3. Background analysis
3.1 Business characteristics
Firm Size
Firm sizes of social enterprises and for profit enterprises are reported in Tables A3.1- A3.3 (see Appendix A). Three measures of size are reported: average number of employees; average income by number of employees; and average business assets by number of employees. This analysis indicates that:
• Regarding the number of employees (Table A3.1), social enterprises have a significantly lower percentage of businesses with no employees than for profit enterprises (3.8% versus 61.1%). This finding is very likely to be due to the sample of social enterprises consisting solely of incorporated legal forms (CLGs and IPSs).
• Social enterprises have significantly higher percentages of businesses in all size- bands with employees than for profit enterprises:
o 1-9 employee size-band (social enterprises 46% versus for profit enterprises 32.5%).
o 10-49 employee size-band (social enterprises 39% versus for profit enterprises 5.8%).
o 50-249 employee size-band (social enterprises 11.2% versus for profit enterprises 0.6%).
• Regarding income (Table A3.2), the average trading income (turnover) of social enterprises (£657,509) represents about 70% of their average gross income (£941,878).
• Across firm size-bands the average percentage of income derived from trading activities amongst social enterprises varies as:
o 0 employee size-band – 80%. o 1-9 employee size-band – 71%. o 10-49 employee size-band – 65%. o 50-249 employee size-band – 73%.
• Comparing the average turnovers of social enterprises and for profit enterprises (£657,509 and £758,999 respectively) no significant differences are found.
• However, social enterprises in the 10-49 and 50-249 employee size bands have average turnovers of £578,263 and £2,786,909 respectively; this is significantly lower than the corresponding amounts amongst for profit enterprises (£2,311,035 and £8,069,480 respectively).
• Regarding business assets (Table A3.3), the respective average amounts for social enterprises and for profit enterprises are £1,813,652 and £685,757 (but these differences are not statistically significant).
Smaller firms are usually viewed by finance providers as being more risky than larger firms. One reason for this is that smaller firms tend to keep fewer financial records making risk assessments more difficult for finance providers; and they may be more susceptible to shocks through concentration on a single product or service or reliance on one or two key individuals. Also smaller firms tend to be younger (implying a shorter track record) and have fewer financial assets (implying less available security), factors which increase lending risk. A further issue is that high lending fixed costs, specifically borrower screening and monitoring costs, can potentially make lending relatively small
amounts unattractive to finance providers. Developments in credit scoring techniques have reduced the fixed costs of small business lending considerably in the last decade. However social enterprises are less likely than for profit enterprises to benefit from the use of credit-scoring due to their non-standard characteristics.
Looking across the various size measures it appears that social enterprises are larger than for profit enterprises in terms of employment; this finding is unsurprising given that providing employment may be one of the objectives of a social enterprise. However, financial measures of size are more relevant than employment from the perspective of finance providers. In this regard, social enterprises are at a disadvantage relative to for profit enterprises in having a significantly lower average trading income. On the other hand, comparisons of amounts of business assets do not suggest that social enterprises hold less than for profit enterprises. Nonetheless there may be restrictions on the use or sale of assets amongst social enterprises which would limit the ability to use the assets as loan collateral.
Figure 3.1.1: Firm size (average number of employees) 3.8% 46.0% 39.0% 11.2% 61.1% 32.5% 5.8% 0.6% 0% 10% 20% 30% 40% 50% 60% 70% 0 1--9 10--49 50--249 Social Enterpises For Profit Enterprises
Bases:
Social Enterprises n=14,952 For Profit Enterprises n=3,625,416
Figure 3.1.2: Firm size (average income per annum by number of employees) 892,916.20 3,811,320.00 657,508.5 210,572.3 578,263.0 2,786,909.0 78,652.8 1,556,369.0 2,311,035.0 8,069,480.0 941,878.2 296,978.40 80,325.90 63,869.9 758,998.6 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 All 0 1--9 10--49 50--249 Social Enterpises (Gross) Social Enterprises (Trading Activities Only) For Profit Enterprises
Bases: Social Enterprises
All reporting income/turnover; n=12,129 0; n=443
1-9; n=5,495 10-49; n=4,742 50-249; n=1,449 For Profit Enterprises
All reporting turnover; n=3,100,000 0; n=1,800,00
1-9; n=1,000,000 10-49; n=196,983 50-249; n=20,513
Figure 3.1.3: Firm size (average business assets by number of employees) 1,813,652.0 282,776.9 511,097.7 1,483,767.0 8,308,439.0 685,756.6 719,429.7 292,065.3 2,020,563.0 4,248,313.0 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 All 0 1--9 10--49 50--249 Social Enterpises For Profit Enterprises
Bases: Social Enterprises
All reporting business assets; n=11,420 0; n=470
1-9; n=5,291 10-49; n=4,270 50-249; n=1,389 For Profit Enterprises
All reporting business assets; n=3,000,000 0; n=1,800,00
1-9; n=995,602 10-49; n=193,256 50-249; n=20,705
Profitability and growth
Tables A3.4 and A3.5 report the average amount of profits and the return on assets (profits divided by assets) earned by social enterprises and for profit enterprises respectively. This analysis shows that:
• Social enterprises and for profit enterprises earned similar levels of profits on average (£92,804 and £90,992 per annum respectively; Table A3.4).
