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Social Justice, Economics and Change: The first in a 3-part series: Social Enterprise Revisited

Consistent with CityU Canada’s launch of a Management program http://www.cityuniversity.ca/programs/bachelor-of-management/ we are happy to publish this suite of three articles from economist and industrial consultant Ken McFarlane.

Ken McFarlane’s academic and professional background is in economics and law. He is a Rhodes Scholar and has been an associate of several major think-tanks, including the Brookings Institution. After a diverse early career in the public, legal, non-profit and university sectors (including senior positions with the federal government and roles with a number of royal commissions of inquiry) he founded The Katalysis Group Inc. Over the course of twenty years, this company was involved in the development and implementation of nine successful industrial technology ventures in Europe and North America. He is now the Principal of Regeneration, LLP an international consultancy that, among other activities, focusses on a diverse variety of econoAprilmic and social development ventures.

Social Enterprise Revisited

Written by Kenneth J. McFarlane  

The promise of social enterprise is much discussed, but infrequently realized. With its diversity of socio-economic perspectives, social enterprise has become of particular interest in British Columbia. But the buzz does not mean that social enterprise, as currently conceived, is a concept worthy of widespread application, particularly at the local level.

After decades of direct involvement with not-for-profit, NGO, charitable organizations and socially responsible businesses here and abroad, I have come to the conclusion that attempts to develop social enterprises, as traditionally defined, generally create more problems than they solve in areas of the economy that already have enough challenges.

Historically a social enterprise is an unincorporated venture, usually launched by an established not-for-profit charitable society, which provides a product or service for a fee, with any positive net revenues (less expenses) being allocated to the social, cultural or environmental purposes of the founder. The theory is that social enterprises are entrepreneurial organizations that innovate to raise money and solve problems in ways that their originators cannot. Most are small, local operations but there are ones of significant scale, particularly in the USA and on the international stage.

Examples include gift shops at museums, gear sold by conservation groups, restaurant, catering or recycling services that hire street kids or people with physical or mental challenges, affordable housing projects, home repair services, clothing exchanges, day cares, couriers, flea markets and seniors facilities. Tax law requires that the enterprises must only pursue a type of business that is related to the mandate of the charity that set it up.

Traditional social enterprises share the non-profit and charitable status of their founders. To be a true social enterprise – as opposed to a social program where the success measurement are primarily non-monetary – an important requirement has historically been to attain at least self-sufficiency regardless of any other aspirations. An ongoing dependency on scarce public and private resources is to be avoided. A firm goal of a social enterprise should be to generate enough revenues to cover its expenses, grow its activities and then provide cash to the founding organization.

Some not-for-profit social enterprises are self-created and operate as stand-alone operations attached to no charity, but nonetheless utilizing net revenues to pursue needs-based community goals. The provincial Blue Cross organizations in Canada are a classic example and were founded by organized labour decades ago, without direct recompense. Nonetheless, the record shows that such ventures succeed best in the international context for reasons discussed below. Examples include Good Weave International, KIVA, One World Health, Bread Basket and the Byrd Trust Company.

Unfortunately, in recent years, organizations that have no intention or ability to become self-supporting have begun referring to themselves as social enterprises. Further confusion is created when full-fledged businesses do the same. Too often these businesses are simply pursuing valuable, profit-generating consumer-driven niches in the standard free market tradition.

Good examples of this are sustainable fisheries, organic farms and firms that roast and then sell fair-trade coffee or coffee-based products. As discussed below, it would be more accurate to describe at least some of these ventures as socially responsible businesses, assuming stakeholders are well treated and at least a portion of net revenues are distributed to good works in the community. At the same time, some of them are facades that have as their primary goal the enrichment of their owners rather than a sincere pursuit of social or environmental goals.

Tight economic realities dictate that the notion of combining social goals with free enterprise principles is not only enticing but likely essential. However, the evidence shows this will only happen if addressed head-on in the private sector, rather than indirectly through the non-profit sector. Happily, there are reasons to be hopeful this will happen. I will return to this point later.

THE TRACK RECORD

Much ink has been spilled reporting on the small group of successful social enterprises in British Columbia and elsewhere. What is rarely objectively discussed are the squandered resources and outright failures involving non-profit agencies desperately looking for cash to keep their services afloat by launching such a venture.

But even the “successful” enterprises are seldom subjected to close scrutiny or basic value-for-money analysis that might tell a quite different story. Surveys that report on numbers of workers employed and gross revenues and expenses are seldom verified. (See 2016 survey by ASI CCC and Buy Social Canada concerning the Vancouver inner city.) In fact, it is reasonable to surmise that very few social ventures attain the goal of becoming self-sufficient, let alone significant money generators or employers.

