About Mark Johnson

Mark is an experienced commercial solicitor and company secretary working with clients to manage risk, assure compliance and protect their legal position.

Community Interest Company & Community Shares?

Can a Community Interest Company Issue Community Shares?

With growing appetite for socially motivated investment and community share offers, is it time to level the playing field for CICs?

Community and social enterprises are booming. According to government data, there are now 70,000 social enterprises in the UK contributing £18.5bn to the UK economy and employing nearly a million people (BIS/BMG 2013). Social and community enterprises are businesses that aim to generate their income by selling goods and services, rather than through grants and donations; they are set up to specifically make a difference and they reinvest most of the profits they make in their social mission. At a time of dwindling trust in large corporations, they have really found their niche.

To date they have focused on renewable energy, local food production, community shops, pubs and brewing, affordable housing, sports and leisure. Increasingly, they are also running a wider range of public services, including health services, social care and childcare. They have also been very successful in raising capital from their communities and supporters. Since 2009, 286 community share offers have been successfully completed or are underway. According to the Community Shares Unit’s Inside the Market report (June 2015), more than £80m of share capital has been raised from over 60,000 investors since 2009. There is growing appetite from philanthropists, foundations, charities, and crucially members of the public, to invest in these enterprises. The new Social Investment Tax Relief allows individual investors to offset 30% of the cost of the investment against their tax bill, if relevant criteria are satisfied. The involvement of these community based members and investors creates strong engagement between the new enterprise and those it serves. They can enhance the governance of the organisation by holding the board the board to account.

To date, community share offers have mainly used the industrial and provident societies (now called cooperatives or community benefit societies), as their legal format of choice. This legal format has a long and proud history dating back to the self-help movement of the nineteenth century and was recently reinvigorated with the passing of the Cooperatives and Community Benefit Societies Act 2014. There are three main reasons for the use of this format. Firstly, cooperatives and community benefit societies can issue ‘withdrawable shares’ – a type of share capital unique to this legal format, which allows the enterprise to pay a fixed or capped rate of interest (usually at the discretion of the board, as finances allow), but at the same time allows the investor to withdraw their capital, but normally not to sell or transfer their shares. Secondly, share offers made by a community benefit society or cooperative are an exempt category of security for the purposes of the Financial Promotion Order 2005, (by virtue of Schedule 1, paragraph 14(3)(c)), which means there is no obligation to involve an expensive FCA authorised adviser in structuring or marketing the investment. Thirdly, a community benefit society (but not a cooperative) can qualify as a charity (if it has exclusively charitable objectives), with all the attendant tax reliefs and status and still issue shares to the public.

Community interest companies on the rise?
The community interest company (CIC) is the newer kid on the block. This format has just celebrated its tenth anniversary. There are more than 10,600 in existence. This legal form was heralded as the new way to kickstart social investment and philanthropic ventures when it was introduced in 2005. The community interest company has a number of attractive features which should promote investor confidence: an automatic ‘asset lock’ is designed to ensure that the company’s cash and assets are only used for the stated community purpose. A ‘dividend cap’ ensures that a CIC limited by shares can only distribute 35% of distributable profits to shareholders and the other 65% must be reinvested in the community mission. And the CIC is overseen by a community interest regulator who will only register it if it has a genuine community purpose and who expects to see annual reports detailing how its mission has been fulfilled in practice. (Arguably, these present a much more demanding regime than the FCA’s current supervision of cooperatives and community benefit societies). But in raising community investment, this format is lagging behind. Why is this?

We first need to understand the restrictions which apply to the community interest company. A lot of these stem from the fact that legislation creating CICs was grafted onto the back of existing company law for commercial enterprises. There are two main issues.

Firstly, a CIC is caught by the prohibition in section 755 of the Companies Act. Section 755 (1) states:

“A private company limited by shares… must not (a) offer the public any securities of the company, or (b) allot or agree to allot any securities of the company with a view to their being offered to the public”.

If companies wish to offer shares to the public, they are supposed to become public limited companies (PLCs), which are more heavily regulated. This provision also catches a CIC limited by shares by virtue of section 1 of the Companies Act 2006. The phrase ‘offer to the public’ is defined in section 756. An offer is not to be regarded as an ‘offer to the public’ if it can properly be regarded in all the circumstances as-

(a) not being calculated to result, directly or indirectly, in securities of the company becoming available to persons other than those receiving the offer, or
(b) Otherwise being a private concern of the person receiving it and the person making it.

A successful community share offer does depend on heavy promotion and marketing amongst supporters of the project. To rely on the first alternative (a), the promoters would have to take extreme care that the investment was not publicised generally, but only to prequalified supporters.

756 (4) goes on to say that an offer is to be regarded (unless the contrary is proved) as being a private concern if (a) it is made to a person already connected with the company..
756(5) defines ‘a person already connected with the company’ as (a) an existing member or employee of the company or (b) a member of the family of a person who is or was a member or employee of the company

[plus others categories not relevant for our purposes].

So from this we can take that a CIC limited by shares could lawfully issue shares to a defined class of persons provided they were already supporters or members or employees of the company.

So far so good. We then turn to look at the second obstacle. That derives from Financial Services and Markets Act 2000, specifically section 21 and the Financial Promotions Order 2005 made under it. This paternalistic piece of legislation is designed to prevent unscrupulous promoters of investments from taking advantage of unsophisticated investors by making it an offence to promote investments unless, either they have been approved by an FCA regulated advisor, or one of the exemptions applies. As we saw above, the issue of shares in a cooperative or community benefit society benefits from a complete exemption in Schedule 1 paragraph 14(3)(c). However, there is no such explicit exemption for shares in a community interest company. It is difficult to see a justification for this apparent disparity, since both legal formats are regulated and should have an asset lock in place, both formats are equally capable of being used to fulfil the social investment purpose.
So we must then turn to look at other possible exemptions that might be helpful in issuing shares to supporter members. The one which is likely to be most helpful is in Article 52. This applies to an offer of shares or debentures to an identified group of persons who, when the financial promotion is made might reasonably be regarded as having an existing and common interest with each other and the company.

Article 52 states—(1) “Common interest group”, in relation to a company, means an identified group of persons who at the time the communication is made might reasonably be regarded as having an existing and common interest with each other and that company in—

(a) the affairs of the company; and
(b) what is done with the proceeds arising from any investment to which the communication relates.

(2) If the requirements of paragraphs (3) and either (4) or (5) are met, the financial promotion restriction does not apply to any communication which—

(a) is a non-real time communication or a solicited real time communication [a real time communication is defined as a ‘personal visit, telephone conversation or other interactive dialogue’];
(b) is made only to persons who are members of a common interest group of a company, or may reasonably be regarded as directed only at such persons; and
(c) relates to investments falling within paragraph 14 or 15 of Schedule 1 which are issued, or to be issued, by that company [which includes the issue of shares in a corporation].

The relevant conditions in paragraphs (3), (4) and (5) can be summarised as follows:

(3) the communication must be accompanied by an indication—

(a) that the directors of the company (or its promoters named in the communication) have taken all reasonable care to ensure that every statement of fact or opinion included in the communication is true and not misleading given the form and context in which it appears;
(b) that the directors of the company (or its promoters named in the communication) have not limited their liability with respect to the communication; and
(c) that any person who is in any doubt about the investment to which the communication relates should consult an authorised person specialising in advising on investments of the kind in question.

(4) The requirements of this paragraph are that the communication is accompanied by an indication—

(a) that the directors of the company (or its promoters named in the communication) have taken all reasonable care to ensure that any person belonging to the common interest group (and his professional advisers) can have access, at all reasonable times, to all the information that he or they would reasonably require, and reasonably expect to find, for the purpose of making an informed assessment of the assets and liabilities, financial position, profits and losses and prospects of the company and of the rights attaching to the investments in question; and
(b) describing the means by which such information can be accessed [e.g. on a website]

(5) The requirements of this paragraph are that the communication is accompanied by an indication that any person considering subscribing for the investments in question should regard any subscription as made primarily to assist the furtherance of the company’s objectives (other than any purely financial objectives) and only secondarily, if at all, as an investment. [emphasis added].

Furthermore the communication must satisfy additional criteria:

The communication must accompanied by an indication that:

– it is directed at persons who are members of the common interest group and that any investment or activity to which it relates is available only to such persons;
– that it must not be acted upon by persons who are not members of the common interest group;
– proper systems and procedures are in place to prevent recipients other than members of the common interest group engaging in the investment activity to which the communication relates with the person directing the communication, a close relative of his or a member of the same group

Paragraph 8 further restricts the definition of a common interest group for the avoidance of doubt: Persons are not to be regarded as being in a common interest group just because
(a) they will have such an interest if they become members or creditors of the company;
(b) they all carry on a particular trade or profession; or
(c) they are persons with whom the company has an existing business relationship, whether by being its clients, customers, contractors, suppliers or otherwise.

