What type of legal structure a social enterprise has determines what kind of funding it can attract
LONDON (TrustLaw) – Social entrepreneurs, keen to strike a balance between making money and social impact, walk a slippery tightrope as they ponder where to go for financing and how much say to allow investors in running the business.
A crucial decision right at the start is what kind of legal structure to adopt from an array of options – some familiar, like Ltds or PLCs, others exotic hybrids somewhere between the worlds of charity and business.
Get it wrong, and you fail to raise the investment capital needed to grow the business. Or you may be crippled by taxes or forced to govern yourself in ways that are at odds with your core purpose.
“A key issue is … how to balance safeguarding the social mission with the ability to raise the type of finance that you need to help your business grow,” Louise Savell, director of Social Finance UK, told a panel discussion on Tuesday.
“It’s about making sure that your organisation can raise particularly growth capital where the investor can share the risk or success of your venture.”
Saville was speaking at an event titled “How can I structure my social enterprise to attract the right investors?”, hosted by the Thomson Reuters Foundation in London.
The event allowed social entrepreneurs to “pitch” their ideas to a panel of legal and investment experts, who critiqued their business plans and offered advice on appropriate legal structures.
The resulting discussions underlined a classic bind that many social enterprises find themselves in as they come up against limitations with tax and regulatory codes that view a venture either as a profit business or charity.
This traditional business dichotomy simply doesn’t work for social ventures set up to create a positive change in society, often combining charitable aims with making a profit.
“There are probably too many structures and none is particularly suitable for social entrepreneurs,” said Ben Higson, a partner at law firm Hogan Lovells. “So, questions that we come up against often are what is my liability, how do I deal with tax issues, what finance is available for what type of structure.”
It might be very difficult to find investors, for example, if a social entrepreneur decides to be a sole trader because this legal structure doesn’t allow investors to buy shares in the company. Or, if it is a charity, an investor’s ability to get a return on investment will be restricted.
Ed Dowding, of Sustaination, an online platform that helps small food businesses find, buy, sell and promote locally produced food and drink as alternative to the supermarket-led food system, told the panel that attracting investment had not been hard but that it was hard to negotiate the right structure.
Like many social enterprises, Sustaination gets revenue both from philanthropic donations as well as from earned income.
Jake Hayman, of Future First, a social enterprise that works to help increase social mobility by building alumni communities in British state schools, said his company opted for a dual legal structure.
“We started off as company limited by shares and then licensed for free to a charitable arm all of the technology, including the software,” Hayman told the panel.
This approach proved useful in attracting funding from investors who did not want to put their money into a for-profit businesses, he explained.
COLLABORATE FOR GROWTH
Arthur Wood, founding partner of Total Impact Advisors, a social finance investment advisory, said the current “bipolar structure”, in which social entrepreneurs and investors negotiate bilaterally for capital, hampered effective collaboration between all players.
“We hear a lot about ‘multi-stakeholder collaboration…but one of the fundamental problems of our sector is that we invent these (legal and financial) structures one by one, issue by issue, silo by silo,” said Wood.
“It’s hugely expensive, and it is very difficult to replicate. And it means that you create a system that is essentially incredibly fragmented.”
Even though new legal forms aimed specifically at social entrepreneurs have been introduced in Britain - such as Community Interest Companies and Charitable Incorporated Organisations - as well as the United States and other European countries, the choices remain confusing.
To help make informed decisions the Thomson Reuters Foundation and law firm Morrison & Foerster have put together a guide “Which Legal Structure Is Right for My Social Enterprise?”, a free step-by-step outline for social enterprises in England and Wales to use in navigating the legal structures for incorporation.
The guide features case studies and a user-friendly decision tree that outlines the most important strategic considerations for an enterprise, Sophie McGrath, counsel at Morrison & Foerster and author of the guide, explained.
These questions include, for example, whether a social entrepreneur would want to raise money from the public, if they would they want to return any investment to your investors or whether they have solely charitable goals.
“The key strategic consideration should always be what social role is, what is the enterprise trying to achieve before we get bogged down in the legal structure,” McGrath said. “And by answering that simple question it can often lead us to what is the right structure.”
“But what often drives structure from a legal perspective will be finance, where will you raise it from and how will you use it, if and how you want to return profit to investors,” said McGrath.
** Find out more about TrustLaw Connect, a free online platform to connect social entrepreneurs to pro bono lawyers
Our Standards: The Thomson Reuters Trust Principles.