, which is sometimes held, that social enterprises are poorer served than mainstream businesses by the financial services sector. Social enterprises have less concentrated financial relationships than mainstream businesses (69.2% are banked with the Big Four versus 77.4% amongst mainstream businesses) and they make significant use of specialist institutions which are able to cater for their specific needs. Social enterprises have shorter banking relationships but, on the evidence presented in Chapter Five, this does not seem to significantly affect their access to finance. Importantly, there does not appear to be a systemic lack of understanding of social enterprises amongst finance providers. In fact, in key aspects of the financial relationship: availability of finance; bank charges, competence of banking staff; and understanding of the business, social enterprises appear to be more satisfied than mainstream businesses. Social enterprises are as capable as mainstream businesses of shopping around for financial products although there is a high degree of inertia in both business groups (around 7.5% of businesses having switched in the last three years). Whereas it might have been expected that rates of financial delinquency would be higher amongst social enterprises, due to either strategic defaults or irregular cash flows, the evidence suggests the contrary is true (14.0% of social enterprises have exceeded their overdraft limit without authorization in the last year versus 25.9% of mainstream businesses). 18

20 Chapter Seven: Econometric analysis of grant dependence, the use of commercial finance and sales growth The analysis in Chapter Five highlighted the level of grant dependence and the relatively low take-up of commercial finance amongst social enterprises. The policy view is that grant dependence may be inhibiting the development of the sector. Increasing access to commercial finance may be one way of achieving higher growth in the sector. Good financial advice may play an important role in facilitating the transition from grant dependence toward greater use of commercial finance. In this context, an econometric model is used to test four hypotheses: H1: An increase in the use of commercial finance reduces grant dependence amongst social enterprises. H2: A reduction in grant dependence increases the use of commercial finance amongst social enterprises. H3: An increase in the use of commercial finance enhances the growth of social enterprises. H4: Financial advice: i) helps to reduce grant dependence; ii) facilitates an increase in the use of commercial finance; and iii) enhances the growth of social enterprises. The estimates of an equation for grant dependence supports the first hypotheses in that an increase in the use of commercial finance is associated with lower grant dependence. This finding supports the use of policies designed to reduce grant dependency amongst social enterprises by increasing the availability of commercial finance (e.g., Community Investment Tax Relief) There is also some support for H4i) which states that financial advice reduces grant dependence amongst social enterprises. In this regard, financial advisers and 19

21 government initiatives appear to be particularly effective in facilitating the transition away from grant dependence. Estimates of an equation for the use of commercial finance do not support H2; a decrease in the availability of grant funding appears to have no impact on the use of commercial finance. This finding suggests that policies designed to increase the use of commercial finance by reducing the availability of grant finance would be ineffective. In addition, there is no evidence in favour of H4ii) which states that business support facilitates an increase in the use of commercial finance amongst social enterprises. None of the sources of advice included in the model are associated with an increase in the use of commercial finance (relative to businesses relying mainly on friends and business associates for advice). The final set of estimates relate to an equation for sales growth. This analysis offers no support for H3 which stated that an increase in the use of commercial finance enhances business growth. Indeed, the estimates suggest the contrary to be the case i.e., an increase in the use of commercial finance is associated with lower sales growth. One explanation for this finding is that in this survey respondents used mainly debt finance, rather than equity. Commercial providers of debt select businesses with low risk-return characteristics or influence businesses to adopt strategies with a low risk-return profile (in return for funds). The reason for this is that debt repayments are not influenced by the amount of upside return (assuming there is sufficient upside to cover capital and interest repayments). Accordingly debt providers are more concerned with reducing downside risk, than increasing upside return, leading them to select borrowers with low risk-return characteristics (or influence business strategies towards a lower risk-return profile). Analysis of the influence of equity finance on sales growth is more likely to show a positive relationship with sales growth (since the return to equity providers increases with the amount of upside return). However there are no users of equity finance in the sample to be able to test this conjecture. 20