From this we can take it that, subject to complying the various formalities outlined above, the CIC could proceed to issue shares to a group of people who already have some form of engagement or commitment to a common cause. There is of course quite an onerous responsibility on the board of directors to comply with the specific requirements. We return to this point below.

The third obstacle is then how could the attractiveness of the ‘withdrawable share capital’, which is unique to cooperatives and community benefit societies, be replicated? This allows investors to ask for their original stake back. Controls normally exist in the governing document to stop all investors withdrawing at once and for the board to set limits and timetable for withdrawals. Company law does not have an exact equivalent to this concept, however, its nearest equivalent would be ‘redeemable shares’. Section 684 of the Companies Act allows a private limited company to issue redeemable shares, unless its Articles of Association provide otherwise. The shares can be redeemed by the company at their nominal value (i.e. the amount paid for them, rather than the market value) at some stated future date. It would be possible for the Articles to set out the mechanism for determining this date at the board’s discretion. Model Article 22 for private limited companies contains helpful wording: “The company may issue shares which are to be redeemed, or are liable to be redeemed at the option of the company or the holder, and the directors may determine the terms, conditions and manner of redemption of any such shares.” There are two conditions which must be satisfied (a) there must normally be sufficient distributable profits to make the redemption. (This is calculated by net realisable profits less net realisable losses – usually found in the retained profit line in the balance sheet); (b) there must be at least one share in issue which is not redeemable to ensure the entire capital is not redeemed leaving no shareholders. In theory, a payment out of capital would also be possible under section 709 and 713 of the Companies Act 2006, however in practice the need to have a directors’ statement of solvency, obtain an auditor’s report, and pass a resolution of the members and advertise the proposal would make this a complicated and expensive process.

Once redeemed the shares are cancelled and cease to exist. Article 33 of the Model Articles for a CIC limited by shares (with power to pay dividends) states:

“Purchase of Own Shares: Subject to the articles, the Company may purchase its own shares (including any redeemable shares) and may make a payment in respect of the redemption or purchase of its own shares otherwise than out of the distributable profits of the Company or the proceeds of a fresh issue of shares. Any share so purchased shall be purchased at its nominal value.”

So CICs are able to issue redeemable shares, provided that the amount of redemption does not exceed the amount paid for them at the outset (Regulation 24 of the CIC Regulations 2005). This is to stop capital and profits being siphoned off in contravention of the statutory asset lock provisions.

How does this compare with the position for cooperatives and community benefit societies? Coops and community benefit societies do not have the same formal statutory restriction on repaying shareholders only from distributable profits, however in practice the same constraint is likely to apply, since a prudent board could only sanction repayment if there was sufficient accumulated reserves and working capital to make the payment. A second difference is that cooperatives and community benefit societies are allowed to pay interest on share capital at whatever rate which is reasonable to attract investment (which is a more subjective judgment), whereas CICs have an absolute cap of 35% of distributable profits.

Thirdly, cooperatives and societies can treat interest paid on their share capital as a deductible expense against any corporation tax liability, whereas dividends paid by a CIC will have to come out of post corporation tax surpluses.

A further wrinkle – the requirement for a prospectus?

Section 85 of the Financial Services and Markets Act 2000 states:

“It is unlawful for transferable securities to which this subsection applies to be offered to the public in the United Kingdom unless an approved prospectus has been made available to the public before the offer is made.”

Contravention is punishable by a prison sentence or fine and can give rise to claims for damages by persons who suffer loss. If the Articles of the CIC or the Rules of a CIC permit the shares to be transferred from one person to another (which may not actually be necessary), this prohibition could apply. Most withdrawable shares in societies are expressed in their rules to be non-transferable so the problem does not arise. However, Section 85 (5) goes on to say that the prohibition does not apply to securities listed in Schedule 11A. In Schedule 11A we find exemptions for a charity, registered housing association, a community benefit society (but not a cooperative) registered under the 2014 Act, a pre-existing old style industrial and provident society and “(e) a non-profit making association or body recognised by an EEA State with objectives similar to those of a body falling within [any of the other categories]”. Perhaps unhelpfully, there is no specific reference to a community interest company, but it would be reasonable to describe a community interest company as a non-profit making body falling within (e) since its core purpose is not to maximise profit, but to serve a community purpose. Alternatively, Section 86 (1)(b) may help: it states that the prohibition does not apply if the offer is made to or directed at fewer than 150 persons or is for an amount less than 100,000 euros (currently £70,688).

A possible route for CICs to issue community shares?

Some commentators have suggested extreme measures, such as winding up the CIC and transferring assets into a community benefit society, or setting up a community benefit society alongside the CIC as a subsidiary or holding company in order to facilitate a community share offer using a CIC. All these artificial routes entail additional costs and complexity which most community groups could do without, frankly.

Taking into account all of the above, I would like to suggest a scenario which could be used for a CIC to issue community shares (though this comes with a health warning that it is untested and unproven). A group intending to raise funds from the community using a CIC format could proceed as follows:

– Set up an unlimited company – this is a body corporate, but does not benefit from limited liability status. It could be used to assemble and organise a body of supporters who will later become investors.
– Recruit supporter members to this unlimited company
– Once the membership drive is complete, re-register the unlimited company as a private company limited by shares and community interest company
– Proceed to offer and issue shares to the existing membership who are then within the common interest exemption, being careful to comply with the requirements about the communications with investors and making suitable background documents available to enable investors to reach an informed view.

Creating legal certainty
Looking to the longer term, it would be immensely helpful if the Cabinet Office and legislators introduced specific exemptions to create legal certainty in this area: (a) An ‘offer of shares to the public’ in section 755 of the Companies Act could specifically exclude share offers by any community interest company for community benefit; (b) the Financial Promotions Order 2005, Schedule 1 paragraph 14(3) could include an additional exemption for ‘Offer of securities by a community interest company for community benefit’; and (c) the Financial Services and Market Act Schedule 11A, paragraph 7 could usefully include an explicit exemption for prospectuses for a ‘community interest company’.

I am happy to be shot down in flames on these proposals, but I offer them up to advance debate in this area!

Mark Johnson is an experienced solicitor and company secretary helping social enterprises, charities and SMEs to flourish. His company Elderflower Legal advises on the development of successful community and social enterprises. This article is intended for general guidance and to stimulate debate on the topic. We are not responsible for action taken in reliance on this post unless you have a professional retainer with us.

Community Share Offers

A new way to raise capital from local citizens to kick start funding for public services and infrastructure?

With continuing austerity measures in local authority and NHS budgets, local communities are seeking innovative ways to protect local services and infrastructure as the state decommissions services or withdraws grant funding. Politicians are increasingly having to shift their mindset and seek the holy grail of financially self-sustaining services, income generation and co-production of local services, involving the community more in designing and delivering services, as well as harnessing the power of volunteering. The Localism Act 2011 introduced new rights for communities to bid to run local services and to acquire local infrastructure, such as buildings, shops or pubs before they are sold off for development. These ‘community rights’ recently received a funding boost from Government to kickstart more activity. In tandem with this, an exciting programme to build capacity and awareness of community share offers has been undertaken by Locality and Cooperatives UK. With funding from the Department for Communities, this saw the launch in October 2012 of the Community Shares Unit devoted to developing the market. On 30 June 2015 the new Community Shares Standard Mark was unveiled– a quality assurance scheme designed to give social investors confidence that community share offers have been properly designed.

A virtuous circle of community engagement

Community share offers are a neat way to raise capital from local citizens to support local projects and community enterprises. Fledgling enterprises often struggle to raise the seed capital required to launch the business from traditional sources. Community shares offer a solution. With bank deposit interest rates still running at low levels, retail investors with some spare cash to invest may obtain a rate equal or better to the deposit account, whilst also supporting a worthwhile venture with positive social benefits. Set up correctly, the medium of share offers creates a really positive alignment and increased engagement between the new community enterprise and the wider public. Shareholders become natural ambassadors for the products and services offered by the new enterprise, creating a virtuous circle where it is in their interests as members and investors also to be active as customers, supporters and volunteers.