• However, this similarity is due to the larger average size (employment) of social enterprises. Indeed looking across size-bands:
o Social enterprises with 1-9 employees earned significantly lower profits than for profit enterprises in the same size-band (£28,208 versus £66,666 respectively).
o Social enterprises with 50-249 employees earned significantly lower profits than for profit enterprises in the same size-band (£198,897 versus £660,445 respectively).
• Also, the return on assets is significantly lower amongst social enterprises compared to for profit enterprises (70 pence and £2 per £1 of business assets respectively).
• Specifically, amongst businesses with no employees social enterprises earned 50 pence per £1 of business assets which is significantly lower than amongst for profit enterprises (£2.50 per £1 of business assets).
• And amongst businesses with 50-249 employees social enterprises earned 20 pence per £1 of business assets which is significantly lower than amongst for profit enterprises (40 pence per £1 of business assets).
The above analysis indicates that the financial performance of social enterprises is on average lower than amongst for profit enterprises. This is unsurprising given that social enterprises are run for a mix of both financial and social objectives whereas for profit enterprises are more likely to be run exclusively for financial objectives. However since commercial finance providers typically do not take into consideration social returns in allocating finance, social enterprises are likely to be disadvantaged by their lower profitability in obtaining finance relative to enterprises which are run to earn a profit.
Table A3.6 reports the percentage of businesses with an average annual income growth of 30% or more over a period going back up to 3 years (high growth businesses). This table shows that:
• The percentage of high growth businesses is nominally, if not significantly, higher amongst social enterprises (13.6% versus 10.8%).
High growth is a double-edged sword. On the one hand growth increases the potential returns to investors. On the other hand high growth is associated with higher risk. Finance providers response to high growth (i.e., increase or decrease the supply of finance) will therefore depend on their attitude to risk.4 In terms of characteristics, high
growth social enterprises have similar size, sectoral and geographical distributions to the general population of social enterprises.5
From the perspective of business performance, it is interesting to note that in terms of income growth social enterprises have performed at least as well as for profit enterprises over the last three years. This is an interesting finding since it suggests that social enterprises are run by individuals with as much entrepreneurial talent as those which run mainstream businesses.
4 Indeed some high growth firms may be more suited to equity finance than debt finance. However there is no data on
equity finance users to determine whether high growth social enterprises are more likely to use this type of finance.
Figure 3.1.4: Average profits (left-hand scale) and return on assets (profits divided by assets; right hand scale) by number of employees
28,208.0 198,896.5 24,769.6 66,665.8 731,172.4 660,444.5 139,551.7 29,571.0 92,804.0 90,992.0 0.7 0.5 1 0.6 0.2 2 2.5 1.5 0.7 0.4 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 All 0 1--9 10--49 50--249 0 0.5 1 1.5 2 2.5 3
Social Enterpises (Profits £) For Profit Enterprises (Profits £) Social Enterpises (Return on Assets) For Profit Enterprises (Return on Assets)
Bases: Social Enterprises All reporting profits; n=7,729 0; n=267
1-9; n=3,499 10-49; n=2,992 50-249; n=971 For Profit Enterprises All reporting profits; n=2,400,000 0; n=1,400,00
1-9; n=779,350 10-49; n=160,643 50-249; n=17,155
Figure 3.1.5: Percentage of high growth businesses 13.6% 18.6% 15.6% 11.8% 10.4% 10.8% 9.0% 14.4% 9.9% 9.6% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% All 0 1--9 10--49 50--249 Social Enterprises For Profit Enterprises
Bases: Social Enterprises
All reporting at least two years of income; n=12,167 0; n=411
1-9; n=5,546 10-49; n=4,751 50-249; n=1,458 For Profit Enterprises All reporting profits; n=2,959,920 0; n=1,779,723
1-9; n=971,684 10-49; n=188,521 50-249; n=19,993
Sector
Table A3.7 presents the distribution of social and for profit enterprises across sectors. This table shows that:
• Social enterprises are most heavily concentrated in Health and Social Work (32.7%). This is significantly higher compared to for profit enterprises (4%). • Social enterprises are also heavily concentrated in Other Community, Social and
Personal Services (21.5%). Again this is significantly higher than the corresponding figure amongst for profit enterprises (8.1%).