And why would anyone be surprised at this?   Business — or social enterprise — requires a different set of skills, motivations and risk analysis than those required by a social service or cultural agency.   Such agencies rarely have access to fully-committed and seasoned small business entrepreneurs who are

prepared to shoulder personal risk and invest the necessary time and energy — if not cash — particularly when there is not the usual pot of gold at the end of the rainbow.

More important, attempts at launching social enterprises can steal focus from the core mandate and function of non-profit institutions by eating up inordinate amounts or time and energy. The managers of these organizations are trained as social, environmental or cultural workers, and then are expected to run small businesses off the corner of their desks. In my experience, the refrain “it’s more trouble than it’s worth” is heard all too frequently.   Hiring traditional managers with no entrepreneurial experience solves the problem only occasionally.

There are also ethical considerations when social enterprises, benefitting from a non-profit and charitable status, compete directly with, say, traditional mom and pop businesses which shoulder more onerous tax and reporting requirements.   Recent developments in the thrift, low-budget and consignment store sectors highlight this, as economic realities push consumer demand down market.

Social enterprises in the international setting, pursuing development aid projects of various kinds appear, by and large, to have more success than domestic initiatives. (Exceptions include large-market American enterprises such as Rocket-Ship and the Kahn Academy, but the list is short). This is because they are often high-profile established fixtures on the world stage, and therefore have the necessary economies-of-scale while attracting better resources in terms of personnel and investment. Examples include the Grameen Bank, Amazon River Conservation Team, Africa Enterprise Group and the Orbius Partnership.

The fact remains, however, that most attempts at social enterprise are small, local operations and most of these struggle to gain traction.

GOVERNMENT STEPS IN

In early 2011 the provincial government mandated a task force, The BC Social Innovation Council, to take a look at social enterprise in the province. It came back in April, 2012 with a list of recommendations involving such things as tax credits, social impact bonds, start-up labs and better research. No significant effort was made to analyze the basic raison d’etre of social enterprise.

Allowing for the fact that the recommendations are speculative and underdeveloped, I nonetheless believe that if implemented they would do little to solve the problems noted above or enhance the cause of social enterprise in British Columbia. To my mind, the report only worsens the situation by raising expectations that cannot be fulfilled.

To date, the only recommendation acted upon by the BC government is to provide legislation creating “community contribution companies”. C3’s are billed as hybrid corporations which can seek equity investors who receive a limited share of any profits (40%) as dividends, the balance being applied to some community purpose or transferred to a charity.

On winding up of the corporation, only 40% of assets can be distributed to the original shareholders while 60% would be transferred to a charity or community service cooperative. (Upon involuntary  dissolution of a C3, the assets would be transferred to the government). There are fairly onerous reporting requirements and a modified amount of tax is paid.

No resources will be expended on regulation or monitoring to ensure that C3 companies are actually living up to their assertions about their activities, while enjoying the “seal of approval” that the progenitors believe they will benefit from.

The creation of legislation for C3s is based on reasoning that is unrealistic and impractical. I am not aware of any pent-up demand among private investors to participate in ventures from which they glean restricted returns, share in a limited amount of the left-overs on termination or reorganization and are required to involve themselves in a considerable amount of paper-work. Without regulation it is hard to know what use the filings will accomplish, assuming a C3 bothers to honour this unenforceable “requirement” in the first place.

It is difficult to generalize at this point, but I suspect the cost-benefit analysis, for both the givers and receivers, would favour traditional charitable donations that are prudently deployed.

Where is the evidence that the lack of provision for community contribution corporations in B.C. heretofore has undermined the effectiveness of the not-for-profit sector? Can it truly be said that individuals and institutions with funds to invest in good works are now more inclined to do so?

Determining the efficacy of public policy only works if there is a clear and correct definition of the problem to solve in the first place. Therefore, ten to fifteen years out, how will the effectiveness of C3s be evaluated or will this even be possible?

GOOD INTENTIONS GONE AWRY?

More to the point, providing for such a new legal structure is neither prudent nor necessary. The B.C. community contribution company is based on models that have been operating in Britain and the USA for some time. They were required in those jurisdictions because of strictures concerning corporate shareholder rights and charitable giving that are quite unlike our own.

In any event, the recent experience in Britain has seen less “community interest companies” being set up with each passing year. Meanwhile, more and more such companies are winding down and reorganizing as full-fledged, carefully crafted businesses or not-for-profits. These companies have, according to several surveys, found no compelling reason to continue as CICs primarily because fewer funders / investors have materialized than expected and legal requirements have evolved concerning corporate shareholder rights and charitable giving.

In Canada, the simple fact is that any not-for-profit charitable corporation can set up its own business from which it can draw cash for its good works. The key point is that the business must be a separate, arms-length entity with carefully crafted articles of incorporation clearly delineating how and when revenues will be distributed to the sole share-holder, which is the charitable corporation. It would also cover how equity investments and debt financing are to be satisfied. Professional management with entrepreneurial experience and proper incentives would be hired to make things happen.

