The idea of "doing good while doing well" certainly isn't new, but it is increasingly popular in both the business and non-profit worlds. Increasingly, non-profits are developing social enterprises to help the organization become financially sustainable without being as dependent upon the good will of donors. On the other hand, some for-profit businesses are intentionally being established with the mindset that the business's social impact or mission is at least equally as important as earning a profit.
A social enterprise is a business that is both purpose-driven and market-driven. Unlike a typical for-profit business, a social enterprise is not exclusively dedicated to maximizing profits, but unlike a typical non-profit organization, a social enterprise does sell goods or services to raise revenue while addressing a larger societal issue. Social enterprises can range from socially responsible or philanthropic-minded for-profit businesses to revenue-generating arms of traditional non-profit organizations.
How is forming a social enterprise different from establishing other types of business entities? And how should you structure a social enterprise?
Is it an LLC, a non-profit, or something else entirely?
A social enterprise can be structured in many different ways, each of which raises its own legal and tax issues.
Traditional LLC or Corporation: If all of the owners of the business are on board with the social mission, then using a traditional business entity may work out. However, the management of the business has a duty to act in the best interests of the business's owners. This often means maximizing profits and increasing the value of the business, goals which can certainly compete with the social mission. Mix in outside investors or even a disgruntled business partner, and your traditional business entity could find itself in a legal fight over profits versus mission.
Benefit Corporation or Low-Profit Limited Liability Company: To address the tension between management's duty to the business's owners and fulfilling a social mission, some states have adopted Benefit Corporations (B-Corps) or Low-Profit Limited Liability Companies (L3C's). Generally, these types of entities will shield management from claims (usually from minority shareholders or owners) that management breached some fiduciary duty by not acting in the best interests of the owners. However, Ohio has not yet adopted either of these entities.
Be careful about forming a social enterprise in another state to take advantage of that state's B-Corps or L3C's. By doing so, you subject your enterprise to that state's laws and jurisdiction, meaning the owners or the organization could find itself subject to a lawsuit out of state.
Non-Profit Organizations: The reality is that relying predominantly on charitable donations to run a non-profit is no longer viable. There are too many organizations competing for too few charitable dollars, and those dollars often dry up during economic recessions. Because of this, many non-profits are turning to social enterprise models to create sustainable funding sources. However, this can create its own set of legal and tax challenges if the IRS questions whether the non-profit is truly being operated exclusively for religious, educational, scientific, or other charitable purposes. (This question often arises when the non-profit's unrelated business income reaches a point where the non-profit's commercial activities seem to over-take its charitable activities, threatening not only the organization's tax-exempt status, but also potentially incurring an unexpected tax bill.)
To avoid this and other complex liability issues, non-profits often create a subsidiary corporation to run their social enterprise activity so that the liabilities of the social enterprise entity do not threaten the assets of the non-profit organization. Like any business venture, the question has to be asked—what happens if the social enterprise fails? Will the nonprofit be accused of using funds inappropriately, particularly funds that could have better supported its charitable purpose? Could the failure of the social enterprise impact the nonprofit organization’s financial viability, especially if the nonprofit was using its own funds to start the social enterprise? Separately, does the social enterprise itself pose any risks that could be subject to litigation?
Joint Ventures: To avoid dealing with unrelated business income or the legal and tax complications of having a subsidiary, some non-profits create a joint venture with a for-profit LLC. The classic example of this setup is the non-profit hospital (which provides the hospital, staff, and resources) partnering with a for-profit healthcare company (which provides management services). In this arrangement, the non-profit (in order to maintain its charitable purpose) must exercise control over the joint venture by having the majority voting power. The non-profit's charitable purpose must also take precedence over the LLC's profit motive, which must be "incidental." And the joint venture agreement between the non-profit and LLC must be negotiated at arms-length.
Structuring a social enterprise is a complicated area of law for both mission-driven for-profit businesses and non-profit organizations looking to maintain their tax exempt status.