Starting a social enterprise? Here’s how to choose its legal structure

The role of social enterprises in reaching the bottom of the pyramid and helping close the inequality gap has been receiving increased prominence through the years. Since the start of the year, social enterprise has been broached as one solution to a better future for Haiti, as a way to strengthen South Korea’s position in the international development community, and a means to address poverty and inequality in South Asia. And with increased attention on the power of social enterprise comes increased interest, especially from the more socially aware entrepreneurs, to set up their own social enterprises. In the United Kingdom alone, the number of social businesses has grown over twelvefold from 5,000 to about 62,000 in a span of half a decade. This growth, according to Social Enterprise U.K. chief executive Peter Holbrook, is mainly due to three things: social responsibility, public accountability and necessary adaptability. “There’s a number of drivers behind the growth in social enterprise around the world [including] a growing clamor for larger businesses to effectively balance their societal and environmental responsibilities along [with] their profit motive,” he told Devex. This trend, he added, has pushed many young people to venture into social enterprises to pressure the government to do better — or to at least bridge the gap — in providing social services as “state-run models frequently lack innovation, are unresponsive and can suffer with bureaucracy.” Rich Leimsider, vice president of fellowship programs for Echoing Green, shared that the “millennial generation is coming of age, ignited by a passion for living with purpose, and the world of philanthropic giving is changing at the same time.” Passion isn’t and shouldn’t be the only consideration, however. Leimseider clarified that it is “important that social entrepreneurs don’t jump on a growing trend and make the decisions … for the wrong reasons.” While much has been written about what makes a successful social enterprise and what lessons can be learned from the common pitfalls, there has been little discussion on the considerations around the social enterprise’s legal structure — whether for-profit or nonprofit. According to Daniela Papi-Thornton, deputy director of the Oxford-based Skoll Center for Social Entrepreneurship, it “all boils down to what kind of change you’re trying to make in the world and what structure you need to best make that change.” As with many things, there is no definitive guide to determining the best legal structure for a social enterprise. But there are key considerations to keep in mind. 1. Know the legal requirements and restrictions. Each country has different laws or policies for social enterprises. The United Kingdom, for instance, has some of the most robust policies and assistance programs to support the growth of social enterprises. Countries like China, meanwhile, have yet to define concrete policies as the legal framework to support these entities is “still underdeveloped.” So the decision on whether to set up as a nonprofit or for-profit social enterprise depends on the country’s enabling environment. “[Go for-profit] when local laws require it,” Leimseider said. But it is also important to note that “sometimes the restrictions of a government make it impractical to work within a nonprofit structure.” 2. Determine the size of startup capital needed. In general, the size and type of startup capital needed dictate whether a social enterprise should register as a nonprofit or a for-profit. Papi-Thornton said that if the social enterprise has minimal potential for income generation and will subsist mainly on a “donation or grant model,” then registering as a nonprofit is the obvious choice. Nonprofits are eligible to receive grants from governments and funding agencies. And, depending on the laws in the country where they are set up, nonprofit social enterprises may also be exempted from paying donation and income taxes. When he started his first social enterprise, Sunlight Development Trust, Holbrook said registering as a nonprofit gave him room to “significantly limit overheads through tax advantages that charities receive in the U.K.” However, “if social entrepreneurs need significant startup capital to get their venture off the ground, they may want to look for a ‘for-profit’ status,” Leimseider said. The Echoing Green official shared the experience of Joel Jackson. An Echoing Green fellow, Jackson launched in 2011 his social enterprise, Mobius Motors, to democratize transportation in East Africa. He needed a lot of capital for design and production — something that can only be addressed by shares and investments from other stakeholders. “It was a smart choice for Joel to launch as a ‘for-profit’ organization that offered equity to mission-aligned investors,” Leimseider explained. 3. Identify who will benefit from the profits. Holbrook believes all social enterprises generate profit, but not everyone directs these earnings to the same group of beneficiaries. “If you mean ‘for private profit’ whereby owners can direct decisions and direct profit to anywhere they choose, then I’d question whether that is actually a social enterprise,” he said, adding that for-profit social enterprises should have a social purpose reflected by the allocation of a portion (usually half) of their profits “reinvested into the business or used to further its mission … owned in the interests of its beneficiaries.” He added that apart from monitoring profit direction, social entrepreneurs need to take note of three things: be realistic, go beyond your original mission, and stay close to the issue and people you want to benefit. “Halve your income projections, double your cost forecasts and if you still think the business model stands up and is viable, then go for it,” Holbrook explained. “It’s easy to become detached from your original motivations and a social business that is disconnected from its mission is just a business.” What other factors should potential social entrepreneurs consider to determine whether to set up a for-profit or a nonprofit social enterprise? Let us know by leaving a comment below. Check out more insights and analysis for global development leaders like you, and sign up as an Executive Member to receive the information you need for your organization to thrive.