Community Benefit Societies

The term ‘community shares’ refers to ‘withdrawable shares’ in community benefit societies set up under the new Cooperative and Community Benefit Societies Act 2014. This Act overhauled old legislation around industrial and provident societies. The community benefit society is a limited liability entity with a constitution based on a set of rules and a two-tier governance structure comprising the board and general membership. Unlike shares in a limited company, these shares are usually non-transferable and carry a right to capped or fixed interest only. There is no right to participate in profits or a slice of the underlying assets – so no scope for capital gain, so the enterprise is preserved for the common wealth. The decision to pay interest on the shares is usually at the discretion of the board and will only occur if there are sufficient trading surpluses to justify this, without compromising the organisation’s core mission. If a shareholder wishes to cash in, the society simply returns the original cash stake. Controls exist to stop all shareholders cashing in at the same time. Most societies are also subject to an asset lock, which prevents the society being sold and the proceeds of the sale being distributed amongst shareholders.

Tax reliefs and lower costs

There are three other important advantages of this legal format. First, the shares may qualify for Social Investment Tax Relief, which allows the investor to claim 30% of the amount invested as relief against their tax bill in that year or the previous year, either through their tax return or PAYE – thereby adding to the return on investment. Second, if the rules and objects are drafted correctly, they may qualify for charitable status, which may bring tax benefits for the enterprise in corporation tax, stamp duty land tax, relief from business rates and some VAT privileges. Third, the issue of such shares is exempt from the heavy regulation which otherwise applies to promotion of shares to the general public by companies, meaning that a community share offer can be put together much more cost-effectively, often using low-cost crowd-funding platforms.

A growing market

Since 2009, over 400 new societies have been registered, and 286 community share offers have been successfully completed or are underway. According to the CSU’s Inside the Market report (June 2015), more than £80m of share capital has been raised from over 60,000 investors since 2009. Amazingly, this now represents a 10% share of the total social investment market and is the second largest form of crowd-funding in the UK. This seed capital been used to attract matched funding from grants or commercial loans. These new enterprises have so far focused on renewable energy, local food production, community shops pubs and brewing, affordable housing, sports clubs and faith groups. There is no reason why they could not be used to support and kick start activity in a wider range of public services. We are working with groups now running former statutory services who intend to raise funds through this route. An obvious area for further development would be health and social care services, particularly for high growth areas such as services for older people or patients coping with long-term health conditions in the community. The initiative already has the backing of DCLG and DEFRA and it is understood HM Treasury is increasingly taking an interest in the potential for further development.

Launching a successful share offer

The process for achieving a community share offer requires careful forward planning. There needs to be a competent development team in place to develop the idea and get the organisation investment ready; then a business plan demonstrating the viability of the enterprise and its ability to generate a profit to pay a (modest) return to shareholders. The target community needs to be fully engaged in the development process to persuade them to invest in shares. Marketing and promotion plays a key role here. Finally, experienced professional support is needed to launch the share offer.

Community share offers can be a great tool to support local services and infrastructure. The availability of new tax reliefs and lower regulatory burden make this an attractive route for enterprises and investors alike. This year sees several new initiatives and programmes focusing on kick-starting more community enterprises, such as Big Potential, The Power to Change and DCLG’s latest Community Rights programmes: community share offers will dovetail nicely with these.

Mark Johnson is an experienced solicitor and company secretary helping social enterprises, charities and SMEs to flourish. His company Elderflower Legal advises on the development of successful community share offers and he is part of the Community Shares Unit’s licensed practitioner development programme.

How Can the Board Develop an Effective Approach to Risk Management?

Does Your Board Have an Effective Approach to Risk Management?

Risk management is a key component of sound corporate governance. There has been a popular view in the past that risk management was a brake on progress: a discipline inhabited by clip-board clutching box tickers intent on stifling entrepreneurial innovation. Not any more – for enlightened organisations have embedded an effective approach to managing risk into their culture and everyday processes. Risk management should be as much about spotting opportunities, as avoiding hazards.

‘The effective development and delivery of an organisation’s strategic objectives, its ability to seize new opportunities and to ensure its own long-term survival depend on its identification, understanding of, and response to, the risks it faces,’ says the Financial Reporting Council.

High profile scandals in private, public and third sectors, corporate failures, the banking crisis of 2008-2009, as well as increased globalisation, interconnectedness and the fast pace of change in the business environment, have all focused more attention on the way boards handle risk management. There has been a step change in the need for boards to focus on risk in the last few years. Regulators have toughened their approach – all but the smallest companies in the UK must now prepare a ‘strategic report’ which includes a ‘fair review of the company’s business and a description of the principal risks and uncertainties facing the company.’  For charities, the SORP 2015 requires in the annual report from trustees ‘a description of the principal risks and uncertainties facing the charity and its subsidiary undertakings, as identified by the charity trustees, together with a summary of their plans and strategies for managing those risks’. Sector specific regulators from the Care Quality Commission, to the Health & Safety Executive expect to see a proper risk management strategy.

Corporate Governance codes all stress the need for an effective approach. The UK Code states in Section C, ‘The board is responsible for determining the nature and the extent of the principal risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal control systems.’ In the 2014 edition this was strengthened to include a new provision that ‘a robust assessment’ is carried out annually of the ‘principal risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity.’ Similarly, the Governance Code for the Voluntary Sector requires that the board must ensure ‘..it regularly identifies and reviews the major risks to which the organisation is exposed and has systems to manage those risks.’ But also, there are increasing expectations from all stakeholders that the Board is aware of risks and has an effective plan to manage them. It is no longer acceptable in the public’s mind for organisations to find themselves in a position where unexpected events cause financial loss, operational disruption, damage to reputation and loss of market position. Witness the outcry every time a bank’s cashpoint network goes offline.

What is risk?

A useful working definition is ‘an event with the ability to impact (inhibit, enhance or cause doubt about) an organisation’s mission, strategy, projects, routine operations, objectives, core processes, key dependencies and/or the delivery of stakeholder expectations.

By taking a proactive approach to risk management, organisations should achieve positive benefits:

  • Operations should be more efficient because events that can cause disruption are identified in advance and actions taken to reduce the likelihood and containing the costs if they do occur.
  • Processes should be more effective because of the thought that is given to selecting processes and thinking about the risks involved in different alternatives.
  • Strategy should be more effective, because risks associated with different options will have been carefully analysed and better decisions reached, leading to better outcomes.

Types of risk

Risks break down into different types. Risk management practitioners classify risks into hazard risks, control risks and opportunity risks. In general terms, organisations seek to mitigate hazard risks, manage control risks and embrace opportunity risks.

Risks break down into categories:

  • Financial risks – (e.g. accuracy and timeliness of financial information, accurate accounting records, adequacy of cashflow, interest rates, exchange rates, investment returns).
  • Operational risks (machine failure, human errors, service quality, incorrect contract pricing, employment issues, health and safety, IT failures, data breaches, fraud and theft).
  • Environmental and external risks (reputation and adverse publicity, cyber attacks, demographic trends, government policy, terrorism, extreme weather events, pandemics).
  • Compliance with laws and regulation – risk of legal claims, regulatory action, prosecution and fines for failure to comply with obligations.

Risk assessment

Having identified the risks faced by your organisation, they should be categorised in terms of their likelihood of occurrence and potential severity of impact (including financial loss or impact on reputation). Sometimes a risk score of 1-5 may be awarded (with 1 being very low and 5 being very high). The impact score may be multiplied by the likelihood score to identify the areas where most board attention and scrutiny is required.  This will build up into a risk register similar to the one shown in Figure 1 below.

Figure 1 Example Risk Register

Risk Table

Once each risk has been evaluated, the board will need to consider any action that needs to be taken to mitigate the risk, either by reducing the likelihood of it occurring, or lessening the impact if it does. The technique of ‘4Ts’ is sometimes used:

  • Tolerate – accept the risk because it is not considered a significant threat.
  • Trim – take measures to control or reduce the risk, so that the residual risk after control measures have been applied is acceptable (e.g. create policies and processes, train staff on how to reduce likelihood).
  • Transfer – shift the financial consequences to third parties (e.g. through taking out insurance or outsourcing to the supply chain, or using indemnity clauses in contracts).
  • Terminate the risk – by getting out completely – e.g. closing down an excessively risky operation or facility.

The risk register should be used for recording risks that have been identified, actions taken to investigate the risk, identifying the person with management responsibility for the risk, recording measures taken to deal with risks, and recording regular reviews of the risks. The risk register should be a living document that is reviewed at scheduled intervals by the board – not a one-off exercise that then sits in a filing cabinet

How does the Board discharge its responsibility?