• For profit enterprises are most heavily concentrated in Real Estate, Renting and Business Services (36.6%) which is significantly higher than amongst social enterprises (19.5%).
Firstly, it is unsurprising to find that social enterprises are concentrated in sectors providing social and community services whereas for profit enterprises are more likely to provide business services. In relation to risk, sector is an important factor in finance providers’ credit assessments since it is a significant predictor of default risk. If social enterprises are clustered more heavily in sectors with high failure rates than for profit enterprises, they will appear relatively unattractive to finance providers. In this regard, the three year survival rates in the top two sectors amongst for profit enterprises, Real Estate, Renting and Business Services and Construction, are 72.5% and 70.4% respectively (source: Small Business Service, February 2006). In Health and Social Work and Other Community, Social and Personal Services (the top two sectors amongst social enterprises) the three year survival rates are 75.5% and 69.9% respectively. Since there is not much difference in these survival rates, sector seems unlikely to be a major factor in explaining differences in access to finance between social and for profit enterprises.
Figure 3.1.6: Business sectors 19.5% 32.7% 21.5% 14.4% 11.9% 3.6% 5.1% 21.0% 15.8% 2.1% 3.7% 36.6% 4.0% 8.1% 0% 5% 10% 15% 20% 25% 30% 35% 40% Agric ultu re Ma nufac turin g Const ruct ion Wh oles ale/R etail Hote ls a nd R estau rant s Transp ort, Sto rage a nd C om muni cation s Rea l Est ate, R enting and B usin ess S ervic es Hea lth a nd So cial Wor k Othe r Com muni ty, S ocial and Pe rson al S ervic es Educ ation Othe r
Social Enterprises For Profit Enterprises
Bases:
Social Enterprises n=14,952 For Profit Enterprises n=3,625,416
Business age
The analysis of business ages (Tables A3.8 and A3.9) indicates that:
• Social enterprises in this survey are significantly older on average than for profit enterprises (27.2 years versus 18.5 years; Table A3.8).
• The percentage of start-ups amongst social enterprises in this survey is significantly lower than amongst for profit enterprises (0.6% versus 6.8%; Table A3.9).
Entrepreneurship is often regarded as a learning process.6 Initially there may be large
uncertainty about the talents of the entrepreneur and the demand for the firm’s product (markets). With the passage of time these uncertainties become resolved with the less talented or fortunate exiting the market leaving behind the most talented (and luckiest) entrepreneurs. In other words risk will tend to diminish with business age making older businesses more attractive investment propositions than younger ones. In addition younger businesses will tend to have accumulated fewer assets to use as loan security which may further hamper their access to finance. In this regard the older ages of social enterprises may have the affect of diminishing the risk of lending to them.7
6 This view has been expressed by writers in the Austrian school of entrepreneurship theory such as von Hayek and
Kirzner.
7 The paucity of start-ups in this survey (contributing to the higher average age) may be due to the social enterprise
sample consisting primarily of larger and more established businesses (because the sample is restricted to CLGs and IPSs).
Figure 3.1.7: Business age; average business age (left-hand scale) and percentage of start-ups (right-hand scale) by number of employees
27.2 28.2 22.8 28.5 40.1 18.5 18.5 18 20 22.2 0.60% 2.50% 0.70% 0.20% 0.50% 6.8% 6.2% 8.3% 5.0% 3.6% 0 5 10 15 20 25 30 35 40 45 All 0 1--9 10--49 50--249 0% 1% 2% 3% 4% 5% 6% 7% 8% 9%
Social Enterprises (Average Age in Years) For Profit Enterprises (Average Age in Years)
Social Enterprises (% Start-ups) For Profit Enterprises (% Start-ups)
Bases: Social Enterprises
All reporting business age; n=14,882 0; n=568
1-9; n=6,880 10-49; n=5,774 50-249; n=1,660 For Profit Enterprises
All reporting business age; n=3,600,000 0; n=2,200,00
1-9; n=1,200,000 10-49; n=208,464 50-249; n=21,119
Legal form
For the reasons discussed in the introduction the social enterprise sample is restricted to CLGs and IPSs which are legal forms entailing limited liability. The sample of mainstream businesses includes both limited liability companies and unincorporated firms (around two-thirds of SMEs are sole traders). This has important implications for the comparisons of access to finance between social enterprises and mainstream business. To the extent that personal assets are at risk in the event of bankruptcy, sole
traders may appear to lenders to be less risky than companies. Analysis of Small Firms Loan Guarantee (SFLG) data for example indicates that sole traders have default rates which are substantially below those of companies (see Graham, 2004). This suggests that the possibility of losing one’s house and other possessions in the event of bankruptcy encourages sole traders to make every effort to ensure the business is a success. Accordingly, simply by the design of this social enterprise sample, legal form may be a factor which makes it appear that finance providers are less willing to lend to social enterprises. In order to control for this issue comparisons between social enterprises and the sub-sample of mainstream companies will be included in the analysis of access to finance in Chapter Five.
