At the Lex Mundi Pro Bono Foundation we work with social entrepreneurs from around the world to help them identify their legal issues and access pro bono legal services. We see that social entrepreneurs often face the same legal issues and challenges that confront any entrepreneur.
One of the first questions that nascent social entrepreneurs typically confront is whether to form a legal entity and if so, where and in what form. In the past this was an easier question for social entrepreneurs to answer – given the lack of alternatives, they would either establish a traditional nonprofit corporation or form a for-profit enterprise. Thus, a social entrepreneur would either become dependent on charitable contributions or would organize as a for-profit entity in order to attract equity funds or accept loans in order to sustain itself.
Today, the same innovative spirit that defines the social entrepreneurship movement is inspiring the legal community to develop creative solutions that meet the unique needs of modern-day social entrepreneurs. As a result, laws are being enacted in the United States, the United Kingdom and several EU jurisdictions that blur the line between nonprofit/charitable organizations and for-profit business enterprises, enabling social entrepreneurs to pursue their social missions and at the same time attract capital.
This proliferation of hybrid forms of organization is an encouraging step toward sustainability and scalability that is likely to spread to other parts of the world. Present and would-be social entrepreneurs should take note.
Entity Formation in the US
Many if not most social entrepreneurs in the US are organized under state law as nonprofit corporations, usually in the state where they reside. If they are organized exclusively for charitable, educational, religious or scientific purposes, they apply for Section 501(c)(3) federal tax exempt status from the Internal Revenue Service. If granted, contributions to the entity are deductible.
Increasingly, social entrepreneurs are taking advantage of statutes which entitle them to establish entities that can pursue social missions as well as accept equity investments and issue debt instruments. Varying from state to state, these statutes allow formation of entities with names like low-profit limited liability companies (L3Cs), benefit corporations, public benefit corporations, flexible purpose corporations and special purpose corporations. Aside from formation under state statutes, the nonprofit B Lab confers “B Corp” certification on social entrepreneurs that satisfy certain standards and survive an impact rating assessment.
Entity Formation Outside the US
In Canada, B Corp certification is available and benefit corporation legislation has been recommended but not yet enacted. Most social entrepreneurs are still organized as registered charities.
The UK permits the establishment of registered charities, non-domestic charities and community interest companies (CICs – similar to a limited liability company but tied to a social mission). The UK recently enacted an investment tax credit for those who invest in social enterprises — charities, CICs and community benefit societies (BenComs). To our knowledge this is the first tax relief of this kind to be enacted anywhere in the world.
Elsewhere in Europe, Belgium permits the formation of social purpose companies; Italy enables the creation of social cooperatives; France allows the formation of collective interest social cooperatives; and Finland maintains a special register of companies organized as social enterprises.
Outside the US, Canada, the UK and Europe, new legal structures that specifically address the needs of social entrepreneurs are not nearly as common, although they are likely to be more prevalent in the coming years.
Hybrid Legal Structures: Tools for Success
The new legal structures are attractive to social entrepreneurs for a number of reasons. Social entrepreneurs have long found that the old legal frameworks – either nonprofit or for-profit – do not accommodate for-profit companies that are also driven to pursue social missions.
While the new forms differ, they are all designed to allow social entrepreneurs to pursue a social mission and at the same time earn profits and attract capital (B Corp certification, while requiring changes to an organization’s governing documents, is not a legal form and does not hold legal weight). Under the new forms, a social entrepreneur is not legally required to only maximize profit for owners, but may also pursue social and environmental objectives as well.
The primary motivation of social entrepreneurs to structure themselves under the new forms is access to capital and relief from the legal obligation to maximize shareholder value. Lack of capital has been cited by many social entrepreneurs as the major barrier to scale and success. As a for-profit entity with a clear and protected social mission, organizations can move beyond charitable grants and contributions and tap into the growing global social finance and impact investing market – which some estimate will grow to hundreds of billions of dollars within the decade.
In addition, the new legal forms can help clearly signal an organization’s social mission to the market and to its stakeholders (investors, employees, customers, etc.). This is a powerful opportunity to help a social business establish its brand, identity and credibility.
Challenges of New Legal Innovations
Despite the possible benefits of the new legal forms, it is important to remember that while the hybrid structures might permit capital investment, such investment will not magically follow an inviting structure. Social entrepreneurs still need to focus on the fundamentals – mission, strategy, implementation, execution. Many social entrepreneurs find that challenges persist in accessing social and impact capital. For many, the traditional nonprofit/charitable form might still be the best option, at least initially.
In addition, hybrid business structures are new and relatively untested. Until they are proven, some investors may be reluctant to invest. Finally, it can be a challenge to find lawyers who have expertise in the new hybrid forms and are skilled at finding creative ways to use old and new forms of organization to help social entrepreneurs achieve their missions.
Social entrepreneurs have long questioned the status quo in order to find innovative solutions to the world’s most pressing social challenges. Forward-thinking lawyers are following their lead, always looking for innovations in the law, particularly around legal structures, that can more effectively help their social entrepreneur clients achieve their missions.
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