Structuring Social Ventures: Choice of Legal Structure
By: B. Ray Dinning, JD, LLM (taxation)
November 29, 2009
Part I – Introduction
This is Part One of a Four Part Series on Choice of Legal Structure for Social Ventures
Social Ventures and social entrepreneurship are alive and well in the for-profit and non-profit communities, universities, foundations and with social investors worldwide. With every major MBA Program educating future business leaders about the social benefits of ventures that make money and help others and with amazing examples of social entrepreneurship by Professor Yunus and the Grameen Bank, Social Ventures are the business wave of the future. With roughly 2/3rds of the world’s population living with an income of $2 a day, the applicability of technology and products to this burgeoning world market is a new phenomenon. Bill Gates, Richard Branson and others are finding new ways to market products and services to this market. Innovation is a key component to this process as products must be re-engineered to be affordable to the world market. For example, the wind up computer, cell phones and other technology are currently being marketed and sold to this demographic group. In Africa, this challenge is even greater and the need more prolific. One thing is certain: social entrepreneurship is the wave of the future in world markets.
A social venture is an undertaking by a firm or organization established by a social entrepreneur that seeks to provide systemic solutions to achieve a sustainable, social objective. The distinguishing characteristic of the social venture versus the commercial venture is the primacy of their objective to solve social problems and provide social benefits to those in need. The social venture may generate profits, but that is not its focus. Rather profits are the mechanism to achieve sustainability in providing a social benefit. The problems addressed by social ventures cover the range of social issues, including poverty, inequality, education, the environment, and economic development.
The challenge in this fast-paced developing area is that guidance in how these beneficial ventures should be structured is amorphous and undefined. Some have estimated that – depending on how one defines social enterprise – this activity could account for as much as 4 trillion dollars in the global economy. Social Enterprise Alliance estimates in a recent poll, 71% of respondents reported that making a determination as to the proper and best legal structure for their social ventures was the greatest challenge they faced. The pool of respondents included not just people who were starting new ventures, but also investors seeking a social return on investment (SROI) in addition to financial returns.
Because so many legal disciplines are necessary to properly structure a venture which many include non-profit, for-profit and even community partners and where business principles must be modified, it is hard to find concrete guidance in how to set up and structure social ventures. The legal areas implicated in a structuring social ventures include: tax, non-profit, corporate, partnership, international, mergers & acquisitions, business entity formation and perhaps more.
Social ventures can be structured in several legal formations including, but not limited to: business for-profit corporations, nonprofit corporations, tax-exempt organizations, for-profit subsidiaries of nonprofit entities, limited liability companies, charities created by business corporations, joint ventures, and less formal structures created through financing, shareholder and licensing agreements. New forms of business structures including the use of the L3C entity and the so-called “B Corporation” are also adding to the mix of potential business structures available to social entrepreneurs.
Perhaps because of our capitalistic roots and the emphasis in the United States on profit and wealth generation or simply because of the relative infancy of social enterprises and social ventures, our legal system in the United States does not provide a legal form that is designed to accommodate the particular needs of social ventures. Obviously, public companies have, as their primary objective, the bests interests of the shareholders of the company which, to date, has allowed them to pursue “green” or eco-friendly ventures as an aside to their primary objective of producing a good or service which generates profits for the shareholders. Non-profit organizations have social good and charitable purposes as their primary objective but many complex rules and onerous penalties exist for the organization and its directors should their profit making objectives be structured improperly, become too large or simply conflict with their tax-exempt social purposes. Additionally, non-profits face potential donor confusion when they start to introduce the concept of “business” and “profit” to their donor base. Thus, many pitfalls, regulatory landmines and business issues such as access to capital and modifying the traditional rules of business come into play when attempting to structure a social venture.
In structuring a social venture, the ideal legal structure for social enterprise would allow management to pursue the dual goals of profit and social benefit within a single venture. It would allow the venture to raise private capital and compensate investors for the use of their capital on competitive terms but also management to make business decisions that further the social mission of the venture, even at the risk of reducing profits. This ideal legal structure would also allow donors to support the social purposes of the venture with tax-deductible contributions, provided the money they give is a gift and they do not receive anything in return. Such an enterprise could freely enter into joint ventures and other business relationships with charities or for-profit companies without jeopardizing the tax or corporate status of the participating entities or exposing management to complex regulation or potential liability. Under the right circumstances, the social enterprise itself could become exempt from paying tax on its net revenues.
Next, we will discuss Foundations of the social venture movement.
B. Ray Dinning, JD, LLM (taxation) is a United States based attorney specializing in nonprofit joint ventures, social ventures, domestic and international taxation and public private partnerships. Mr. Dinning assisted Professor Michael Sanders with the research and drafting of the authoritative legal text in this area called “Partnerships and Joint Ventures Involving Tax Exempt Organizations by John Wiley & Sons in 1994 with later editions. Mr. Dinning holds an Advanced Law Degree from Georgetown University Law Center in Taxation – an LL.M in Taxation. Mr. Dinning has traveled around the world structuring social ventures from the grassroots to the Heads of State. Mr. Dinning can be reached at (757) 232-2619.