Location in a deprived community
Social enterprises play a valuable role in alleviating the problems associated with deprived communities. They do this by providing jobs, skills and social capital in communities sometimes overlooked by mainstream businesses. On the downside, any limitations in key resources (skills and financial capital) and markets can mean that businesses located in deprived areas (social or mainstream enterprises) will appear less financially viable to lenders. As a consequence these businesses may face greater financial constraints than those located in wealthier areas.
In this context, the report looks at the role of deprivation in determining access to finance amongst social enterprises. The data used for this analysis is an index of multiple deprivation for England published by the Department for Communities and Local Government. This index is formed as a weighted aggregate of 7 domains of deprivation:
• Income deprivation • Employment deprivation
• Health deprivation and disability
• Education, skills and training deprivation • Barriers to housing and services
• Living environment deprivation • Crime
Each domain is comprised of a number of indicators of deprivation which are relevant to the domain. From these indicators a deprivation score is obtained where higher scores denote greater levels of deprivation. A deprivation rank is obtained from these scores which assigns a rank of 1 to the most deprived area and a rank of 32,482 (which equals the number of Super Output Areas in England) to the least deprived area. It is this deprivation rank which is used in the following analysis and in the remainder of this report.
Table A3.10 reports the mean deprivation ranks of the locations of social and for profit enterprises. This shows that:
• Social enterprises tend to be situated in areas which are more deprived than the areas in which mainstream businesses are situated.
• Across size groups, small social enterprises (no employee and 1-9 employee size-bands) tend to be situated in significantly more deprived areas than small mainstream businesses.
• Across common sectors, social enterprises operating in business services and health and social work tend to be located in significantly more deprived areas than their mainstream counterparts.
These findings suggest that deprivation may be one reason why social enterprises could face greater barriers to finance than mainstream businesses, since finance providers may feel that local markets in those areas are more marginal. However, on the positive side, this analysis highlights the important contribution of social enterprises to disadvantaged communities. In this regard, smaller social enterprises and those offering business, health and social services to the community may have a particularly important role.
Figure 3.1.8: Mean deprivation rank (England only) – lower rank = greater deprivation 13,390.5 15,926.1 12,611.1 14,182.3 12,996.5 17,910.9 18,808.1 16,574.8 16,097.9 14,620.6 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 20,000 All 0 1--9 10--49 50--249
Deprivation rank Social enterprise Deprivation rank For profit enterprise
Bases:
Social Enterprises in England All; n=12,634
0; n=495 1-9; n=5,832 10-49; n=4,871 50-249; n=1,436
Real Estate, Renting and Business Services; n=2,311 Health and Social Work; n=4,041
Other Community, Social and Personal Services; n=2,910 For Profit Enterprises in England
All; n=3,000,000 0; n=1,900,000 1-9; n=968,909 10-49; n=181,583 50-249; n=18,331
Real Estate, Renting and Business Services; n=1,100,000 Health and Social Work; n=119,183
Further information on the geographical distributions of social enterprises and mainstream businesses are reported in Table A3.11. Businesses were located into regions on the basis of the location of its head office. This analysis shows that:
• The geographical distributions of social enterprises and mainstream businesses are broadly similar: London and the South-East are the regions which are most densely populated with both types of business, accounting for over a third of the respective business populations.
• However, the region which is least densely populated with social enterprises is the East Midlands with a share of 3.2% of all social enterprises. This is
significantly lower than the percentage of mainstream businesses in the region which is 6.0%.
• Yorkshire and Humberside is another region which has a significantly lower share of social enterprises than mainstream businesses (4.0% versus 7.5%).
Figure 3.1.9 Geographical distributions of businesses
22.3% 12.4% 5.8% 3.7% 10.7% 9.6% 4.0% 7.0% 17.1% 6.7% 7.5% 2.8% 7.8% 2.9% 4.7% 6.0% 3.2% 3.5% 4.0% 13.8% 5.4% 9.6% 8.8% 20.8% 0% 5% 10% 15% 20% 25% Lond on Sout h E ast Sou th We st We st Mid lands Yor ksh ire a nd Humbe rside North Eas t North We st East of En gland North ern Irela nd Scot land Wal es East Mid land s Social enterprises For profit enterprises
Bases: Social Enterprises All; n=14,952 For Profit Enterprises All; n=3,596,948