So You Want to Start a Social Enterprise? (Part 1)

Flywheel Social Enterprise Hub’s three-part blog series, So You Want to Start a Social Enterprise, will walk you through the formation of a social enterprise through a legal lens. Produced in partnership with Northern Kentucky University’s Chase College of Law, the series will answer questions about general legal structure, funding, and scaling your business.

Part I: Understanding Where to Start

Let’s start at the very beginning…a very good place to start.

We can put it on the table straight away – there is no official definition of a social enterprise. However, all social enterprises have some characteristics in common. In general, a social enterprise is an organization with a social, cultural, community, or environmental mission, and that generates revenue similar to traditional commercial enterprises. We like to call social enterprises “businesses where society profits.” Social enterprises take many forms and may fulfill their mission in many ways – whether they do so based on who they hire (for example, at-risk urban youth) or based on the goods they provide (for example, a product or service with proceeds that benefit a specific cause).

Regardless of what your social enterprise is, you’ll need to consider how you intend to structure your startup. Like all businesses, social enterprises require funding. We will cover how to secure funding in a later installment, but one of the early decisions you will need to make is whether you will fund your enterprise through charitable donations, making it a non-profit, or whether you will seek investors who provide capital in return for equity, which makes it a for-profit enterprise. Either of these options is fine – it’s a matter of choice and focus. How you are organized is known as your legal entity status.

If you intend to fund your enterprise with donations, you will most likely need to apply for 501(c)(3) status by filling out IRS Form 1023. A 501(c)(3) designation exempts the enterprise from federal income tax, but requires that the enterprise restrict its work to one or more qualifying purposes. The qualifying purpose must address, in general, some charitable or educational mission. Some examples of this include soup kitchens, an afterschool enrichment program for children or teens, counseling programs, job training for underprivileged or at-risk communities, and support for recovering addicts. There are many more.

The other big difference between a non-profit and a for-profit business is that in a for-profit business, the owners can keep (or pay out to themselves) all or a portion of the profits earned by the company; of course, many for-profit companies with a social enterprise purpose elect to share a portion of the profits with a nonprofit organization or otherwise use them to support a social enterprise. By comparison, in a non-profit, all revenues must be used to support the IRS-approved public purpose. The only way that the founder of a nonprofit can receive any income is if the board of directors approves the payment of a salary, and most nonprofits have insufficient funding early on to be able to pay even modest salaries.

In the category of for-profit legal structures, there are two types to consider – those available to all enterprises, and those available exclusively to social enterprises. Which legal entity is right for you depends largely on your business model, your funding strategy, and your personal tolerance for risk. The chart below provides a high-level overview. For a comprehensive review, consider reading “Which Legal Structure Is Right For My Social Enterprise? A Guide to Establishing a Social Enterprise in the United States.” It is available courtesy of the Thompson Reuters Foundation. Not all social enterprise entities are available in all states, so it is important to check.

 

General Legal Structures

In addition to the above traditional legal entity structures, there are a few structures that are unique to social enterprises. These include social purpose corporations, low-profit limited liability corporations (known as L3Cs), and benefit corporations (called B-corporations). Again, these options are not available in every state and each of them has pros and cons, so it may be worth understanding these options as you consider building, scaling and funding your social enterprise.

 

As you think about starting this journey, keep in mind a few things:

  1. Think about how you will fund your enterprise and how you will fund yourself. Do you need to earn an income from your business? If you plan to fund with charitable donations, you will likely want to establish the enterprise as a 501(c)(3). If you plan to raise capital in exchange for equity, there are a variety of traditional legal entity options as well as newer social enterprise-specific legal entity structures. Which option is right for you depends largely on your business model and business plan.
  2. Once you determine which legal entity is right for you, familiarize yourself with the related requirements – including which governance structure is necessary; what to report, when, and to whom; how to handle taxes and the like.
  3. Stay on top of the emerging category of social enterprise legal structures. As this category matures and there is more clarity on the pros and cons, you may have the flexibility to start with one legal entity structure and convert to another. For instance, an existing LLC may have the option to convert to an L3C.

 

In the next installment, we will share our perspective on how to scale your social enterprise. In the meantime, good luck – we’re here to help.

Produced in partnership with:

The Small Business & Nonprofit Law Clinic at Northern Kentucky University’s Chase College of Law provides free legal services to entrepreneurs, small businesses, and nonprofit entities in the local northern Kentucky-Southwest Ohio community who could not otherwise afford access to quality legal representation. Staffed by law students, it gives those student the opportunity to provide legal services to real clients under the supervision of an experienced supervisor. In its first five years, the Small Business & Nonprofit Law Clinic prepared 65 students for the practice of law and provided over 7,000 hours of free legal services to over 160 clients.

Contributors:

Professor Barbara Wagner is the Director of the Clinic. As Director, she helps students acquire the hands-on practical skills necessary to succeed in corporate and transactional work. Before joining the Chase faculty, Wagner practiced law for over 30 years at major law firms and inhouse, in areas including corporate, securities, finance, governance, compliance and other transactional law areas. Wagner is admitted to practice in New York, Ohio and Kentucky, and is a member of the American, Kentucky, Cincinnati and Northern Kentucky Bar Associations, as well as the Society of Corporate Secretaries and Governance Professionals and the Ethics and Compliance Officer Association. She earned her BA at Yale University, an MSBA from Boston University and her JD from Columbia University.

Craig Buchholz has more than 20 years of experience in marketing, public relations and communications. He currently leads the Global Communications organization at P&G where he serves as a key advisor to P&G senior leadership. He is responsible for developing and directing an overall strategic communications plan that fosters favorable perceptions of P&G, its products, its services, and its people. In May 2017, Craig received his J.D. from The Thomas R. Kline School of Law at Drexel University in Philadelphia; he participated in the Small Business & Nonprofit Law Clinic during spring 2017 as he completed his studies to support local entrepreneurs and growing non-profit organizations in a hands-on and practical fashion.

Comments

  1. Do you know if B-Corps are recognized by Ohio? Or where I could find that information relatively easily?

    We’re planning on following the B-Corp guidelines whether or not we go for certification because they really lay out everything you need to think about when you care about the community, the environment, and making a positive social impact in the course of a profitable business.

    • Ohio is currently working on recognizing Benefit Corporations and joining the 33 states that currently have passed legislature. You can follow along with the progress here: http://bit.ly/2wrMU7z

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