CIC Association

Serving Community Enterprise

Our respone to the CIC Divividend Cap Review

Questions 5 & 6 for Social Enterprises and community interest companies.

Question 5 – dividend cap
Do you consider that the double cap on dividends unduly restrict your ability to raise adequate financing of business start-up and growth?

Using the BofE rate, and the subsequent downward movement of the BofE rate since CICs came into being has definitely diminished the opportunities available to attract investment, but we believe the original positioning of the caps is generally sound. Relaxing the caps would undoubtedly create the potential to attract more capital into CICs, but generally the feeling is this could reduce the primacy of community benefit. We recommend maintaining the intentions of the original technical consultation as closely as possible, but to look at the opportunities and threats in more detail in time for the full review in 3 years time. There is a lack of clear evidence and collating this data would help inform opinion.

Lack of understanding regarding CICs in general amongst Banks and Investors is as much a barrier to investment as the double cap. Investors generally wont invest in something they don’t understand, and Social Entrepreneurs find the process complex to engage with and difficult to communicate to potential investors. A lack of clear, concise information for relevant stakeholders is sited as a barrier, as is variable and often inaccurate information and advice from support organizations.

Question 6 – performance related interest cap
Do you consider that the cap on performance related interest unduly restricts your ability to raise adequate financing of business start-up and growth?

This cap is relevant for ‘debt with equity characteristics’ and as such we recommend for simplification purposes you have the same calculation as the equity cap. It adds a layer of confusion in the legislation that has no apparent benefit.

Questions 7 - 11 for Equity Investors and Debt Financiers
Question 7 – dividend cap
Do you consider that the maximum dividend per share cap (5% above the Bank of England base rate) unduly limits incentive to those who might make an equity investment?

Yes, the original BofE rate was 4.75, which provided for a maximum dividend of 9.75%. Even at this rate a lot of work needs to be done to attract investors. The current rate (5.5%) is disproportionately low relative to risk.

Question 8 – dividend cap
Do you consider that the maximum aggregated dividend cap (35% of a relevant company’s distributable profits) unduly limits incentive to those who might make an equity investment?

No- undoubtedly increasing the aggregate cap would attract more investment opportunities, but when community primacy is taken into account we feel this is reasonable. We recommend a thorough examination of the opportunities and threats prior to the larger review in 3 years time.

Question 9 – dividend cap
Do you consider the interrelation between the dividend per share and aggregated dividend caps unduly limit incentive to those who might make an equity investment?

Yes, it can add a layer of confusion, but it should remain in place until a detailed investigation of the outcomes is conducted. The market is nebulous at the moment but this control will become very relevant should shares be traded above the original paid up value.

Question 10 – performance related interest cap
Do you consider that the cap on performance related interest (4% above the bank of England base rate) unduly limits incentive to those who might consider debt financing?

Yes- 4.5% is a disproportionately low relative to risk.

Question 11 – performance related interest cap
Do you consider that the 1% more by way of return on equity (under the dividend cap) than on performance related loans unduly limits incentive to those who might make equity or loan investments in a CIC to choose equity rather than a loan?

Yes, but its not a major factor in the decision of an investor as to the most suitable investment type. This cap is relevant for ‘debt with equity characteristics’ and as such we recommend for simplification purposes you have the same calculation as the equity cap. It adds a layer of confusion in the legislation that has no apparent benefit

Questions 12 – 17 for all
Question 12 – dividend cap

Do you consider the limit to the level of return on investment to equity investors (the dividend caps) provides adequate protection of community assets?

Yes

Question 13 – performance related interest cap
Do you consider the limit to the level of return on investment to debt financiers (the performance related interest cap) provides adequate protection of community assets?

Yes- but for simplicity and uniformity it should be set at the same rate as equity investors

Question 14 - general
Do you consider the Bank of England base rate should be the preferred option for calculating the caps?

Yes, with caveat below. We also believe that discussions should take place to ensure the BofE as the preferred option for calculating the caps on an ongoing basis. The market is nebulous and needs supporting to establish itself. We recommend looking at the opportunities and threats in more detail in time for the full review in 3 years time

Question 15 – dividend cap
What principles should be used to set the dividend cap?

We recommend the Regulator inserts a collar to the cap, setting a minimum maximum dividend of 10%. This would ensure the opportunity of a modest and proportionate return even in low interest rate environments is maintained, and allows the rate to follow any upward move in interest rates, keeping a consistent and simple long term approach that should be easily understood by CICs and potential stakeholders. Eg

Bank of England Base Rate 0.50% Max Dividend Cap 10%
Bank of England Base Rate 4.75% Max Dividend Cap 10%
Bank of England Base Rate 9.75% Max Dividend Cap 14.75%

This would allow CICs to position the cap and asset lock more favourably to investors, without affecting the primacy of community benefit. This would also simplify communications to investors and other relevant stakeholders.

Question 16 – performance related interest cap
What principles should be used to set the performance related interest cap?

As above, we feel both caps should be uniform, with a full discussion on the opportunities and threats in time for the full review in 3 years.

Question 17 - general
Please tell us anything else from your own experience that you consider can add to a body of evidence about the dividend and performance related interest caps.

This consultation gives us a great opportunity to clearly define where CICs fit into the existing landscape, and send a clear signal on which direction the legislation is taking. We believe both the CLG and CLS opportunities can be developed within the recommendations made above, but with the caveat that a lot of work needs doing to develop the market. The potential pool of socially minded investors is relatively huge, but the existing routes to investment aren’t always familiar with the concept of the caps, and we need to ensure we build positive and simple communication material to overcome confusion and build confidence.

Many of the existing routes to equity investment within the social enterprise environment and in general attract equity investors who have an expectation of unrestricted returns. The general feedback from the routes to equity suggest a maximum dividend cap of 15% could fit into their current strategies and would be potentially attractive to their pools of investors

The Equity Dividend Cap should not be fixed to the initial paid up value for life, this in effect renders the share illiquid. On trading the share, the dividend cap should be calculated on the market value(transaction price) of the share, thereby avoiding a disproportionately low dividend cap to the secondary owner. Allowing the maximum dividend to be calculated on the sale price/market value of the share will allow a market to be created, and also builds an opportunity for a return for the sweat equity of the entrepreneur. This will raise further issues and relative solutions, and we feel a more detailed discussion needs to take place on this matter.

Investment readiness is exacerbated by inconsistent advice, and a lot of the core issues regarding understanding can be solved by creating developed generic information.

Promoting actual CIC social outcomes will accelerate investor understanding

Creating a direct portal to connect investors and CIC practitioners will dramatically increase capital inflows

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