22 There is also no evidence that financial advice has any direct impact on sales growth (leading to the rejection of H4iii)). Chapter Eight: Conclusions and policy implications Social enterprises are highly dependent on grant finance and use less commercial finance than mainstream businesses. However, in terms of their access to finance, social enterprises experience similar rejection rates to, and pay loan margins on a par with, mainstream businesses. The analysis therefore suggests that reliance on grant funding is more likely to reflect the preferences of financial managers in social enterprises (e.g., debt aversion) rather than constraints in the supply of commercial finance. On the downside, the report finds that social enterprises are more likely to report critical problems with finance and financial advice is largely ineffective at ameliorating these problems compared with mainstream businesses. Also, amongst smaller social enterprises, there is a higher perception that they will be rejected by finance providers, as reflected in a higher incidence of financial discouragement, compared to mainstream businesses. A lack of good financial advice, and/or financial discouragement, may contribute to a greater reliance on grant finance. In relation to the issue of financial discouragement, it is suggested that better communications between finance providers and social enterprises need to be fostered to deal with (unwarranted) perceptions that banks are unwilling to lend to the sector. Also more work is required to improve the quality of financial advice available to social enterprises, particularly to those experiencing serious financial problems. An increase in the take-up of specialist advice (from sources such as social banks and CDFIs) may help in this regard. The report finds strong evidence that an increase in the use of commercial finance reduces grant dependence. This supports current policies designed to increase the amount of funding available to CDFIs for on-lending to social enterprises. Also support and advice from financial advisers and various government initiatives appears to be 21

23 effective in assisting the transition away from grant dependence (if not in ameliorating serious financial problems). However, there is no evidence that a reduction in grant funding would increase the use of commercial finance indeed reducing the availability of grant funding is not part of the current policy framework nor, on this evidence, should it be in the future. More importantly, in terms of the current policy framework to expand the social enterprise sector, there is no evidence that an increase in the use of commercial finance leads to enhanced sales growth in the sector. In fact, to the contrary, greater use of commercial finance is associated with lower sales growth. It is possible that this result is biased due to the restriction of the analysis to debt finance; also a broader range of performance measures is required to fully assess the development of the sector. Future work may therefore usefully look at the roles of both debt and equity finance in relation to a wider range of performance measures. 22

24 1. Introduction The government defines a social enterprise as: 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. [DTI, 2002] These businesses are diverse in nature and include local community enterprises, social firms, cooperatives and large-scale international organizations. High profile examples of social enterprises include the Big Issue, an international organization providing income opportunities for the homeless, and the Eden Project whose mission is to promote environmental awareness and the sustainable use of natural resources. Smaller scale examples can often be found amongst organizations involved in childcare, recycling and training. Large or small, the common theme amongst these enterprises, and what distinguishes them from standard business models, is that they combine a mix of social, financial and, sometimes, environmental objectives. The mission of these businesses is invariably non-commercial but commercial activities are nonetheless an important source of income to fund the mission. However, a social or environmental mission can lead to misalignment with the financial objectives of businesses engaged in commercial transactions with the social enterprise, such as finance providers and other resource suppliers. This misalignment has the potential to lead to resource constraints which may jeopardize the growth or even survival of the social enterprise. Until recently social enterprise has attracted little attention from policy makers, finance providers and business support agencies. A key reason for this is that the social 23

25 enterprise sector is small relative to the overall business population. recent estimates reported in DTI (2006) indicate that: In this regard, There are around 55,000 social enterprises in the UK comprising 5% of all businesses with employees. The combined turnover of social enterprises is 27 billion which is equivalent to 1.3% of the total turnover of all businesses with employees. Social enterprises contribute 8.4 billion to Gross Value Added (0.85% of GDP). However it is recognised that these comparisons under-estimate the true significance of social enterprises since, unlike most mainstream businesses, they generate social surpluses which are harder to quantify. Indeed, it is now a central strategy of the UK Government to grow the social enterprise sector to help achieve its broader policy objectives including raising productivity, helping with the social inclusion of disadvantaged or under-represented groups such as women and ethnic minorities and improving the delivery of public services. Ensuring that social enterprises receive good business support and are able to access appropriate finance are key components of the Government s strategy. In this context, the principal aims of this report are to compare social enterprises and mainstream businesses in the following aspects: Comparisons of business problems. Comparisons of sources of financial advice and satisfaction with these sources. Comparisons of access to finance. Comparisons of sources of finance and satisfaction with these sources. The UK policy context for social enterprises forms the backdrop for much of the analysis presented in this report. Accordingly, this context is outlined in more detail in the following section. 24