The key point is that such a business is not directly attached to the founding non-profit charity and does not take on the rights and obligations of that founder. There are examples of Canadian charities that have successfully done this in order to allow themselves access to the full range of financing options necessary to generate healthy revenue streams. The medical research sector is dotted with such arrangements.

The Canada Revenue Agency is always available for consultations if an organization is uncertain about how to properly launch such an arrangement. And it has shown its intention to redouble its effort to monitor the marketplace to ensure lawful, ethical behaviour, as evidenced by its recent review of the structure for ReStores operated by Habitat for Humanity chapters in Canada.

BUSINESSES VS. SOCIAL PROGRAMS

Social service, environmental and even cultural agencies in the non-profit (“third’) sector are often engaged in dealing with problems created by private sector and government initiatives. In short, the need for social programs in many communities is generally a result of market failures.

The most well-intentioned business people, not unlike well-intentioned governments, practise an imperfect art and make mistakes that need to be ameliorated if not corrected. The collateral damage – non-recouped negative externalities, in economist-speak — often involve our most vulnerable community assets: disadvantaged people, children, culture and the environment.

This is where social, cultural and environmental initiatives of various kinds step in and play an important role in any economy. If there is a legitimate community-based reason for a particular service to exist, then it must be decided if it should be delivered with the assistance of a social business or strictly as a program provided by a non-profit charity or government service.

If a not-for-profit has a reasonable chance of setting up a full-fledged business which sells a product or service that will cover its expenses and lead to self-sufficiency while contributing to the coffers of the founders and not undermining the core social function of the non-profit, then it could be argued it has an obligation to arrange its resources and access private funds to do just that. As noted above, the key factor will be to pay close attention to organizational tenets concerning governance, how revenues will be allocated and the value proposition for the initial investors.

If the social initiative is not able to launch a business, in the fullest sense of the word, and yet its raison d’etre is essential to the social, environmental or cultural underpinnings of the community, then it will need to be set up as a program administered either by the government directly or via a not-for- profit, non-governmental organization. The latter should be given priority access to the public purse and private charitable philanthropy through targeted legislation and smart delivery mechanisms.

Governments and socially inclined venture funds, not to mention philanthropists and charitable foundations, will have to seriously improve their current capacity to determine which initiatives can make it on their own as businesses, after traditional investments, and which can be trusted to return real value for the investment of public and charitable resources on a more traditional basis. This is hard work that urgently needs to be improved upon in Canada.

In this regard, much can be learned from cutting-edge evaluation and tracking organizations in the USA and Britain. Worth reviewing are the achievements of The Robin Hood Foundation, New Profit, New Philanthropy Capital, the Edna McConnell Clark Foundation, Bridges Ventures, Blue Orchard and Global Impact Investing Corporation.

At a time when governments and private benefactors (at least the ones who care about more than just securing tax write-offs) must engage in tough choices, having an array of analytical and strategic tools based on realistic metrics at their disposal would be invaluable in assessing impact and performance.

SOCIALLY RESPONSIBLE BUSINESS REDUX?

There is another way for businesses to support social, environmental and cultural endeavours that I believe is preferable to all others. Listening to the values of many millennials, one cannot help but feel at least mildly optimistic that the raison d’etre for business, be it corporate or entrepreneurial, may well evolve into something more than just building share-holder value in the traditional sense. Such a development would mean a return to the type of business ethos that existed not long ago, during the 25 years immediately after World War II.

During this era, firms were much more likely than today to recognize their fundamental obligations to a range of stakeholders, including their employees, customers, suppliers, and the social well-being of the communities they operated in.   Aggressive charitable giving was pursued along with investment in other businesses that had like-minded principals. This is still the case in various European countries, such as Germany and Finland, where corporations of all sizes have generally weathered the aftermath of the Great Recession with satisfactory balance sheets but also with undiminished community involvement.

Somewhere along the way in Canada and elsewhere an urban myth developed that the law requires that the first and only duty of corporate directors and managers was to maximize profit and share-value for investors. (Social investments were only made if they enhanced financial returns.) This is the case in a number of American jurisdictions but not in Canada and most other modern economies.

It is refreshing that a new generation of business people in North America is asking the fundamental questions necessary for a shift back to the ethos that existed in the 1950s, ‘60s and ’70s.  How much is enough in terms of profit and what uses can retained earnings be put to beyond shareholder enrichment? What are the duties of business in facilitating community development?

Why do we tend towards an immutable either-or proposition which requires business to be primarily about creating economic growth and prosperity, while the non-profit sector and government are left to deal with social, cultural and environmental issues with whatever resources are made available?   What is the private sectors’ responsibility around the major issue of our time, that is, environmental sustainability?

