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The latest guidance note produced by the Institute’s Public Governance Interest Group explores the concept of the social enterprise.

The guidance notes produced by the Institute’s Public Governance Interest Group (PGIG) have explored the many different legal structures available to an organisation dedicated to the public good. The first guidance note, published in August 2016, introduced a hypothetical scenario of a director seeking advice from a company secretary on how to set up an non-governmental organisation (NGO) to help budding musicians. The first two PGIG guidance notes used this hypothetical case study to explore issues such as the relative advantages of the different legal structures available to such an organisation – a trust, a society established under the Societies Ordinance, a company under the Companies Ordinance (including a company limited by guarantee) and a statutory body.

The second guidance note explained that a limited liability company will be the most flexible form for incorporating an NGO, and the latest PGIG guidance note, the third in the series, builds on this advice. Many people not familiar with NGO governance may assume that an organisation established for a philanthropic cause will usually be a charity. The new guidance note points out that, in practice, a charity refers to a company that has obtained a tax-exempt status under Section 88 of the Inland Revenue Ordinance (Section 88 exemption).

Having a Section 88 exemption will mean that profits are exempt from tax if they are made in the course of carrying out charitable objects, but it would impose restrictions on our hypothetical NGO. For example, the objectives of the organisation would have to be restricted to those set out in law, such as the relief of poverty, or the advancement of education or religion. For this reason, establishing a for-profit ‘social enterprise’ without tax-exempt status offers a flexible alternative route for our hypothetical director.

What is a social enterprise?

Social enterprises are for-profit companies that opt to donate part of their profits to the furtherance of philanthropic goals. The new guidance note points out that they have become widely accepted and more common. Moreover, the Hong Kong government is keen to encourage this trend in Hong Kong, particularly since social enterprises can provide opportunities for the employment of the disadvantaged.

Establishing a for-profit social enterprise can therefore be a hybrid form between a charity and a purely commercial organisation. It can provide the flexibility of a for-profit company – there are no restrictions on money-making activities and profits can be distributed and reinvested back into the company – while also benefiting from having a recognised philanthropic mission. The enterprise may benefit from the financial incentives the government has devised to encourage the creation of more social enterprises in Hong Kong. For example, where a social enterprise reinvests 65% or more of its distributable profits for social objectives, it may be eligible to seek support under government initiatives. The new guidance note highlights a number of government and private websites that may be of use to fledgling NGOs (see the ‘Useful resources’ sidebar).

As you might expect, there are governance considerations that should be taken into account if this route is followed and the guidance note provides an overview of these.

Governance considerations

The importance of shareholder assent

The guidance note stresses that getting shareholder assent for the use of part of the profits of the organisation to pursue social objectives is key for the social enterprise model to work. In the historical context, companies were supposed to maximise profits for shareholders. While times have changed and the ‘social licence’ for companies is now dependent on environmental, social and governance concerns, shareholder assent is still a key part of ensuring that shareholders, objectives are aligned with those of the enterprise.

The guidance note recommends the drafting of a shareholders’ agreement at the outset to ensure full transparency on the objectives to be pursued. The agreement should set out clearly the purpose of the enterprise. It should also set out the register of shareholders and the voting arrangements for ordinary and ‘special’ business matters. For example, matters designated as special business – such as acquiring real estate or changing the objects and distributions of the enterprise – may require a super-majority of votes. Some social enterprises may also, on a voluntary basis, adopt ‘asset lock’ and ‘cap of profit sharing’ provisions in the shareholders’ agreement, meaning that any change to key issues would require unanimous shareholder approval.

Another key issue for the shareholders’ agreement to cover is the composition and governance arrangements of the board. For example, the agreement should set out any rights conferred upon shareholders to appoint board members. This affects the whole system of checks and balances on governance-related issues like the operation of bank accounts and authorisation for entering into contracts.

Other issues the shareholders’ agreement could cover would include identifying who has the right to appoint the company secretary, legal advisers, auditors and other relevant professionals to the business. In addition, there may be provisions dealing with conflicts of interest and the financing of operations, which the company secretary could explore with those seeking to set up the social enterprise.

The importance of a business plan

The guidance note points out that it has become increasingly difficult for charities to open bank accounts in Hong Kong, as banks will require detailed customer due diligence prior to establishing an account. This is partly because receiving money from the public brings with it anti–money laundering and counter–financing of terrorism risks. This risk, which is an international issue for charities, should be less of a problem for social enterprises. However, the guidance note points out that a social enterprise that can provide the bank with a clearly defined business plan and financial projections will facilitate the opening of a bank account. The guidance note also sets out the list of documents required by banks and provides a link to the relevant Hong Kong Monetary Authority webpage: www.hkma.gov.hk/eng/other-information/ac-opening/documents.shtml.

What’s next?

The latest guidance note from the Institute’s PGIG provides timely, relevant and practical advice to governance professionals involved in NGO governance. Building on the two previous guidance notes in the series, it covers the advice governance professionals can give on the setting-up of social enterprises. In the next guidance note in the series, the PGIG will turn to the compliance issues under the Companies Ordinance where a company is the vehicle used by an organisation to deliver public good.

The guidance note reviewed in this article is available from the Publications section of the Institute’s website: www.hkics.org.hk.

SIDEBAR: The Public Governance Interest Group

April Chan FCIS FCS (Chairman)
Lau Ka-shi BBS
Rachel Ng ACIS ACS
Samantha Suen FCIS FCS(PE)
Stella Ho
Stella Lo FCIS FCS(PE)
Mohan Datwani FCIS FCS(PE), Senior Director and Head of Technical & Research of the Institute, serves as secretary to the Institute’s Interest Groups. Feedback on this project is welcome; please contact Mr Datwani at: mohan.datwani@hkics.org.hk.

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