26 1.1 Policy context The UK Government launched its strategic vision for social enterprise in a report published in July, 2002 (DTI, 2002). That report identified the growth of the social enterprise sector as playing an important role in the Government s key policy objectives by: Increasing productivity and competitiveness. Adding to socially inclusive wealth creation. Helping with the regeneration of local communities. Providing new methods of public service delivery. Helping to develop an inclusive society and active citizenship. However the report identified a number of barriers to the growth of the social enterprise sector. These barriers included: Poor understanding of the particular abilities and value of social enterprise The issue here was that finance providers have been uncertain as to the risks of lending to social enterprises and business support providers have been unable to offer appropriate advice due to a lack of information on social enterprise. Little hard evidence to demonstrate the impact and added value of social enterprise In this context, there has been little statistical data on the social and financial importance of social enterprise. This had led to their being largely ignored by providers of finance and business support. Fragmented availability of accessible, appropriate advice and support Whereas social enterprises share some characteristics with mainstream businesses it is also the case that they diverge in many aspects. The distinct nature of social 25

27 enterprises had not received adequate recognition from Government or business advisors. This had led to a lack of specialist support to social enterprise. Difficulty of accessing and making use of what is perceived to be limited appropriate finance and funding available The report identified that many social enterprises had difficulty in accessing appropriate finance due to a lack of understanding by lenders of the characteristics of social enterprises, difficulty in assessing their risk, and a lack of track record. Further issues in this context included a lack of assets to use as loan security and poor financial expertise in social enterprises. Limited account taken of the particular characteristics and needs of social enterprise within an enabling framework The main issue identified here was that social enterprise does not fit the mould of traditional private and public sector models with the result that their needs were not addressed by existing financial, legal and regulatory frameworks. Also, in the context of public procurement, many social enterprises may not have been fully benefiting from Government initiatives because neither they nor the scheme administrator recognised their eligibility to participate. Complexity and lack of coherence within sector combined with widely varying skills and knowledge The key issue noted here was a possible lack of professionalism in the sector. In particular an absence of financial and general management expertise undermined the credibility of social entrepreneurs and limited their impact on finance providers, business support agencies and policy makers. 26

28 To help overcome these barriers and achieve the strategic objectives for social enterprise the report identified that it was necessary to: Create an enabling environment. Make social enterprise better businesses. Establish the value of social enterprise. Under the heading make social enterprise better businesses, and germane to this report, the importance of better access to finance was identified. The following steps were identified in DTI (2002) as central to the finance strategy for social enterprises: Monitor what is currently available and identify gaps In this context that report set out a strategy of encouraging social enterprise to be less dependent on grants and to rely more on commercial finance. This strategy involved public assistance to specialist lenders, such as Community Development Finance Institutions (CDFIs), through investment from the publicly funded Phoenix Fund. Also private sector investment was to be promoted through development of Community Investment Tax Credits. Build capacity and financial awareness to help social enterprises make stronger bids for financial support This strategy acknowledged there is a lack of financial expertise in social enterprises leading to their making poor applications for commercial finance. In this context the report recommended that the Small Business Service (SBS) develop a financial awareness programme for social enterprises in conjunction with the Community Development Finance Association (CDFA), major banks and regional partners. Addressing the asset transfer issue The report recognised the importance of the availability of assets to use as loan security. However social enterprises were often limited in the use of assets which were owned by 27

29 the public sector. For example, government accounting rules prohibit the purchase of assets for investment purposes or borrowing against publicly funded assets. In this context the Government was to build on the work of the Active Communities Unit in examining the issue of community asset transfer with the aim of facilitating the transfer of publicly owned assets to communities. Tackle clawback clauses Whereas established (mainstream) businesses often use retained earnings as a source of finance, there was a perception that some social enterprises were unable to re-invest surpluses where public funding was involved due to clawback rules. These rules required grant funds be re-paid if spent on a purpose other than Parliament s original intentions. However the report noted that there is flexibility in these rules which was not sufficiently recognised. In this context, an important issue was that social enterprises and finance providers are helped to fully understand the rules and flexibility in relation to clawback. Simplify grant funding Despite the general strategy of reducing grant dependency the report recognised that some social enterprises will remain reliant on grant funding. Simplifying public grant schemes would directly benefit these businesses. In this context, the aims of the Small Grants Action Plan was to: rationalise national programmes and improve the coordination of government small grants (less than 10,000); to provide outreach and support to marginal businesses; and to ensure that small grants programmes can be adapted to local need. In summary, the 2002 report said that grant dependency, poor financial expertise and a general lack of understanding about social enterprise may inhibit access to finance and the expansion of the sector. Better support for social enterprises in making the transition from grant dependency to greater use of commercial finance would be important if the Government s strategy of expansion for the sector was to be achieved. 28