The approach taken by any Board obviously depends on the size of the organisation and the complexity of its operations, but any organisation can benefit from a structured approach. In an organisation with full time professional managers, it would be usual for the managers to take the lead in assembling the risk register and bringing it to the board for review. However, in a smaller organisation the board members themselves may have to take the lead in compiling a risk register, perhaps with the assistance of an external facilitator, such as Elderflower Legal.

The processes  which boards use to consider risks were examined in some detail by the FRC in 2011 and the Sharman Inquiry in 2012. The key areas of best practice recommended were:

  • The board must first decide on its appetite and willingness to take on risk – this feeds into the organisation’s culture, behaviour and values. Are the risks commensurate with the expected returns? An environment of excessive or ill-informed risk-taking could be fatal to the organisation’s long-term future. The Walker report into the banking crisis found that boards simply did not understand the risks that their traders were taking on mortgage backed-securities. At its simplest level, the board may set financial downside limits on transactions and these feed through into specific limitations on the authority of managers in any scheme of delegation. There are also inevitable linkages to personal reward systems and motivations and HR policies and how these influence staff attitudes to risk.
  • Risk management and internal control should be incorporated within the organisation’s normal management and governance processes – not treated as a separate or one-off compliance exercise.
  • The board must make a robust assessment of the main risks to the organisation’s business model, including ability to deliver its strategy, solvency, liquidity and long-term viability.
  • Once the risks have been identified, the board should agree how they will be managed and mitigated. It should satisfy itself that the management and control systems are adequate and, in larger organisations, receive adequate formal assurances from managers, the audit committee and external auditors. Regular reports should be coming to the board to provide this. Risk data should be captured from across the organisation: often front-line staff are the first to be aware of problems.
  • Risks and associated control systems should be reviewed on a regular ongoing basis.
  • The organisation should report publicly and transparently to its stakeholders on the principal risks it faces, any material uncertainties and their review of the risk management and internal controls. Stakeholders should feel that the board has a visible role in governance and stewardship and that the board is held accountable.

Five key questions for the Board

What are the top 5 actions the board can take to ensure success?

  • Focus on the culture – is there an embedded commitment to risk management and control in your organisation? Does the board lead by example? There should be openness and creativity around risk issues. (Don’t be like HBOS, which sacked its group head of risk when he tried to warn the Board they were taking excessive risk).
  • The risk register and associated controls must be documented, understood, reviewed and disseminated regularly – not locked in a filing cabinet and dusted off once a year, or even less frequently.
  • There must be a process for monitoring and reviewing risk – adequate time must be scheduled at board meetings to consider risk issues and review whether the organisation has the skills and capacity and tools to manage risks effectively. The board should focus its attention on the top ten areas identified with highest risk score.
  • The board must be alert to new and emerging risks (such as cyber attacks, sovereign debt crises, Grexit/ Brexit, global political instability/ terrorism, climate change, social media, pandemics, demographic changes).
  • Report on the board’s activities in examining and reviewing risks so that stakeholders can gain assurance that the board is discharging its duties and form a balanced, clear and informed view of the organisation’s prospects.

As with all aspects of good governance, the effectiveness of risk management and internal control ultimately depends on the skills, knowledge and behaviour of those responsible for operating the system. The board must set the desired values, ensure they are communicated, incentivise the desired behaviours, and sanction inappropriate behaviour.

Mark Johnson is an experienced solicitor and company secretary helping SME businesses, charities, social enterprises to manage risk, ensure good governance and protect their legal position. elderflowerlegal.co.uk

Late Payment of Invoices – Are You Claiming Your Full Entitlement?

Good cash flow management is essential to any business. Used wisely, Late Payment legislation can help you with cash flow management.

Late Payment legislation was introduced in 1998 to encourage a culture of prompt payment. Evidence suggests that late payments are a major continuing problem. A survey by the Federation of Small Business in March 2015 found that 43 per cent of firms have waited over 90 days beyond the agreed payment date before they got the money they were owed.

New rules were brought in during 2013, but the level of awareness about how to use the rules still appears to be low. Businesses may fear upsetting their customers and jeopardising future business, but used wisely the rules can help your business.

What can you claim for?

Claim interest

If you are in business (no matter what your legal structure) and have supplied goods or services for business purposes (i.e. B2B and not to an individual consumer) you can claim interest on late payments at 8% plus the Bank of England current base rate (0.5%), so 8.5% in total.

You can claim interest for the period starting from the date on which the invoice should have been paid, and ending on the date it was actually paid.

For example, if your business were owed £1,000:

Annual interest would be £1000 x 8.5% = £85
Divide that by 365 days, daily rate = £0.23
So a payment which is 60 days after the due date, 60 x £0.23 = £13.80

You can still claim the interest, even if the payment has since been made outside the permitted period. You have up to 6 years to make your claim (So you could go back 6 years from now and claim on payments that were made late – something to think about perhaps if you have no ongoing relationship with the customer).

When do payments become overdue?

Public authorities must always pay within 30 days of either (a) the date of receipt of invoice or (b) the date of delivery of goods or service (if later). ‘Public authority’ for these purposes includes schools, academy trusts, NHS trusts, housing associations, clinical commissioning groups and council-owned companies. Public authorities are not allowed to set a longer period. They may specify a process for verification of invoices, but this must be made explicit in tender documents or contracts and cannot exceed 30 days, unless expressly agreed. New public procurement legislation has recently included a legal requirement for all new public contracts to include 30-day payment terms for all the sub-contracts in the supply chain.

Commercial customers – if the contract doesn’t specify a period, a default period of 30 days from delivery or receipt of invoice applies (and interest runs thereafter).However, if the contract does allow a longer time for payment, 60 days is the maximum and statutory interest starts to run from 60 days after delivery, unless the customer can argue that an extended period is reasonable and fair in all the circumstances and in accordance with normal commercial practice (a high hurdle to overcome in practice).

If the contract says payment will be by instalments, you can claim statutory interest on each instalment that is paid late. If a payment is made upfront before delivery, the interest will run as from the date on which all the goods or service have been delivered.

You can also claim compensation for recovery costs.

As well as the interest, the law allows you to claim a fixed sum for each invoice paid late, depending on the amount.

Below £1,000            £ 40 per invoice
£1,000 – £9,999.99   £ 70 per invoice
Over £10,000           £100 per invoice

If you take the debtor to court, you may also recover additional costs of recovery above these sums.

How do you claim?

You could send a new invoice, but in fact all you are required to do is write to the customer and tell them what is due:

  • Amount of interest, compensation and costs
  • What it relates to – state the invoice number(s)
  • How they can make payment

You don’t need to send a prior warning letter. You charge interest on the gross amount of the debt (including any element of VAT, but you do not pay VAT on the interest).

Are there any exclusions?

  • If the amounts are disputed, the customer is still expected to pay any amount that is undisputed, while the issues are resolved.
  • If there is real doubt about the amount due, you may not be entitled to claim until the position has been clarified.
  • Consumer Credit Agreements and mortgages are not covered.

How can you take steps to protect your position?

  • Check your terms and conditions – what do they say about due date for payment?
  • What do they say about interest on late payment – don’t set a lower interest rate than the 8.5% you are entitled to by law.
  • Include a clause entitling you to charge ‘indemnity costs’ for recovering any sums not paid by the due date. This will increase your chances of getting more of your costs back if the dispute goes to court.
  • Circulate updated terms of business to all those affected.
  • Watch out for purchase orders which seek to impose the customer’s terms and conditions over yours – e.g. if they attempt to deprive you of a remedy by setting a low rate of interest – they may be struck down as void.
  • Tell your customers on your quotations, orders and reminder letters that it is your policy to make full use of the Late Payments legislation: “Please note we will exercise our statutory right to claim interest and compensation for debt recovery costs if we are not paid according to agreed credit terms.”
  • Remember the best way to secure timely payment is to agree clear terms in advance of the transaction and to invoice promptly and accurately.
  • Send your invoices electronically with confirmation of receipt or post them with a proof of posting certificate (free) or recorded delivery, so that you can prove the date of despatch.

Late payments continue to be a hot political issue. The amount tied up in late payments runs into billions and acts as a drag on the economy.  Further legislation is expected which will oblige public authorities and larger businesses to publish regular statistics on their payment records, thereby allowing persistent late payers to be named and shamed.

Mark Johnson is an experienced solicitor and company secretary with Elderflower Legal. He helps SMEs, charities and social enterprises to flourish by managing risk, assuring compliance and protecting their legal position. See more at elderflowerlegal.co.uk.

