07 Feb Advantages and disadvantages of a community interest company
A community interest company (or CIC) is a special form of non-charitable limited company, which exists primarily to benefit a community or with a view to pursuing a social purpose, rather than to make a profit for shareholders.
But a community interest company is not the only form of business available for those looking to pursue a social enterprise – they might also be set up as charities, trusts, standard companies (either a private company limited by shares or guarantee company), unincorporated associations or a Charitable Incorporated Organisation (CIO).
This article by Inform Direct looks at the advantages and disadvantages of a community interest company, providing some background on the circumstances in which they may be particularly useful and those where they’re likely to prove inappropriate to the needs of a business and its owners.
1: A clear commitment to social goals
While social aims can be prescribed in the articles of association of normal limited companies, community interest company status confers a clear commitment to a communal cause.
The statutory basis of the asset lock, which ensures that a CIC’s funds will be used for the benefit of the company’s social objectives rather than for individual shareholders, helps provide reassurance to investors and the wider public. More generally, the fact that community interest companies are subject to ongoing regulation by the CIC Regulator helps to create confidence in the integrity of a CIC.
2: Access to certain forms of finance
Some donors will only give to charities or community interest companies, because of the protections these vehicles provide that funds will be used for stated purposes. Therefore, access to finance – whether through provide donors, grants or community development finance – may lead a social enterprise to operate as a CIC rather than as a standard company.
The fact a CIC is set up as a limited company offers a number of specific advantages:
3: Limited liability and protection
The primary advantage, as for other businesses operating as a limited company, is limited liability. This provides an important element of security for those who own and manage the business.
At the same time, it provides some protection for any assets related to the social enterprise, which would not generally be available for an unincorporated entity – where they will often be held in the names of individuals.
The limited company structure, complete with directors and shareholders/members, is likely to be familiar to those responsible for running the organisation and relatively simple to operate, especially compared to a charity. It’ll also be readily recognised by the business community and others the company engages with – it might help, for example, to have such a known, formalised structure when dealing with government or other bodies making grants.
5: Flexibility of limited company structure
The limited company structure which forms the basis of a community interest company can provide flexibility to meet the individual needs of different organisations. A CIC can be set up as a private company limited by shares, private company limited by guarantee or public limited company.
A guarantee company basis will often be particularly familiar to those with a history working in charitable organisations. On the other hand, a CIC set up as a company limited by shares can issue shares to raise capital, including the option of employing multiple share classes. A CIC limited by shares can also pay dividends up to a ‘dividend cap’, which might be attractive.
While it’s not possible to change between different structures, a non-charitable company does typically have significant freedom to identify and adapt to circumstances, potentially being able to take advantage of opportunities in a way that would not be possible (or as easy) with other, more rigid, business structures.
6: Continuity of purpose
As a type of limited company, a community interest company has its own legal status and will therefore continue in operation – and able to provide benefit to the community – until it is dissolved or converted into a charity. Even if it is dissolved, a specific feature of the CIC model is that any residual assets (after paying off any creditors) must be transferred to another asset-locked body, like another CIC or a charity. This ensures that funds invested in a CIC will continue to benefit social or charitable ends, even if the CIC itself is no more.
These advantages stand alongside many of the other standard benefits of a limited company.
Compared to setting up as a charity, a CIC offers several further advantages:
7: Quicker to set up
A community interest company is quicker to form than a charity, with a single consolidated application to form the company made to Companies House, which they and the CIC Regulator separately review. By contrast, in a charitable company, the incorporation of the company must be undertaken with Companies House and then a further application is made to the Charity Commission to register as a charity, which itself can take weeks or indeed months.
8: Reduced governance requirements
There is also a lower level of ongoing governance for a community interest company than a charity. While CICs are regulated by the CIC Regulator, this is comparatively ‘light touch’, with the main requirement being the submission of the annual Community Interest Report. Charities, by contrast, are more strictly regulated by the Charity Commission (in England and Wales) or the Office of the Scottish Charity Regulator (in Scotland). The reporting requirements, in financial and other areas, are more stringent for charities than CICs.
This relative freedom from regulatory restraints means that a CIC can focus intensively on its social aims, with fewer restrictions on trading activities than a charity faces meaning they can also take a more commercial approach to achieving their ends.
9: No requirement to choose between strategic control and being paid
Board members of a charity may generally only be paid where its constitution allows this and it can be justified as in the best interests of the charity. In practice, therefore, someone cannot both receive commercial payment for their services and retain strategic control over the direction of the charity: usually, those wishing to be paid for their work must hand over control of the organisation to a board made up of volunteers, which many founders will not wish to do.
In contrast, the founders of a community interest company can retain control over the business while being appointed and paid fairly for their work as directors of the company. As well as the founders themselves, it may be easier to attract additional high calibre individuals to the CIC through the offer of a measure of control alongside a salary set at a market rate.
10: A wide range of possible social aims and specific focus on social enterprise
The social aims permissible and ways they can be pursued are wider for a CIC than a charity. The definition of community interest in the ‘Community Interest Test’ which applies to CICs is wider than the equivalent ‘Public Benefit Test’ which applies for charities. This means that many aims which would not qualify for charitable status can legitimately be pursued via a CIC.
