HCT Group

The deal was led by Bridges Ventures, supported by the Futurebuilders Fund, which was managed by the Social Investment Business on behalf of the UK Government. 

Bridges Ventures is a fund management company which seeks to deliver a blend of financial returns and social and environmental benefits. The Bridges Social Entrepreneurs Fund aims to provide solutions “tailored to the needs of ambitious social enterprises”. Investors include the Cabinet Office, NESTA (the innovation charity), Sir Ronald Cohen (the so-called father of UK venture capital and social investment), Deutsche Bank and the Esmée Fairbairn Foundation (one of the UK’s leading grant-making trusts). The fund aims to invest equity-like capital, which shares risks and returns. Bridges saw HCT as an attractive investment with a strong track record and high growth potential. Antony Ross of Bridges described HCT as “an exemplary social enterprise that has demonstrated a sustainable and scalable model, and we are delighted to support the next stage in HCT’s growth”. 

Futurebuilders was a pioneering investment fund, backed by the UK Government, which made investments in third sector organisations in England delivering or planning to deliver public services and which were unable to secure investment from commercial lenders. The fund invested in a wide range of third sector organisations, helping them win and deliver public service contracts and to become more financially sustainable and resilient.

In 2010, HCT raised £3m to fund the expansion of its community transport businesses. The specialist social investment consultancy ClearlySo advised on the investment and Bridges Ventures were joined as co-investors by the Social Investment Business who were managing the Futurebuilders Fund. The partners together designed an innovative financial instrument which they also believed would be valuable for the wider social enterprise sector.

The investment is comprised of a fixed rate loan and a so-called “Social Loan”, where the interest rate is tied to the growth in sales at HCT. This took the form of an equity-like investment, or quais-equity, whereby interest payments are linked to gross revenue (with certain items disregarded). Under the ‘Social Loan’, investors receive 1% of any increase in turnover above an agreed base level of £24.4m, which was the turnover forecast for HCT the year following the investment. 

The maximum payment per year is capped at 20% of the loan amount. Other conditions were attached to the investment around social impact. This ‘Social Loan’ was designed as a “flexible financing tool” that made sense specifically for social enterprises that were unable or unwilling to issue conventional equity. Furthermore, HCT don’t cede control in the same way as they might under an equity based investment. But the investment nevertheless, recreates some of the features of equity. 

Bridges Ventures initially invested £1m in the “Social Loan”. The Futurebuilders Fund invested £1m in the fixed rate loan and half a million pounds in the ‘Social Loan’.

Traditionally, social enterprises have a choice (aside from grants, gifts and donations) between debt and equity. Both these types of investment can pose certain problems for social sector organisations. First, as debt creates a liability on the investee’s balance many social entrepreneurs are sceptical about debt in any case, some seeing it as the instrument at the heart of the global financial crisis. Second, as equity is not appropriate for the vast majority of social enterprises who are unwilling or unable to pay dividends. Indeed, most are set up explicitly with structures that disallow them from distributing profits. 

Investments known as ‘quasi-equity’ have existed in ‘mainstream’ financial markets for some time. Significantly, however, this investment was based around revenue, rather than profit or margins as other investments are often modelled. European Union definitions of quasi-equity describe these investments as instruments where returns are linked to profits or losses rather than revenue, income or turnover. This investment was different. HCT Group believe that this was the “first use by a registered UK charity of a revenue participation agreement”.

This investment was seen at the time by participants as establishing “a benchmark which is likely to help draw further investment into the social business and enterprise sector. The importance of a benchmark cannot be overstated. We have heard for some time, and ourselves believe, that there is a wall of money is sitting in the hands of fund managers and advisors, on behalf of their clients, looking to get into the sector. The complaint is that there are no quality assets to purchase”. This investment created the opportunity, through some innovative financial engineering, to start to connect up social enterprise with this ‘wall of money’.

HCT’s turnover is now over £40m. Business has expanded into the Channel Islands, with new contracts and new services and investment in new vehicles. HCT secured a contract to provide transport for the building of the London Olympic Park and were the main provider by volume of accessible transport for both the Olympics and Paralympics. The business has grown both its turnover and its capacity to demonstrate social impact. HCT won the Evidence of Impact award at the 2012 Social Enterprise Awards. The award is for the social enterprise that not only makes a real difference with its social impact – but can demonstrate that impact it in a clear, transparent and accessible way through its impact reporting. 

Dai Powell himself was named Social Enterprise Leader of the Year, chosen as an inspirational role model for the sector and his organisation. Speaking about the awards, Dai Powell said, “These awards are a testament to the dedication and hard work of all our staff, and I am thrilled that this has been recognised at a national level by our peers in the social enterprise movement.”

But the investment has had a wider impact on the social enterprise sector and the emerging social investment market in the UK, by setting a precedent for further investment. Dai suggested at the time that while this deal “won’t be the biggest deal done in corporate finance today, but it may well be amongst the most far reaching in its consequences… This gives ‘proof of concept’ that social enterprises can now compete on a more level playing field in the capital markets.” 

Rodney Schwartz of ClearlySo said that the deal was a “benchmark transaction. Social minded investors have proved keen to offer their support to a company of HCT’s quality and track record, as evidenced by the range of investors who are participating.”

One of the risks associated with the investment is how it fits with charitable law in the UK. Charities in the UK are bound by laws which restrict their ability to pay dividends, profits or surpluses to private interests. The use of an instrument whereby revenue would be shared with investors could potentially attract the attention of o the Charity Commission and be subject to an investigation. To date, this has not occurred. This may be partly because the partners settled on the term “Social Loan” to describe the investment rather than a term that referred to equity, shares or dividends.

A further risk was that to the core business and management of HCT. The deal took a significant amount of time to put together, up to 50% of the CEO’s time during the second year. NESTA reported that “The positive lesson from HCT’s experience is that it has been possible to find a legally permissible structure that allows a charity to continue to enjoy the tax benefits of charitable status, while offering investors equity-style returns on growth capital.” But in doing so, they noted that while the deal “deal provides a template with applicability to other social enterprises that cannot issue equity” HCT had to absorb significant costs in the wider interest as the “lengthy gestation period required to finalise the deal reflects the fact that financing structures of this type are not yet widely used by social enterprises.”