A guide to third sector trading - WCVA

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It’s an idea, but is it business? A guide to third sector trading 1: Getting started 2: First steps 3: Business planning 4: Legal and governance 5: Funding and resourcing 6: Financial controls 7: Managing growth 8: Management and governance 9: Social enterprise 10: Sources of support • Loan repayments: − Interest payments on loans must actually be paid to the charity. This means they cannot be transferred to the outstanding balance of the loan and allowed to accumulate. − Loan agreements between charity and trading subsidiary must be in writing and provide for the recovery of the loan. Equity Investment: • Equity investment by the charity in the trading subsidiary must be within the investment powers of the charity and be a commercially sound proposition. Grants and donations: Charities can make donations to a trading subsidiary – eg to pass on a start up grant made by an outside funding body. Guarantees: Charities may have the power in its memorandum and articles of association to guarantee commercial loans to develop trading subsidiaries. But there may be serious obstacles to doing so. • Commercial lenders may ask the parent charity to make the guarantee if they regard the subsidiary itself to be an unsatisfactory risk. But this could expose the charity’s own assets in a way which is unsatisfactory to the Charity Commission – and if the investment went wrong the trustees could be personally liable. • An alternative is for individual trustees to make the guarantee in a personal capacity, though they may be extremely unwise to agree to do so. • The problem may be avoided by securing loans from investors who have an understanding of social enterprise, such as the Charity Bank and the Local Investment Fund. These institutions set out to lend to the third sector and as such are experts in financing commercial venture development. Transferring profits to the charity: Charities may prefer to pay corporation tax on some of the subsidiary’s profits so that they can hang on to finance to develop the business. • This is because, if all profits are transferred as Gift Aid, the subsidiary could become starved of cash and unable to take advantage of opportunities to expand. This is not a remote possibility. Careless Gift Aid donations can do serious damage to a trading venture. • On the other hand, if no profits at all are transferred to the charity, the subsidiary company is demonstrably not fulfilling its purpose of funding the charity, and the trustees will need be careful about continuing to offer it support. 126
It’s an idea, but is it business? A guide to third sector trading 1: Getting started 2: First steps 3: Business planning 4: Legal and governance 5: Funding and resourcing 6: Financial controls 7: Managing growth 8: Management and governance 9: Social enterprise 10: Sources of support Legal obligations when charities invest in trading subsidiaries The overriding responsibility: The parent charity’s trustees must be able to justify financial support for a trading subsidiary as an appropriate investment of the charity’s resources. In all cases the interests of the charity must be paramount. Any investment should be consistent with the charity’s overall investment policy. General rules on investments: The Charity Commission offers unequivocal advice to trustees whenever they invest a charity’s resources. Exactly the same considerations apply to an investment by a parent charity in a trading subsidiary as to any other financial investment with an outside body. They must: • be certain that the investment is within the charity’s investment powers • exercise such care and skill in the investment process as is reasonable in the circumstances • have regard to the suitability to the charity of investments of the same kind as the particular investment which it is proposed to make • have regard to the suitability of the particular investment in question, as an investment of the kind which it seems appropriate to make • have regard to the need for diversification of investments, as appropriate to the circumstances of the charity, and • ordinarily obtain and consider advice about the investment from a person reasonably believed by the trustees to be qualified to give it by his or her ability in and practical experience of financial and other matters; the advice needs to have regard to the suitability and diversification points mentioned above. Investing in a non-primary purpose trading subsidiary: When trustees are investing the resources of a charity in a trading subsidiary to carry on a non-primary purpose trade, the Charity Commission expects that trustees: • consider whether it is in the charity’s interests to make the investment by making a comparison with the risks, benefits and returns of other forms of investment which could be selected • are satisfied with financial viability of the trading subsidiary, based on its business plan, cash flow forecasts, profit projections, risk analysis and other available information 127
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