The Pivotal Role of the Chair in Ensuring Good Governance

How can the Chair perform the role effectively to maintain accountability and high performance from the Board?

Last time we considered the conditions for a high performance board. A critical player in making the Board effective is the Chair. He or she has a crucial role to play both inside and outside the boardroom. The Chair should be a team-builder: ensuring the Board understands the strategy and common objectives; promoting open and two-way communications, facilitating participative decision-making and providing visible leadership.

Managing meetings is critical

The Chair’s role is to create a safe space in which constructive inputs from all board members can occur. The Chair runs the Board and set its agenda. Meetings should be held in conducive locations and should start and finish on time. Agendas should focus on strategic matters, value creation and performance, rather than operational details, which are better delegated to executive managers.

The Chair should ensure that all members of the Board receive accurate, timely and clear information. This should cover both financial and non-financial indicators. This will enable the Board to make decisions based on evidence and properly to discharge their duty to promote the success of the organisation. Information should generally be circulated in advance of meetings to allow reading time.

For each item, the Chair should invite the person leading on it, often an executive manager, to introduce the subject and report, then open up the subject for discussion and debate. Vociferous members of the Board should not be allowed to dominate, particularly if this discourages quieter members from contributing. The Chair’s primary role should be to elicit the views of others and not to manipulate the discussion so that it goes their own way. The sense of the meeting must be ascertained and the outcome documented in the minutes. The Chair must ensure that actions are followed through.

The Chair should manage the Board to ensure that sufficient time is allowed for discussing complex or contentious issues. Board members should not be faced with unrealistic deadlines for decisions. All Board members should be encouraged to participate and offer constructive challenge. One Chair I know always sets homework for individual board members in advance of the next board meeting!

A skilful Chair should encourage feelings to be openly expressed and create a climate of trust and candour. Conflict should be surfaced and handled, with constructive negotiation, rather than personal attacks. Contrary views should not be glossed over. One technique to avoid ‘group think’ and ensure proper debate is to assign the role of devil’s advocate for unpopular alternatives, to stronger members of the group. Or occasionally the Chair could divide the board into two groups to evaluate options.

If consensus cannot be reached on a particular decision, the Chair should consider adjourning the discussion and returning to it at the next meeting. In the meantime, the Chair should attempt to identify the concerns of dissenting directors and reduce differences of opinion. Resisting contrary views may only serve to entrench the dissenter in his views, or even polarise the Board. If agreement cannot be reached, it may be appropriate to go to a vote: this should draw a line under the debate and allow the Board to move on.

The Chair should make certain that the board decides the nature and extent of the risks that it is willing to tolerate in implementing strategy. Sufficient attention should also be given to the composition, skills mix and succession planning for Board roles.

Chair’s role outside of the Board room

A newly appointed Chair should make a special effort to get to know the other board members through one-to-one phone calls or meetings. Valuable insights can be gleaned by drawing out fellow directors’ perceptions of the strengths, weaknesses, opportunities and threats facing the organisation. The Chair may help to facilitate social time in advance or after meetings to enhance teamwork within the group, by encouraging Board members to get to know and understand each other’s background, skills and perspective.

The Chair should take the lead in providing a proper induction programme for all new appointees to the Board (assisted by the Secretary, where appropriate). The Chair should also lead on evaluating the performance of the Board as whole, as well as individual directors, preferably on an annual or biennial basis. The Chair’s performance should be subject review by fellow directors too.  Following the review, the Chair should follow through on any training and development needs which have been identified.

The Chair has a crucial role to play in managing communications with the organisation’s stakeholders and ensuring that board members develop an understanding of the needs and desires of customers and employees, investors, funders, as well as regulators. There is a key role to play in dealing with the media, particularly during a crisis, to protect the organisation’s reputation.

What makes an effective Chair?

An effective chair needs self-confidence, usually acquired through experience, good listening skills and charisma, which arises from being simultaneously in control, yet still open to contributions. To lead the board effectively, the Chair must know the directors, their strengths and weaknesses, so that they can be drawn out on relevant matters, or reined in when they are becoming too long-winded. A visible presence, walking the floor, motivating and talking to staff, as well as meeting and presenting to external stakeholders, is important.

The Higgs Review of 2003 found that an effective Chair:

  • Upholds the highest standards of integrity, probity and good governance, leading by example
  • Sets the agenda, tone and style of board discussions to promote debate and discussion and sound decision-making
  • Ensures a clear structure for running board meetings, including starting and finishing on time and spending proportionate amounts of time on thorny and complex issues
  • Promotes effective communications, inside and outside the boardroom
  • Builds an effective board by initiating change and succession planning for board vacancies
  • Ensures that Board decisions are implemented effectively
  • Establishes a close relationship of trust with the senior executives, providing wise counsel, advice and support, but at the same time being careful not to interfere with operational management decisions
  • Provides coherent leadership of the organisation, including representing the organisation to the outside world and understanding the views of all the organisation’s key stakeholders.

Chairmanship is a challenging role. A good Chair will have a clear vision and focus on strategy, bringing together the disparate skills, qualities and experience of other board members. The Chair should foster a positive culture of corporate governance which then permeates down through the organisation and delivers positive results.

I hope you enjoyed reading about The Pivotal role of the Chair in Ensuring Good Governance.   Next time we look at The Board’s role in identifying and managing risk.

Mark Johnson is an experienced solicitor and company secretary helping charities, social enterprises and SME businesses to flourish. His company Elderflower Legal offers a range of support packages to help organisations with legal compliance, managing risk and good governance. For more resources check out elderflowerlegal.co.uk.

How to Create a High Performance Board

How can you put in place the right systems, structures and processes to ensure that your Board drives success?

Any organisation, whether in the private, third sector or public sector is only as good as the people who lead it. Board members have a vital responsibility to define the vision and mission of the organisation, to decide its strategy and objectives, to manage the risks and to fashion the ethos and culture of the organisation.

The Board is the epicentre of any system of corporate governance, by which the organisation is directed, controlled and held accountable to achieve its purpose and create value over the long-term; it must balance the needs and interests of different stakeholders, whilst at the same time providing the entrepreneurial drive and leadership to succeed. Sound governance should be seen as a source of competitive advantage, not a brake on progress.

Four key tasks of the Board

An effective Board has four main strands to its work:

  • To establish and maintain the vision, mission and values of the organisation (the vision should be an inspiring picture of the organisation’s potential, the mission is a statement of how to achieve the desired state, whilst values are the principles and deeply held beliefs and standards of conduct embedded in the organisation’s way of doing things).
  • To decide the strategy and structure – the Board should continually review and evaluate the strengths, weaknesses, opportunities and threats and consider how best to play to the organisation’s strengths, or bolster the required competencies. (More on strategy here).
  • Delegate authority to managers and then monitor and evaluate the performance of the strategy and business plan, whilst maintaining appropriate monitoring and controls over risks; determine the appropriate KPIs to be used for effective monitoring.
  • Communicate with all the stakeholders in the organisation (such as customers, employees, funders, and members): maintain a continuous dialogue to understand their needs, promote their goodwill and support.

In carrying out these tasks, there needs to be a dynamic dialogue within the Board. As the Walker report into the behaviour of bank boards during the financial crisis found, many boards ‘lacked a disciplined process of constructive challenge’. They had descended into ‘group think’ and had focused on conformance with rules, rather than thinking laterally and strategically. The Financial Reporting Council in its 2010 Guidance on Board Effectiveness tells us, ‘An effective Board should not necessarily be a comfortable place. Challenge, as well as teamwork, is an essential feature’.

The role of the Board

One of the Board’s first tasks is to decide how it will function and identify the key issues and decisions which it must tackle collectively and which cannot be delegated – a schedule of reserved matters. Following that, there will be a scheme of delegation of powers to executive managers, committees and subsidiaries. Typical matters reserved for decision-making by the Board, include:

  • Approval of the annual report and accounts
  • Approval of dividends (in a profit-distributing organisation)
  • Approval of communications with members and the public
  • Appointment or removal of auditors
  • Developing, approving and reviewing the strategy
  • Approval of operating plan and budgets, review of progress against budgets
  • Approval of expenditure and contracts in excess of delegated limits
  • Approving the prosecution, defence or settlement of any litigation
  • Approval and ongoing monitoring of risks – the board should set appropriate risk management policies and seek regular assurance that the system is working effectively
  • Appointment and removal of Board members and senior executives
  • Succession planning for key roles
  • Ownership of health and safety policies
  • Approval and ownership of ethics codes and CSR policies
  • Setting terms of reference for delegation of powers to executives and committees

Practical steps for success

There are several practical organisational steps which will contribute to success of any Board:

  • The Board must be properly constituted with the right skills and have the resources to undertake its duties, such as a good company secretary. Board members must dedicate sufficient time to their role.
  • The number of meetings should be sufficient to deal with the business effectively.
  • Agendas should be properly planned and sent out in advance, together with supporting papers to allow for prior reading and preparation.
  • There should be enough time to devote to the items on the agenda, with the right focus on the most important topics – especially strategic issues, rather than mundane operational detail.
  • Minutes should be accurate and available promptly to aid follow-up actions. (Minutes also form a legal record of decision-making that must be kept for up to 10 years).

