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HCR Law Events

14 April 2022

Risks of rapid expansion: learning from Keeping Kids Company

Keeping Kids Company (formerly Kids Company) was a charity which existed to help children in need of counselling, support, and therapeutic use of the arts by reason of their social or family circumstances. The charity operated with a demand-led model. This type of model carries a continuous risk of having fewer resources than required to meet the demands of the charity’s commitments.

The Official Receiver issued an application for a disqualification order, under section 6 of the Company Directors Disqualification Act 1986, following an allegation of inadequate leadership found within the charity. The Official Receiver claimed that the trustees allowed the operation of a charity which was unsustainable, and that they ought to have known that, without immediate material change, failure was foreseeable.

In response to the Official Receiver’s allegations, the High Court concluded that the model was not unsustainable in principle, despite its high risk. It was found that the trustees recognised in 2013 that the charity could not continue to increase in scale and, in 2014, they reasonably believed that they would obtain additional funding. The trustees also relied upon the charity’s permanent executive and the CEO for change, and they had created a plan to restructure their organisation. These plans were unsuccessful due to unfounded sexual assault allegations at the time, which overshadowed the charity’s work. A disqualification order was not warranted against the trustees by the High Court, because they concluded that the trustees did exercise scrutiny over the expenditure during highly challenging circumstances.

Alongside the High Court case, in 2015, the Commission conducted an inquiry, under section 46 of the Charities Act 2011, as the insolvency of Kids Company became a regulatory concern. This is because the financial difficulties, which led to its closure, were potentially due to mismanagement and/or misconduct by the administrative team.

The Commission’s inquiry found insufficient records, as some had been destroyed at the time of the charity’s collapse, and other records were never even created. By not maintaining proper records, the trustees had not acted in the best interests of the charity or its beneficiaries. Both occurrences meant that there was insufficient evidence of how the charity assessed the needs of individuals in relation to their expenditure. The lack of records meant that the Commission was unable to come to its own conclusion as to whether the charity’s expenditure adhered to the policies in place, although the High Court judgement provided that the policies were obeyed.

The inquiry also found that the operating model for the charity was not unusual in itself but operating in this way, given the size of the charity, was unusual. The low level of reserves had been repeatedly raised by the charity’s auditors, but the trustees prioritised immediate and urgent needs of the charity’s beneficiaries rather than long-term sustainability. A higher level of reserves might have been able to keep the charity going during the criminal investigation they faced. The Commission concluded that it was prudent for the charity to build up reserves for a financial cushion to help stabilise them during times of low income and high expenditure. Overall, the inquiry found that Kids Company’s repeated failure to pay creditors and its own workers on time amounted to evidence of mismanagement in the administration of the charity.

However, both the High Court and Commission concluded that there was no dishonesty, bad faith, or inappropriate personal gain in the operation of Kids Company. The Commission also settled that the CEO was an effective fundraiser and beneficiaries did clearly benefit from the charity. The trustees were also skilled professionals, who were able to contribute to the charity’s legal objects but there were skills gaps within the trustee body as a whole. The charity had good intentions, but a combination of factors contributed to their downfall.

What lessons may be learned by other charities?

Kids Company provided a valuable lesson to all charities expecting or wanting to expand. Rapid development initially seemed ideal as it meant the charity would quickly be able to help more children in need and attract funding from a wider variety of people and companies. However, there are risks involved if a charity does not have a secure stream of income to accommodate the growth, and/or adequate governance to provide oversight. Without these, the cost of expansion can become too great and risk leading the charity into liquidation. For expansion, with long-term success, the Commission advises that charities monitor and record the development in detail.

In February 2022, the inquiry also published in-depth lessons on how charities can manage growth. Please find some of the crucial points below.

Managing growth successfully

  • Measure cash flow

For long-term sustainable growth, a charity requires a continuing source of funding. Before making any big decisions, charities should evaluate their current position, both in terms of finances and the resources available. If your charity is currently not strong enough to accommodate the growth, take time to build up reserves and pay off debts to strengthen your position before you make any investments to grow.

Acquiring seasonal donations could also potentially put your charity at risk. Aim to accrue donations evenly over the year, as expenditure will continue throughout the year and a gap in income could cause a cash flow issue.

  • Ensure controlled progress

It is vital for a charity to be able to keep pace with the growth. Alongside maintaining a steady cashflow, trustees are encouraged to review existing safeguarding regulations and policies to check whether these are adequate for the growing number of people involved in pursuing the charity’s purposes.

Legal requirements also differ depending on the size of a charity’s finances so trustees must regularly review the legal updates which apply to their charity.

  • Keep accurate documents and records

A record of the exact figures of income and expenditure, with evidence that the expenditure pursues the charity’s legal objects, is essential. For transparency, and to avoid misconceptions, the methodology for calculating figures should also be clearly articulated where they are cited.

Trustees are responsible for ensuring accountability through the records kept, so well-maintained records are important to account for, and support, the decisions made.

The standards of accounting records required can be found in the guidance from the Commission, and the charity’s own governing document. You may also wish to consider whether your governing document requires amending if it restricts the growth you are aiming for.

  • Maintain a blend of skills, qualifications, and operational experience

Ensure that your trustee board includes trustees with experience of running charities on the scale required for planned expansion. They will be able to help with their understanding on how larger charities navigate through challenges during difficult financial circumstances.

Board members should have also relevant skills depending on the type of charity. This can be through qualifications or experience. This will help to ensure that the work completed by the charity is effective for the beneficiaries.

It is also in a charity’s best interests to welcome fresh ideas and approaches, which will flow naturally with board rotation. Thus, a clause in your charity’s governing document to restrict the number of terms a trustee can be on the board may be useful. It will often help to avoid complacency within the charity and invite innovation.

  • Develop effective board leadership

Long-term single leadership can prevent the identification and management of risks. No charity should be defined by (or be over-reliant on) a single individual as this may limit what the charity can achieve. Asymmetrical power can also lead to an unhealthy board organisation and poor decision-making as the entire organisation relies on one person’s thoughts and beliefs.

  • Carry out regular reviews

Legal updates in charity law and training should be made available to board members. This will deepen the expertise of the board and enhance the service provided by the charity.

  • Embed financial planning and maintenance of a reserves policy

There is no ‘right’ level of funding reserves to build. Every charity is different, depending on scale, timeline, and purpose. Thus, the Commission cannot provide precise guidance on the level of reserves. However, the higher the level of reserves, the more durable and resilient a charity becomes.  A balance must be struck between holding sufficient reserves and spending money in pursuance of a charity’s objects. Particularly during turbulent times, healthy reserves can be something to fall back on.

It may be appropriate to consider a merger with another charity to prevent a drastic and dramatic negative impact on beneficiaries.

Overall, trustees should avoid investing all funds raised in expansion and should save a small percentage to build the reserves. However, it may be difficult to encourage donations to raise funds via fundraising appeals if these are intended for the charity’s reserves.

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About the Author
Virginia Henley, Partner, Head of Charities

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