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No state aid barrier to government investment in social enterprise

Finance | Ian Allsop | 5 Aug 2008

The government believes it can invest in social enterprises without infringing European state aid rules.

In its response, published last week, to its consultation on the proposed risk capital fund for social enterprise, the OTS stated that it can operate under the market economy investor principle.

This means that it “invests on terms that are the same as, or no worse than, those of other investors, thereby demonstrating that the terms of the government investment are acceptable to an independent investor operating under normal market economy conditions”.

The government was recently in talks with the European Commission after fears that its plans to create a social investment bank would breach state aid rules, designed to ensure fair markets and prevent serious distortion of competition.

The consultation on the fund ran from August to November last year and the evidence gathered was used to inform the government’s announcement in February that a £10m risk capital fund for social enterprises would go ahead.

Investment matched by private investors

Social enterprises told the government that equity or equity-like investment was a crucial finance option for the long-term sustainability of the sector. It is intended that the fund will be run as a pathfinder investment scheme where the government’s investment will be matched by private and independent investors.

According to the OTS response, the vast majority of the arguments and evidence provided by those working in the market supported the government’s belief that social enterprises face a similar equity gap to mainstream small and medium sized enterprises (SMEs). The government agreed that there are “particular issues that can make it even more difficult for social enterprises to access equity finance, and that the equity gap for social enterprises may have an even lower threshold than for mainstream SMEs”.

The government said there was some evidence that informal investors and professional venture capitalists were willing to provide risk capital to social enterprises, and potential investors in the fund were willing to invest on commercial terms.

Fund managers’ fees based on performance

The paper accepted that the fund manager’s overhead costs should not be met from profits, but that the government and independent investment partners should share costs, including up-front if necessary, before profits are generated. And it recommended that fund management fees should be based on financial performance and other deliverables in line with the objectives of the fund.

Capital for Enterprise Ltd, established in April 2008 to manage investment programmes and the small firm loan guarantee on behalf of the Department for Business, Enterprise and Regulatory Reform, will assist the OTS in selecting suitable fund managers, and will manage the ongoing relationship including monitoring and reporting on fund performance.

12-week tender deadline

The government will publish a bidding document over the coming weeks, allowing 12 weeks for potential bidders to respond. It hoped to have a shortlist for potential fund managers in the autumn with appointments completed by the end of the year.

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