Current large-scale examples of this back-to-the-future trend are Unilever, Interface Carpets, Puma, Newman’s Own Foods, Chipotle, Toyota, Nike, IKEA, Omega, Whole Foods, Tesla and Natura. Numerous smaller scale socially responsible businesses also exist in Canada and abroad. No one would question the fact that these ventures, quite correctly, aim to maximize profit as a fundamental goal, but also leave room to undertake significant social, cultural and environmental endeavours.

Given the realities of 2017 and beyond, the acute need to marry profit generation to social and environmental goals is a compelling one. The concept of blended value or “triple bottom line” (financial, social and environmental metrics) must be given the means to become a mainstream reality. This is where government involvement and enlightened private leadership can play an important role in making such an approach sustainable.

LIGHT-TOUCH REGULATION

A major shift in the current political economy of North America, particularly as it relates to the proper role of free market capitalism, is both necessary and inevitable. British Columbia governments can “think globally and act locally” by creating a special space in the province for full-fledged business people who practise more than just profit maximization.

Business people who have worked out “how much is enough” and are motivated by pursuing community values of various kinds, can and should be taken at least as seriously by chartered banks, venture funds, regulators, customers, suppliers and peers as those who find satisfaction through increasing amounts of profit and consumption. Appropriate incentives and regulation will be essential to make this happen.

Correcting tunnel vision and traditional default positions will be challenging. But long-established mores around risk-analysis, incentives and personal motivation can evolve, if the blinders are removed.

Fortunately, a body of literature is beginning to emerge that paints an encouraging picture around debt default and returns on investment in triple-bottom-line businesses. (See the Oxford University Centre for Social Entrepreneurship, Duke University Centre for the Advancement of Social Entrepreneurship, Bridgespan, the Monitor Institute and Skoll Forum on Social Entrepreneurship).

The value proposition and risk analysis for such ventures is attractive. Not only do main-stream consumers increasingly prefer to deal with such companies, but the management and employees of such firms report a greater inclination to “go the extra mile” because of pride in being employed by a company with a progressive agenda.

Avoiding excessive regulation is an important goal but, at a minimum, an essential aspect of incentivizing socially responsible business will be the enforcement of transparency that allows the general public to know which businesses “walk the talk” when claiming they balance other important social, cultural and environmental goals with profit-seeking. A business could simply “(re)brand” itself around these objectives, but then would be subjected to scrutiny which, with the aid of on-line reporting and a modest expansion of Canada Revenue Agency enforcement resources, is likely to be an efficient and cost-effective effort.

Clear guidelines for self-branding as triple-bottom-line adherents and concomitant reporting would have to be established. Likely consumers, armed with social media, would aid in the arbitration of agreeable practices in this area. At the same time, the filters applied by the growing number of ethical venture funds would be enhanced by access to such information.

It is reasonable to assume that this would lead to increased participation by private investors who would come to feel more comfortable with this sort of transaction both in terms of its business fundamentals and attendant social missions. It might also mean that more social venture funds of the angel variety, such as Vancouver’s Renewal Partners, Varshney Capital Corp., and Relentless Pursuit Partners, would be set up to operate in Canada alongside the more numerous funds that are primarily interested in traditional business development.

In short, there is good reason to believe that the provision of a clear and simple means to track and evaluate results within socially responsible businesses may well lead to greater private investment in these firms and, in turn, the communities they reside in.

A respectable number of American companies such as the Acumen Fund are demonstrating the mechanics of how this can play out through diverse market-based tools such as the innovative use of loan guarantees, quasi-equity debt, pooling, modified debentures, the backing of social impact bonds and the facilitation of community bonds.

In September, 2014 the European Council voted to adopt a directive – which holds the force of law – requiring a wide range of companies to begin publicly reporting on environmental and social strategies, actions, policies and programs.

Something similar to this should be undertaken in British Columbia. The goal would be to facilitate wide-spread realization that concrete value is created (both for companies and communities) when businesses focus on the materiality of strategic social and environmental information provided to stakeholders, demonstrate the relationship of this information to key externalities and then integrate it all into their corporate and sustainability planning and implementation.

MORAL OF THE STORY

The notion of social enterprise was conceived, experimented with and failed within the realm of civil society. The practice never lived up to the theory. It should be allowed a dignified death worthy of any noble effort. Governments that attempt “beating a dead horse” to revive it are acting irresponsibly. A much better route is to focus on re-establishing the important social, environmental and community obligations that mainstream businesses took very seriously in the not too distant past.

The British Columbia government now manages an impressive looking web-site on social enterprise called Hubcap. It has also recently awarded a major grant to the ISIS Research Centre of the Sauder Business School at UBC to take a good hard look at social enterprise in British Columbia. It is hoped that the final report of this project is based on well-researched fact and objective analysis rather than further wishful thinking.

Copyright – Kenneth J. McFarlane – January, 2018 – Vancouver BC, Canada