The organisation’s governance framework should be implemented in a way that is proportionate and realistic. However, as the Financial Reporting Council commented in 2009, the quality of corporate governance depends ultimately on the behaviour of individuals, not on procedures and rules. That leads us to consider what are the desired qualities and skills of valuable Board members?

Desired attributes of Board members

The late Neville Bain, former Chairman of the IoD boiled it down to ten attributes:

  1. Ability to understand issues and identify central points for decision
  2. Sound judgment – probes facts and assumptions, weighs evidence to arrive at decisions
  3. The ability to provide and accept challenge in a constructive way
  4. Ability to influence through clear communication and persuasion
  5. Good interpersonal skills and ability to manage conflict
  6. Forward thinking – anticipating new trends and events, alert to the need for change
  7. Ability to think strategically, to understand the role of risk analysis and control
  8. Financial and commercial skills to understand how well the organisation is progressing against its goals.
  9. Integrity and high ethical standards – which they live by in practice.
  10. Good self-awareness – a thirst to improve personal knowledge and performance.

Boards must strive for continuous improvement

An effective Board should aim to be a learning organisation. They should continually review their collective performance as well as the performance of individual members. A useful way to approach this is through a structured external board effectiveness review, such as BoardCHECK360™ offered by Elderflower Legal. The review will examine various aspects of the Board’s operating procedures, composition and succession planning, induction, meetings management, internal controls and risk management, delegation and will highlight good practice, as well as areas for improvement.

As Bob Garratt tells us: ‘Directors are there to ensure that at the cybernetic centre of the enterprise, there is a heart and brain. This heart..creates an emotional temperature appropriate to that specific organisation. This is the essence of that organisation’s climate or culture”.

Next time: the pivotal role that the Chair plays in developing a successful Board.

Mark Johnson is an experienced solicitor and company secretary helping charities, social enterprises and SME businesses to flourish. His company Elderflower Legal offers a range of support packages to help organisations with legal compliance, managing risk and good governance. For more resources check out elderflowerlegal.co.uk.

What Makes a Successful Joint Venture?

Joint ventures can be a useful route to combine resources and skills, to secure greater market power or better access to markets for SMEs, charities and social enterprises.

A new corporate entity can be used to ring-fence more risky trading activities or to develop a distinct brand or business culture outside the strictures of the host participants (such as borrowing controls, pay scales or corporate overheads).

Partnering with an outside organisation may bring access to new technology, lean business processes and technical know-how. A joint venture arrangement in which partners each hold a shareholding provides an opportunity for ‘value capture’: as the business takes off their shareholding should increase in value. A shareholding and directors on the board provide a ‘seat at the table’, visibility and transparency on the money flows and activities of the business: areas of obscurity, which have been frequently criticised in more arm’s length outsourcing and licensing arrangements.

A joint venture is ‘an arrangement between two or more parties who pool their resources and collaborate in carrying on a business activity with a shared vision and a view to mutual profit’.

Analysing the elements of this, we find several main ingredients:

  1. There is a contribution of resources, assets and skills from both parties. Participants need to consider carefully the terms on which they make their staff and assets (land, equipment, brand, intellectual property rights etc) available to the new venture. Do the partners have the necessary powers and approvals to set up the arrangements?
  2. A joint venture is usually about starting a new business. There must be clarity about the business plan and risks, whether there is a demand for services or products supplied by that new business. Is there a wider market beyond the hosts’ areas that can be exploited to generate more revenue?In many cases, the joint venture will involve establishing a new limited company in which the partners each take a stake. The terms of the joint venture agreement are very important. Important areas to consider will be the agreed strategy and business plan for the venture, relative shareholdings and capital contributions, policies on reinvestment of profits vs. distributing them as dividends, decisions for which unanimity is required vs. decisions taken by majority and, crucially, what are the exit provisions if things don’t go according to plan or if one party wants to leave and sell its stake? Some enterprises with long-standing joint ventures have recently found it difficult to extricate themselves from arrangements which are no longer fit for purpose or perceived as too expensive. For example, Liverpool City Council had a long-standing JV with BT plc. It to come to an end after it was reported that BT would not agree to cutting the cost of the £70m-a-year deal any further than the £5m a year over three years they had negotiated so far.
  3. There must be genuine joint working around a shared vision. A lot of joint ventures have come unstuck because the partners have not invested enough time at the outset in considering explicitly what both parties’ objectives are from the arrangement. For one partner, the objective may be to achieve a step change in products or service levels by levering in new investment, technology and improved business processes; for another, the objective may be to achieve a defined level of profit and to use the contract as a springboard to capture more market share and new distribution channels. Open conversations about how each partner can help the other achieve these goals are important.
  4. A good joint venture has an appropriate balance of shared risks and rewards. The parties should ensure that they negotiate an appropriate share of future rewards, but equally it must expect to shoulder its share of the risks of making the business successful

Joint Ventures with the Public Sector?

Joint Ventures are increasingly of interest to public bodies too. They are experiencing a paradigm shift as they move to become smaller enablers and commissioners of services, rather than direct providers. They are looking for new ways to work with private and third sector organisations to ‘do more for less’. Over time this is leading to a diverse landscape of provider organisations, such as joint ventures, spin outs, arms length trading companies. Participants need to think carefully about the governance and accountability arrangements over these more exotic arrangements. All participants need to have appropriate mechanisms to monitor the performance and risks of joint ventures. Are they provided with timely financial information, performance reports against defined KPIs and, the figures for staff turnover, (always an interesting barometer of internal culture)?

So What Makes a Successful Joint Venture?

Here are my top tips for success.

  • Establish the commercial rationale for the arrangements – capture it succinctly in writing and then share and obtain buy-in from all your stakeholders.
  • Set clear objectives for the joint venture – what are the expected benefits and what contribution needs to be made by each partner? Set out the assumptions clearly.
  • Identify the possible partner(s) and select the most appropriate using clear selection criteria – remember cultural and behavioural factors can be just as important as infrastructure and know-how.
  • Carry out a due diligence process – each partner should share key information (under a confidentiality agreement) and introduce their team members.
  • Establish an appropriate legal format for the joint venture – this could range from a contractual arrangement, through to a full-blown new limited company in which each partner takes a stake.
  • Negotiate an agreement that reflects the goals of all partners, but at the same time includes a clear exit strategy (which describes the consequences of leaving), and clear agreed strategies for resolving disputes.
  • Create an appropriate structure for the management and ownership of the JV. Ideally, the principals shouldn’t get involved in the day-to-day issues and decisions, but leave it to a dedicated management with the capability and freedom to get on with the job. The JV management team should have clear control parameters and reporting lines.
  • Put in place proper project management arrangements and get the back-office infrastructure, systems and processes working well.
  • Make time to manage cultural issues – make sure that key personnel get to know each other on a social and professional level – teams that play together, stay together!
  • Be aware of the likely tension points– these include a perceived loss of control by one partner, a change of regime in one partner brings in new personalities, or the external environment changes and the reasons for the joint venture become less compelling.

Joint ventures can be a powerful medium to achieve growth, enter new markets, share and ring-fence risks. However, they need to be properly tended to bear fruit. Leaders need to make time and resources available to promote and defend the partnership, if it is to succeed. Cultural and behavioural factors can often be the most difficult issues to get right. The documentation needs a clear exit plan in case things don’t work out.

Mark Johnson is an experienced lawyer and company secretary working with SMEs, charities, social enterprises and public bodies to create successful collaborations and partnerships. elderflowerlegal.co.uk

Crafting a Winning Strategy: What’s the Secret Sauce?