The CIC model is specifically identified with social enterprise. For some this social, communal element of their endeavours is something they want to emphasise. The ability to distinguish from a traditional charitable status may be seen as a virtue for some, more in keeping with their sense of purpose.
Over time, social enterprises are achieving a higher profile, as well as an independent, distinct voice within the third sector.
Note that it’s also possible for a community interest company to be set up by a charity, in a similar way to which they might establish a Charitable Trading Company – so the two are sometimes complementary rather than entirely distinct, independent options. The CIC would then often be used as the “trading arm” of the parent charity, meaning they still benefit from most of the advantages of a CIC.
Disadvantages of a community interest company
The CIC model will not be suitable for everyone. Among community interest company disadvantages are the following:
1: Formalities of incorporation
Like any standard limited company, a CIC must be registered at Companies House.
Unlike other companies, a community interest company must also submit form CIC36, signed by all the prospective directors alongside payment of a £35 fee, describing the proposed social purpose of the company and providing various other details. In order for the CIC to be established, this has to be reviewed and approved by the CIC Regulator.
2: Ongoing company compliance
As a limited company, there are also a number of ongoing responsibilities to observe. Some form of accounts will need to be filed each year. There will also be a requirement to create and maintain company registers and file information with Companies House, including an annual confirmation statement and event-based submissions.
If the social purpose behind the company is only being pursued on an occasional or part-time basis, these formalities could represent a step too far – possibly leading the founders to look at pursuing the cause via an unincorporated entity.
Many of the other standard disadvantages of a limited company will also apply to a community interest company.
Compared to operating as a charity, there are some specific community interest company disadvantages:
3: Lack of tax breaks available
Charities are able to claim a number of tax reliefs on most income, capital gains and profits, with various schemes available – such as reclaiming gift aid on donations – which can make an important difference to the amount of money they can raise for their cause. More locally, they’re typically eligible for a substantial discount on business rates.
In contrast, CICs don’t receive the same tax breaks, even if their objects are wholly charitable. This means that, all other things being equal, they’ll potentially raise less money for their cause than if they were established as a registered charity.
4: Limited access to certain funding
Certain grants and other funding schemes may be open only to charities and not to community interest companies. Where businesses have Corporate Social Responsibility (CSR) policies which govern who they can donate money to, these are still likely to favour charities over other vehicles.
5: Limited public awareness of the CIC model
Although the position is improving, many people – who the organisation might want to target as donors or volunteers, for example – will not be familiar with the community interest company form. They may feel more comfortable offering their time, services or donations to a charity – a form they’ll be more familiar with.
6: Perceived lack of prestige
Similarly, a community interest company may not appear to carry the prestige of a registered charity. Even though it’s hard to put a value on, a registered charity generally carries a sense of trust that inspires confidence – and which is not fully replicated by the CIC brand.
There are also specific CIC disadvantages when compared to a standard company:
7: Restrictions on dividends
Only CICs limited by shares can pay dividends, and even then they are subject to a dividend cap. As well as the standard limits on dividends under company law, only 35% of a CIC’s distributable profits in a single year can be paid out in dividends to the company’s shareholders (with a limited facility to carry forward unused dividend capacity to future years).
While the dividend cap aims to achieve a balance between dedicated benefits to the community and potential personal gain by shareholders, in some circumstances this might feel quite restrictive and discourage potential shareholders from investment. This restriction will be particularly cumbersome if the social element is only one part of the business, especially if more commercial purposes are a much greater focus.
8: Restrictions on the use of assets
Alongside the dividend cap, there are also wider restrictions on how a CIC can use and dispose of its assets. By virtue of the ‘asset lock’, which must be referred to explicitly within the CIC’s articles of association, assets within the CIC must be dedicated towards benefiting the chosen community.
In practice, this usually means that the company cannot transfer its assets or profits outside the CIC for less than their full market value. Even if the community interest company is dissolved, surplus assets must be transferred to a socially focussed body, like a charity or another CIC.
Again, this is most likely to feel restrictive if the social element is only one element of a wider business.
9: Additional governance requirements
In addition to ongoing reporting to Companies House and HMRC, a CIC must report to the CIC Regulator. This takes the form of form CIC34, the Community Interest Company Report, which must be submitted on an annual basis. To add to the extra hassle of completing this form is the fact it can only currently be completed and submitted on paper rather than electronically.
More generally, the CIC Regulator has the power to investigate and potentially take action against a CIC if there are concerns that it is not serving the specific community it was established to benefit or is otherwise in breach of CIC rules, principally the asset lock requirements.
10: Onerous to convert a CIC to another structure
Once registered, a CIC cannot be converted into an ordinary company, with limited other options available if the CIC vehicle proves unsuitable to the founders’ needs or circumstances change.
A CIC can only be dissolved altogether, with the assets transferred to a similar vehicle, or be converted into a charity (which itself is subject to more onerous charity law and regulation).
This article was extracted from the Inform Direct website, who were the original authors.