30 In this context, analysis is presented in this report relating to: The role of increased access to commercial finance in reducing grant dependency. The role of increased access to commercial finance in enhancing growth in the social enterprise sector. The role of financial advice in facilitating the transition from grant dependency toward greater use of commercial finance. 1.2 Methodology The analysis in this report is conducted using two separate data-sets: The original UKSMEF carried out in 2004 which is used for the analysis of for profit SMEs (a sample consisting of 2,455 UK based businesses with fewer than 250 employees); and. The Social Enterprise Finance Survey carried out in 2006 (consisting of a sample of 1,002 UK based social enterprises with fewer than 250 employees). A full discussion of the UKSMEF 2004 survey is given in Fraser (2005). The Social Enterprise Finance Survey followed a similar approach. The fieldwork for this survey was conducted by telephone by IFF Research, an independent market research company, at IFF s CATI centre between 30 January and 6 March Sample was obtained from the data of an earlier survey of social enterprises conducted by IFF on behalf of the DTI (DTI, 2005). Organisations had been pre-screened as social enterprises as part of this earlier research. The definition of a social enterprise used in the earlier survey was that: Their regular, everyday activities involve providing products or services in return for payment At least 25 per cent of their funding is generated from trading i.e. in direct exchange for goods and services 29

31 They have a primary purpose to pursue a social or environmental goal (as opposed to being purely or mainly profit driven) They principally re-invest any profit or surplus that is made in the organisation or community to further their social or environmental goal. They were a Company Limited by Guarantee (CLG) or an Industrial and Provident Society (IPS) (reflecting the previous sampling approach adopted by DTI 2005). For the present survey, the second of these criteria was relaxed to a simple requirement that some of their funding be generated from trading any amount over 0%. The proportion was checked and recorded as part of the interview to ensure the exclusion of organisations with no trading income. Following DTI (2005), the sample of social enterprises includes only those registered as CLGs and IPSs. Based solely on these legal forms, the sample is likely to underestimate the true size of the social enterprise sector. This restriction also raises issues for the comparisons of access to finance between social enterprises and mainstream businesses. The issue here is that owners of CLGs and IPSs have limited liability for business debts. On the other hand, the sample of mainstream businesses encompasses both limited liability companies and unincorporated firms (whose owners have unlimited liability for business debts). On account of these legal form differences, the social enterprise sample may consist of objectively riskier businesses than the mainstream sample (since finance providers cannot hold the owners of CLGs and IPSs accountable for unpaid debts). Straight comparisons between the samples of social enterprises and mainstream businesses may therefore suggest that social enterprises experience poorer access to finance when this is solely due to the issue of limited liability. Accordingly, in an effort to control for limited liability, the analysis of access to finance in this report includes comparisons between social enterprises and the subsample of mainstream SMEs that are incorporated. As in UKSMEF 2004, quotas were set in the Social Enterprise Finance Survey fieldwork to ensure adequate coverage by size, sector and region. The analysis in this report is then weighted so that the results, for both social and for profit enterprises, are 30

32 representative of the respective business populations. The weights for the UKSMEF data-set were obtained using SME Statistics (2002) which was the most up to date sampling frame available at the time the sample was structured in May, The weights for the social enterprise data-set were obtained from DTI (2005). 1.3 Structure of the report The remainder of the report is structured as follows. Chapter Two sets out some background issues and findings from previous research on social enterprise finances. Chapter Three reports statistical comparisons of business and owner characteristics between social and for profit enterprises obtained from the current Social Enterprise Finance Survey. Chapter Four looks at business owners assessments of the extent of problems experienced in running the business (including financial issues), the use of external advice and satisfaction with advisors. Analysis is also presented for the relationship between financial advice and incidences of serious financial problems (with a view to comparing the effectiveness of financial advice for social enterprises and mainstream businesses respectively). Chapter Five presents hard evidence on the finances of social and for profit enterprises. In particular this chapter reports: the use of different types of financial products; the demand and supply of new finance; financial rejections; and incidences where the business owner felt discouraged from applying for new finance because they believed they would be rejected. This analysis allows the extent of finance gaps (difference between demand and supply) as well as the incidence of financial constraints (financial rejection and discouragement) to be quantified. Analysis of lending terms and conditions is also presented. Chapter Six looks at issues related to the supply of financial services and financial relationships. This analysis includes market shares of the main finance providers, the length and concentration of financial relationships, levels of customer satisfaction with the service provided and banking charges. In addition this chapter presents evidence on differences in financial delinquency (missed debt re-payments and/or unauthorized 31