One of the key tasks of any Board in the private, not-for-profit or public sector is to create a strategy for their organisation. Strategy is inextricably linked to good governance and effective risk management. The UK Corporate Governance Code at C.1.2: “Directors should include in their annual report an explanation of the strategy for delivering the objectives of the company.” Strategy has been defined as “the direction and scope of an organisation over the long-term which achieves advantage in a changing environment through its configuration of resources and competencies, with the aim of fulfilling stakeholder expectations[1]”. For businesses, a winning strategy should provide a sustainable competitive advantage. For other types of organisation, the strategy provides a mechanism to seek an increased share of limited resources, with the aim of advancing a mission, whilst balancing the interests of different stakeholders.

What is an effective strategy?

Creating a successful strategy is not an easy task. It is completely different to operational management. It requires board members to set aside proper creative thinking time, question assumptions and develop a critical enquiring approach. It can’t be achieved by a solo actor working in an ivory tower: it requires contribution and buy-in from a wider group of leaders and senior managers. The statistics show that most boards do not get it right. Studies published by Harvard Business Review show that at least 70% of strategies fail. Some research has found that 85% of directors don’t know what their organisation’s source of competitive advantage is.  In his 2011 book, Good Strategy, Bad Strategy, Rumelt tells us that a winning strategy contains three elements: a diagnosis, which defines the nature of the challenge, a guiding policy to overcome the obstacles identified which builds on or creates some form of advantage and (iii) a set of coherent actions coordinated with each other to accomplish the guiding policy. Typically, insufficient time is spent on diagnosis, as managers rush to action; sometimes the actions are not coherent because of a lack of alignment.

Why do most strategies fail?

Rumelt identifies four hallmarks of bad strategy, which we can all recognise: the use of ‘fluff’ (gibberish and buzzwords masquerading as strategic concepts to give the impression of intellectual thinking!); failure to define the real challenge, mistaking a long list of aspirational goals for strategy (e.g. we will grow our revenue by 20%, we will delight our customers etc, without saying how); setting objectives which are just impracticable in the context of the organisation, or which fail to address critical weaknesses in resources and capabilities.

So how do we avoid falling into this trap? Here I offer a ten point plan from my experience which could be used to help develop a winning strategy.

  1. Start with why?

Simon Sinek has developed a whole business methodology around this question. We first need to understand the motive force behind the enterprise. Why are you in business, what is your core purpose and mission? Has this been explicitly captured and communicated to all your stakeholders? When did you last review it?

  1. Values matter more than ever

Identify what the values of the organisation are and how these reflect your culture (the beliefs, traditions and habits shared by your people). Capturing the values requires input from across the organisation.  Values can be used to set the ethical and legal boundaries for the activities you undertake and to set the emotional temperature of the organisation. However, it is no use articulating a charter if those at the top do not lead by example! Studies show that the Generation Y millennials and Generation Z among your customers and employees are particularly attuned to corporate values- ignore them at your peril.

  1. Assess your current position

Use a SWOT analysis to assess strengths, weaknesses, opportunities and threats facing the organisation. Strengths and weaknesses are normally internal factors, whilst opportunities and threats are external forces. Strengths might include specialist knowledge, a highly skilled workforce; weaknesses might include a lack of working capital or inefficient operating procedures. In looking at external forces, it is useful to employ the PESTEL analysis to identify the political, economic, sociological, environmental and legal factors that could, or do already, impact on your business environment. From this analysis, identify the top 3-5 critical success factors – the essential factors which the organisation must absolutely get right to succeed and keep these front of mind.

  1. Where else could you play?

Having identified your strengths and some opportunities, in which markets (existing, new or adjacent) could you operate? For example, if you were an enterprise with strengths in residential care for the elderly, could you move into caring for learning disabilities? What discontinuities could occur which could open up new avenues of opportunity for you?

  1. What is the structure of competition in your markets?

Use Michael Porter’s Five Forces model to assess the structure of competition in your chosen markets. Porter identifies 5 forces which influence market position:

(1) current competitive rivalry – if there is strong competition this will drive prices down and increase costs for businesses trying to compete

(2) Is there potential for entry of new competitors? How easy would it be for new competitors to emerge – are there factors under your control which could prevent or delay this, such as a well-defined brand identity, differentiated products or services, exclusive IP rights that you own?
(3) Power of the customer – the customer tends to have power if their purchasing power is concentrated (e.g. through buying frameworks), or if the product or service is seen as undifferentiated;
(4) Power of your suppliers – they may enjoy power over you because of high switching costs or because there are few alternatives;
(5) The threat of substitutes – are there other ways of solving the customer’s problem besides coming to you? Being alert to innovation that could be a complete game-changer is important. If competitive pressure is becoming too great, it may be time to move into more attractive markets where demand exceeds supply, margins are better and the pressure is manageable.

  1. What are your distinctive competencies and capabilities?

Your capabilities are derived from your people, financial capital, materials, technology, information and knowledge, buildings and intangibles such as brand, reputation, IP rights and leadership. Barney tells us that to provide real competitive advantage capabilities should ideally be valuable, rare, inimitable and non-substitutable. This allows you to differentiate your products and services from the competition.

  1. How do your activities create value for the customer?

A useful tool to examine the value added in each stage of your operations is Porter’s value chain. In essence, he divides an organisation’s activities into strategically relevant activities and supporting or ‘back office’ activities. In the strategically relevant activities, we find inbound logistics, operations, outbound logistics, marketing and sales and ‘after sales’ service. These labels can be adapted to suit the particular context.

For example, in a service environment, instead of inbound logistics, we may find customer enquiries, brochures, whitepapers etc. Operations would be the way projects are managed and delivered. In the supporting activities we find HR management, technology, procurement and the general infrastructure of the enterprise.

By taking each element, and forensically considering how it is performed and how it can be improved, you should be able to reduce cost or add more value for the customer and differentiate your offer. This is where ideas and innovations from front-line staff can really come to the fore. Do you have mechanisms to encourage and capture these ideas?

Having analysed the areas above, we should by now have a set of choices to consider. It is time to…

  1. Carry out a sense check

Applying the test formulated by Johnson et al, are the options suitable, feasible and acceptable? Suitability tests whether the strategy fits the vision and mission of the organisation. Does it leverage the strengths and minimise the weaknesses? Feasibility is concerned with whether the organisation has the right financial, human and information resources, culture and structure to pursue the strategy. Finally, acceptability tests whether the strategy fits with the risk appetite of the organisation and whether it is likely to find favour with your stakeholders, such as employees, suppliers and funders?

  1. Set Objectives

Having formulated the strategy, embody this in a set of concrete objectives which should be SMART objectives (specific, measurable, agreed, realistic and time-bound). Ensure the high level objectives cascade down to business units and individual performance goals across the organisation. Make sure there is clear ownership of and accountability for the agreed objectives.

  1. Align the organisation

The chosen strategy will have implications for every function in the organisation, including finance, operations, marketing, HR and technology Alignment is crucial to achieve success. It is no good setting high level objectives which are completely at odds with teams’ or individuals’ performance and remuneration criteria or which run counter to the existing culture of the organisation.

Once the plan is developed and resources are committed, be tough and persistent in applying it. Ensure there are consequences for not delivering. The methodology behind successful implementation will be the subject of a future piece.

Of course these tools and models alone do not give directors the right answer, but they do provide the means to have a better conversation, which leads on to the agreed answer. By using these techniques, you can create an effective planning process, build a realistic business direction for the future, and should greatly improve the chances for successful implementation of your strategy.

In Part 2:  how to implement your strategy successfully to differentiate your organisation from the competition.

[1] (Johnson, Scholes et al, 2011).

Mark Johnson is a legal and governance specialist with Elderflower Legal. He is a trusted advisor to SMEs, charities and social enterprises on strategy, managing risk and assuring legal compliance. elderflowerlegal.co.uk.

Ten Top Tips for Effective Governance

How can you set up your governance systems to achieve results?

Corporate governance has received increased attention in recent years as a result of high-profile scandals involving abuse of corporate power and, in some cases, unlawful activity by corporate officers. Governance is all about the way the organisations are directed, controlled and held accountable to deliver their purpose over the long-term. The organisation’s practices and procedures should be organised so that the organisation achieves its mission and goals, whilst complying with the law and sound ethical practice.

Putting in place a well-defined and enforced governance structure can provide a structure which works for the benefit of everyone concerned, by ensuring that your organisation adheres to accepted ethical standards and best practices, as well as formal laws. However, it is important that the systems are proportionate to the size of the organisation and the risks it faces. We set out below our ten top tips for effective governance.

