2.8 Investments in other legal entities
2.8.1 Guiding principles
Section 2 (1) of the Co-operative and Community Benefit Societies Act 2014 requires all societies to be carrying on an “industry, business or trade” which means that a society cannot be registered if its purpose is to raise share capital to invest in other legal entities.
Section 2 (3) of the Act explicitly prevents co-operative societies from carrying on activities with the object of making profits to pay dividends, interest or bonuses to members on the money invested. It also restricts community benefit societies to business which is of benefit to the community.
Section 27 of the Act allows societies to invest funds in other registered societies, building societies, companies or securities issued by a “relevant authority”, meaning certain types of local government body. It makes no provision for investment in partnerships, including limited liability partnerships. The Act also requires societies to state in their rules whether, and if so, by what authority and in what manner, any part of their funds may be invested.
It is permissible for a society to invest some of its general reserves in other legal entities, but it should only do so to further the objects of the society, and in a way that meets the needs of the society to maintain liquidity and solvency. This would include normal treasury practices of keeping cash in deposit accounts and other types of liquid investment.
A distinction should be made between investing the general reserves of a society, and investing capital raised through a public share offer where the purposes of that offer are to invest in another legal entity. In the latter case, a society should ensure that it invests the capital in a way that allows it to have control over the terms and conditions of the share capital it issued. This includes the terms and conditions for withdrawal of share capital.
A society should not raise capital with the specific intention of investing in other legal entities over which it has no overall control, or to act as a collective investment vehicle, unless it is authorised by the FCA to do so.
The guiding principles are:
- Investment by a society in other legal entities should only be made when it furthers the objects and business of the society.
- A society must always act within its own rules on investment.
- Capital should only be raised to further the objects and business activities of a society, and not to invest in other legal entities over which it has no overall control.
- Any capital raised by a society through a public offer should only be invested in other legal entities in a way that fully protects the terms of the public offer.
- A society should not raise share capital with the specific intention of investing that capital in another legal entity over which it does not have overall control.
2.8.2 Wholly-owned and controlled subsidiaries
A wholly-owned subsidiary is a legal entity over which the parent organisation has sole control. The subsidiary may be structured as a company but not normally as a society. A society cannot be a wholly-owned subsidiary because a society must normally have a minimum of three members, or two members if both these members are societies.
Ownership and control usually go together, but in exceptional circumstances it is possible to separate these functions if members are prepared to forgo their control rights in favour of some other entity. This could apply to a community benefit society, where the FCA accept that a parent body can be granted control of the society because the parent body can demonstrate that it will conduct the business of the society for the benefit of the community, and there is provision in the rules of the society to deal with problems of entrenchment. If the parent organisation is a co-operative society then its wholly-owned subsidiaries must also be fully committed to co-operative values and principles (see Section 2.1.2).
If the subsidiary is a company limited by shares, all voting shares must be owned by the society, or, if the subsidiary is a company limited by guarantee, the society must have the sole power to appoint and dismiss directors.
If a society is investing general reserves (retained surpluses and/or donations), it can use whatever method of investment it chooses, be it in the form of equity, debt or donation, bearing in mind its own rules, its overall level of reserves, and the potentially different tax treatments of these forms of investment. If a society chooses to invest in the form of transferable equity then it must be willing and able to sell the subsidiary if this is in the best interests of the society.
If a society is investing capital raised through a public offer it should only invest in a subsidiary in a way that enables it to honour the terms of the public offer. If the society has issued withdrawable share capital, then this capital should only be invested in the subsidiary either in the form of a loan or, in exceptional circumstances, as redeemable share capital if the subsidiary is a company limited by shares.
Company law imposes restrictions on redeemable shares, only allowing a company to redeem this type of share capital using distributable profits, or newly issued shares, unless it is a private company that adopts special procedures to protect creditors. This makes redeemable shares an unsuitable instrument for investing withdrawable share capital in a subsidiary, unless there are reasons for believing that the withdrawal terms of the public offer can still be met.
The repayment schedule for the loan must be consistent with the terms and conditions for withdrawal of share capital from the society. For example, if a society is making an open offer (see Section 4.6) and limits the total amount of share capital that can be withdrawn in any one year to 10%, then the capital invested in the subsidiary must be repayable at this 10% rate. If a society is raising capital through a time bound offer, then the forecast business performance of the subsidiary should be used to set the terms of the offer.
Likewise, the interest or dividends payable on any investment must be consistent with any financial returns mentioned in the offer document. At all times, the society must be minded to manage the subsidiary in the best interests of its members, and be prepared to sell the subsidiary if doing so would serve the society’s best interests.
2.8.3 Majority-owned ventures
A majority-owned venture is a legal entity in which a society holds over half of the voting shares, with other persons owning the remainder of voting shares.
If a society owns a controlling majority of the shares, generally taken to be three-quarters of the voting shares, and in the absence of any shareholder agreements that give any special powers to minority shareholders, then for investment purposes, it can be treated in the same way as a wholly-owned subsidiary.
If a society owns a majority of voting shares but does not have full control of the legal entity, then it can still invest in this legal entity, subject to the following safeguards. The objects of the majority-owned venture should be the same as those of the society. The society should only invest capital in the form of loans or redeemable shares regardless of whether this capital is part of its general reserves or has been raised through a public offer. If the capital being invested has been raised through a public offer, then the terms of the investment should mirror the terms of that public offer. The society should have the power to veto any changes to the governing document of the legal entity, or any associated shareholder agreement.
2.8.4 Joint ventures
A joint venture is taken to mean a legal entity owned by two or more partners on more or less equal terms. Section 2.8.1 explained that there is no provision in the 2014 Act for societies to invest in partnerships, including limited liability partnerships. Instead, the joint venture must be a registered society or a company.
If a society is investing its general reserves in a joint venture, then it should only do so in pursuit of its objects and business. It should only invest in a joint venture where it has influence over the venture that is written into the shareholder agreement, or by holding at least a quarter of any voting rights. The amount invested should not be so large as to adversely affect its own liquidity or solvency, should the joint venture encounter financial difficulties.
A society should not raise capital through a public offer to invest in a joint venture unless it has overall control of the joint venture (in which case it would be more properly described as a majority-owned venture (see Section 2.8.3).
2.8.5 Minority stakes
A minority stake is defined as a shareholding in a legal entity which does not provide the investor with sufficient voting rights to protect their interests. This is usually the case where the investor has less than a quarter of the total voting rights.
A society is entitled to invest some of its general reserves in other legal entities, as long as it acts within its rules and the amount invested should not be so large as to adversely affect its own liquidity or solvency, should the legal entity encounter financial difficulties. It should seek to invest in a way that best serves the business interests of the society, typically in the form of secured loans, bonds or debenture. Shares should only be purchased if the legal entity is listed on a stock market, the shares are redeemable or withdrawable, or there is some other arrangement in place to allow the society to sell its investment.
A society should not raise share capital to acquire minority stakes in other legal entities
2.8.6 Investing in other societies
It is acceptable for one society to invest in another society, subject to the above guidance in this section. But care should be taken to avoid cross-investment of withdrawable share capital, where two or more societies invest in each other, which could artificially bolster the balance sheets of all the societies involved in the arrangement.
2.8.7 Transparency of investments
As a matter of good practice, a society should declare in its annual accounts and report, details of any investments it has made in other legal entities, along with details of any corporate investment it has received.