Social Enterprise Law
What is Social Enterprise?
Interesting question you ask. The field of social enterprise is evolving so rapidly that there isn’t one universally agreed upon definition of “social enterprise”. It spans private business, nonprofits, and government organizations. The Social Enterprise Alliance defines it as:
Organizations that address a basic unmet need or solve a social problem through a market-driven approach.
Social enterprise is when:
- for-profit businesses tackle an issue that is traditionally handled by the government or nonprofit organizations to help people;
- when nonprofit organizations integrate market-based strategies to accomplish their charitable objectives;
- when the government teams up with with the private sector to tackle community issues;
- when consumers hold companies accountable for their social and environmental performance;
- and when investors expect their dollars to have a positive impact on the community.
Essentially, social enterprise is a term for a new frontier where business is leveraged as a force for good through a “triple-bottom-line” approach. With changes in the law, it’s easier for organizations to simultaneously seek profits, social impact, and environmental sustainability. People, Planet, and Profit, for short.
Should I form a nonprofit or a for-profit entity?
Social enterprises often exist at the intersection of the nonprofit and for-profit worlds, where it’s not always obvious which side of the line the entity should live on. Some things you should consider:
Is anyone expecting an ownership stake in the entity?
For-profits have owners who receive a share of the company’s earnings. When the company does well and makes money, its owners enjoy a proportionate share of that wealth. When a for-profit entity dissolves, its assets are usually distributed to the owners.
In contrast, a nonprofit organization has no owners. While officers and other key employees of the nonprofit can be paid market rate compensation for their services, any revenue in excess of expenses must be returned to the organization to be used for charitable activities (this includes administrative expenses).
What is your exit strategy?
If you plan to someday sell the company, then it makes sense to form a for-profit company. Because there are no ownership interests in a nonprofit organization, there is nothing to “sell” to a third party. When the nonprofit ceases its charitable activities and dissolves, its assets must be distributed for charitable purposes (usually to another nonprofit organization). No assets may be distributed to founders, donors, or any other private interests, period.
What is your revenue model?
A nonprofit organization that is exempt from taxation (a “501(c)(3) organization”) can attract funding through donations, because the donor can generally receive a tax deduction for its charitable contribution to the organization. Nonprofits are also commonly recipients of grant funding, because it is generally easier from a compliance standpoint for organizations to make grants to 501(c)(3) organizations (in fact, most grants are available only to 501(c)(3) organizations). So if you intend to raise money primarily through grants and donations, then a nonprofit organization is a good choice.
For-profit companies tend to attract equity or convertible debt financing from investors who receive an ownership stake in the company in exchange for their financial commitment. Because there are no owners of a nonprofit, traditional investor financing options are not available.
What is a “hybrid” entity?
Social enterprises are often referred to a “hybrid” entities, meaning something in-between a nonprofit and for-profit entity. Technically, from a federal taxation standpoint and from a state formation standpoint, an entity must be classified as either nonprofit or for-profit. However, several states (including Colorado) have adopted legislation that creates a type of for-profit entity that has a social purpose. These entities include benefit corporations (or “Public Benefit Corporations,” in Colorado), and low-profit limited liability companies (L3Cs) (not adopted in Colorado). Broadly speaking, benefit corporations and L3Cs are required to pursue social good in the operation of a for-profit business.
Other “hybrid” models exist where a nonprofit organization operates a business venture or partners with a for-profit entity to use market-driven strategies to tackle a social issue. These structures can take all kinds of forms, including a for-profit subsidiary of the nonprofit, or a joint venture or strategic alliance between the nonprofit and for-profit. While each entity within the structure maintains its distinct classification of “nonprofit” or “for-profit”, the entire relationship is often referred to as a “hybrid” structure or entity.
What is a “B Corp”? Is this the same thing as a “benefit corporation”?
The first thing you should know is that a benefit corporation is not the same thing as a “B Corp”. Surprised? It’s okay, most people are.
So what’s a B Corp?
A “B Corp” is a for-profit company that has received the B Corp certification (identified by an encircled “B”) issued by the nonprofit, B Lab. The B Corp certification is to business what LEED certification is to architecture, or what Fair Trade certification is to coffee. B Lab administers the certification to companies that meet rigorous standards of social and environmental performance, accountability, and transparency, as demonstrated by achieving a certain minimum score on a test devised by B Lab.
One requirement of the B Corp certification is that a social mission be built into the legal framework of the company – which is where the “benefit corporation” comes in. Adopting a benefit corporation form of entity is one way (but not the only way) that a company can meet B Lab’s legal requirements.
Now that that’s out of the way…
A benefit corporation is a type of legal entity, like a traditional corporation or a limited liability company. Colorado followed the lead of approximately 20 other states in adopting legislation that creates this alternative type of entity, called a “Public Benefit Corporation” or “PBC” in Colorado. The PBC differs from a traditional Colorado corporation in three importation ways:
1) The directors of a PBC have more flexibility to consider the company’s impact on its community, environment, and stakeholders other than the shareholders. In contrast to the directors of a traditional corporation, who are legally required to place shareholder profit above all else, directors of a PBC are required to manage the company’s affairs in a manner that balances (a) the financial interests of the shareholders, (b) the best interests of those materially affected by the company’s conduct, and (c) the specific public benefit identified in the company’s articles of incorporation, thus placing social responsibility at the core of business decisions.
2) The PBCs’ articles of incorporation must identify one or more “public benefits” that the company will pursue. The PBC statute defines “public benefit” as “one or more positive effects or reduction of negative effects on one or more categories of persons, entities, communities, or interests other than shareholders in their capacities as shareholders, including effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.” C.R.S. §7-101-503(2).
Electing to become a PBC, switching from a PBC to another type of entity, and changing the public benefit to be pursued by the company are all actions that require the consent of two-thirds of the company’s voting shareholders. The high voting threshold and dissenters’ rights provided to shareholders are designed to bake the social mission of the company into its DNA, making it more difficult to abandon the mission through changes in company ownership or management.
3) To promote transparency, the PBC is required to publish an annual report that includes certain information, including, most notably, an analysis of the company’s social and environmental performance, measured against a third-party standard. The report must be provided to shareholders and posted on its website.
There are other differences between a PBC and a traditional Colorado corporation as well. There are also several elements of Colorado’s PBC statute that differentiate it from the model benefit corporation legislation adopted by other states.
Can a nonprofit organization operate a revenue-generating business?
The short answer is generally, yes. While a nonprofit organization must be operated “exclusively” for charitable purposes, the IRS allows nonprofit organizations to conduct some activities that are not considered charitable. Any income from such activities is taxable to the organization as “unrelated business income tax,” or “UBIT.” UBIT is Uncle Sam’s way of keeping the marketplace fair to for-profit companies competing in the same market as the nonprofit.
However, such activities must not be a “substantial” part of the organization’s overall activities. There is no defined line for determining whether that test has been met – it all depends on the situation.
Evaluating how a business activity can impact a nonprofit organization can be a tricky question and one that can have significant consequences for the organization, and should therefore be discussed with an attorney knowledgeable in nonprofit and social enterprise law, like me, Beth Prendergast.
Disclaimer: The following is for general information purposes only and should not be construed as or used in place of legal advice.
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Social Enterprise law is my main practice. I help entrepreneurs; nonprofits, for-profits and hybrid entities; and investors secure income through positive social change and community impact.