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. And 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 combines both sides by creating a business that is both purpose-driven and market-driven.
How is forming a social enterprise different from establishing other types of business entities? And how should you structure a social enterprise?
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.
Non-Profit Organizations: Many non-profits are choosing to run social enterprises 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.
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. 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.