Positive benefits of good governance include:

  • People will trust your organisation (including members, service users, funders, suppliers and the public), leading to improved trading terms
  • The organisation will know where it is going
  • The board will be fully connected with members and wider stakeholders
  • Good and timely decisions will be made
  • The Board will be better able to identify and manage risks
  • The organisation will have greater resilience to cope with problems
  • The organisation should enjoy improved financial stability

In our experience, there are common areas that often cause difficulties for organisations. Here are our ten top tips for effective governance.

  1. Mistakes at the start

When setting up a new organisation it is important to have a clear shared view of the vision and mission for the organisation. It is important to plan ahead and bring your supporters with you. Think carefully about your strategy from the start and articulate the vision continually to all your stakeholders. (A stakeholder is any individual or group who depends on the organisation to fulfil their needs and on whom the organisation depends).

  1. Choose the right legal format and corporate structure

Think about what you want your organisation to achieve and choose the right format. Take professional advice and learn from what others have done. Don’t let the tail wag the dog. When selecting a legal format, form should follow function, structure follows strategy. First decide what you want to do, then choose the right structure which facilitates this. Don’t rush into setting up one particular format without understanding what the choices and implications are. It can be expensive to unravel the wrong choice. Professional advice is a sound investment.

  1. Clarity of roles

There may be many roles in a complex organisation. It is important to have clarity about the responsibilities of the Board, individual directors, officers and managers. Write down the key responsibilities and draw up a structure chart and scheme of delegation so that everyone knows who is responsible for what and who has the authority to take decisions. Role descriptions should be easy to understand and new joiners to the organisation should be offered an induction. Roles and responsibilities should be reviewed annually, perhaps as part of an individual appraisal.

  1. Poor Board performance

Board members may fail to perform effectively unless they have the right training and skills and a proper understanding of what their role is (in a documented role description). This can have a knock-on effect on the rest of the organisation, if it is not tackled effectively. There should be regular skills audits of the Board to ensure they are performing well. Group training session can be run to remind the Board of their role and continually improve their skills. A regular formal review of the Board’s effectiveness facilitated by an independent observer can be a useful tool for improvement

  1. Recruitment and succession planning

You need to attract good people onto your board with a wide range of skills. If you have skills gaps and vacancies this can lead to ineffective performance or lack of scrutiny. Cast the net wide in looking for new and diverse talent and plan ahead to refresh the Board at regular intervals. Proper training and induction should be provided to would-be recruits to the Board. Allow them to attend a few meetings as an observer before taking the plunge.

  1. Ineffective meetings

Regular meetings to enable a proper exchange of views are very important to good governance. In a fast world, where digital communication is becoming the norm, some of the nuances of physical meetings, body language and interaction can be lost. Meetings need to be properly run, with a clear agenda and board papers circulated in advance, at regular times and accessible venues. Attendees should not leave feeling unclear about what has been decided; concise minutes should be prepared and circulated promptly after the meeting. The Chair plays a vital role in running effective meetings, supported by a good company secretary.

  1. Dominant founders

Sometimes the original founder of the organisation, a long-serving Chief Executive or Chair may have undue power or influence. Sometimes they may take on too much responsibility and spread themselves too thin. It is important to document the roles and responsibilities of key officers, including the limits on any delegated authority to make decisions (e.g. financial limits on payments, requirements for second signature etc). It is a good idea to write into the constitution a requirement for certain appointments to be refreshed every few years.

  1. Mission drift

If an organisation starts to drift away from its core mission or principles, this can cause a sense of confusion and disengagement for board members, employees, members and customers. There could be a variety of reasons for this. Funding streams or contracts may encourage managers to move into new areas of activity. It is important for the Board to continually review whether the organisation is still fulfilling the objectives written into its constitution. The constitution may need to be reviewed and refreshed to cater for change and this will usually require the members to vote in favour of the change.

  1. Engagement with members and stakeholders

Members and stakeholders need to feel that their voice counts and need to be kept regularly informed about the organisation’s activities. The board must be accountable to and represent the interests of the membership and service users effectively, otherwise a division can arise. This relies on transparent rules and reporting lines, as well as effective regular communication by the Board to keep all stakeholders informed. Members’ meetings should be appealing and easy to attend – think about possible incentives to get people to attend. Cadburys used to give away free chocolate to shareholders who attended its AGM!

  1. Deal with conflict swiftly and decisively

Conflicts occur in most organisations from time to time. Unfortunately, disagreements can quickly escalate and cause rifts within the organisation as positions become entrenched. Conflicts are not always a bad thing- they can help to bring issues to the fore and lead to better debate. The Board, usually through the Chair, needs to deal with conflicts diplomatically, mediating between the different parties to achieve a positive outcome.

Mark Johnson is an experienced solicitor and company secretary helping charities, social enterprises and SME businesses to flourish. His company Elderflower Legal offers a range of support packages to help organisations with legal compliance, managing risk and good governance. For more resources check out elderflowerlegal.co.uk.

An Ethics Code for Public Services?

Should private and third sector service providers be subject to the same ethical standards as public officials?

That is the view of the Committee on Standards in Public Life in a recent report. The report considers the scope of the public services market – around £187bn is now spent by the public sector on goods and services commissioned from external suppliers and the rate and scale of outsourcing of public services is increasing as austerity measures and demographic pressures increase. The landscape of commissioning and delivery is growing ever more complex as new hybrids like academy trusts, CCGs, staff-led mutuals and arms length companies take responsibility for services.

The Committee’s central finding is that the ethical standards for those operating in the public sector should now have application to all those delivering public services, whether they are private sector or voluntary sector providers.  Specifically, the Seven Principles of Public Life developed by the Nolan Committee should apply to them:

Selflessness – officials should act only in the public interest

Integrity – officials should not take decisions in order to gain material benefits for themselves

Objectivity – officials must take decisions fairly, impartially, without discrimination or bias

Accountability – officials must submit themselves to scrutiny

Openness – officials should act and take decisions in an open and transparent manner and not withhold information unless there are clear and lawful reasons for so doing

Honesty – officials should be truthful.

Leadership – officials should exhibit these behaviours themselves and actively promote them and challenge others’ non-compliance.

The Committee has recommended that the Cabinet Office puts in place an action plan to ensure these ethical principles are reflected in all procurement procedures (an assessment of the ethical code of suppliers and a certificate of compliance may be required); that contractual performance standards should reflect these principles and that ethical compliance should be embedded in training, induction and professional development among service providers.

The Committee was prompted to look into this issue on the back of recent high profile scandals involving large outsourcing companies, in particular problems with the Work programme and offender tagging contracts.

I don’t think anyone would disagree that high ethical standards are essential for anyone who wants to supply services funded by taxpayers’ money. The question is how best to implement this. There is a risk that the behaviour of a few miscreants spawns a whole new area of regulation and compliance for SMEs, charities and social enterprises, with an attendant cost.

If we look in detail at the 7 Principles, we find that some of them may be easier to apply to non-public sector bodies than others. ‘Honesty’ should be a given, leadership and accountability should not pose a problem. But what about ‘selflessness’, ‘objectivity’? An office holder in a private company (including a community interest company) owes a legal duty under the Companies Act 2006 to promote the success of the company (section 172) and to avoid conflicting interests (section 175); similarly, a charity trustee must always act in the best interests of the charity and its beneficiaries. What happens when the interests of the taxpayer conflict with those of the shareholder or the charity’s beneficiaries? Which duty should take precedence? How in practice will the office holder in the service provider be able to demonstrate the duty of integrity if he has received a bonus for delivering good contractual performance? Compliance with the duty of openness also raises some difficult questions: in a competitive market: some commercial information needs to be kept confidential to preserve the competitive dynamic. There are already separate moves afoot to try to extend the Freedom of Information Act to private and third sector organisations who are providing services in the public interest. This will require these bodies to put in place compliance systems with attendant costs. The lines between public and private functions are increasingly becoming blurred.

The Committee also refers to the need to bring in punitive measures and financial penalties for those who fail to adhere to high ethical standards. For these to be legally watertight, there would need to be legal certainty about their application and an appropriate evidential burden.

I don’t think anyone disputes the need to encourage high standards of ethical behaviour across all sectors – whether that be public, private or third sector. Indeed, post banking crisis, most business schools have placed a greater emphasis on ethics in their curriculum. Does a knee-jerk response to a handful of scandals merit a programme of reform of procurement, new contract clauses and a system of financial penalties? This will need to be carefully thought through if it is to avoid imposing new cost burdens on service providers at all levels.  The rush to impose a hasty solution risks being seen as a political cloak for ideological opposition to outsourcing or alternative delivery models in general. We await the new Government’s response to the report with interest.

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