Legal Structures for “Social Enterprise” businesses
We explore what legal structures are most appropriate for impact-focused businesses considering themselves to be "social enterprises".
A few weeks ago, I wrote a blog on how to define a social enterprise (and one on defining social investment). In fact, the blog really explained why this “social enterprise” brand does not matter to us; it’s about the impact you have that counts, not how you talk about it. Indeed, one of our partners, UnLtd, explains: “it is not the legal structure that makes an organisation a social enterprise – it is its activities”.
So we do not see legal structure as a barrier to creating social impact. Different businesses create impact in different ways, but there has been discussion recently of a “legally defined social enterprise” (as a business must be to be eligible for social investment tax relief, for example). Legal structure does, of course, influence how a business works, and one commenter asked for some more clarity on how – so here’s a cheat sheet to explore how you can structure an organisation that is focused on impact as well as the bottom line (and yes, it’s a pretty long one).
One group of legal structures will determine how profits and assets can be distributed, and it is businesses in this group that are most commonly recognised as social enterprises (usually, charities or community interest companies).
Some organisations will want to be structured as a charity. This may give them access to funding from certain trusts and foundations that can only give money to charities that are regulated by the Charity Commission.
Unlike most charities registered with the Charity Commission, an unincorporated association does not have a legal existence apart from its members as individuals (they can be registered with the Charity Commission, however, although they do not need to be). This includes many voluntary and community groups (for example, the Mapesbury Dell – an unincorporated association that was set up to get volunteers to help improve a green space). These organisations are not regulated by Companies House – but individual members will be responsible for debt incurred. It is rare for commonly-understood “social enterprises” to be constructed in this way.
A registered charity receives some level of regulation through the Charity Commission. This may give them a shortcut through some impact assessment metrics because they already have their impact assessed at a high level by the Charity Commission and are constituted for a clear social or environmental purpose (via the Commission’s 12 charitable objectives). Trustees cannot receive money in payment and there will be restrictions on trading activities – and there cannot be shareholders
Within this, organisations can choose to be a Charitable Incorporated Organisation (a CIO), or a charitable company (limited by guarantee).
A CIO will mean the charity is a corporate body with a wider membership – including voting members other than charity trustees. A CIO will need constitution, be registered with the Charity Commission, keep a register of members and submit annual returns. This often works for charities with a wide volunteer base, who may want to give these volunteers influence over the charity’s governance.
Alternatively, a charitable company (limited by guarantee) is a corporate body that may or may not have a wider membership. The “limited by guarantee” means trustees put up a nominal “guarantee” (usually £1) for the company – it means debts incurred are limited to the organisation itself, with trustees only ever paying off debt equivalent to that guarantee amount.
Running a business model as a charity limited by guarantee means you will not be able to have shareholders or distribute profits, but there will be benefits in terms of grants and other funding for which only registered charities are eligible, and it will also protect the core mission of the business, as it must have charitable aims within its constituted and will be regulated by the Charity Commission.
Just as profit-making ventures can also be limited by guarantee, many impact-focused companies can be limited by shares.
Community Interest Companies (CICs)
CICs can be limited by shares or guarantee, or be a public limited company (this means it has publicly-offered shares and limited liability). These companies must satisfy community interest requirements (similar to those for charities, showing how it will contribute to society). They must also have an asset lock, which means its assets are used for the benefit of the community. Specifically, the CIC must retain its assets, or it can transfer them only to another asset-locked body, or for full market value so the CIC retains the value of the assets transferred.
The limitations for a CIC mean there can be a profit made for investors and shareholders but the primary focus must be on achieving community benefit, not maximising profit.
In August 2014, there were over 10,000 CICs in the UK – it is a recognised structure for companies considering themselves social enterprises, and brings benefits such as eligibility for social investment tax relief. Some financiers may not feel as comfortable investing in this structure, and it will make companies ineligible for some grants, but it provides the freedom for an organisation to be entrepreneurial while still retaining its legal commitment to a core mission as it grows.
Companies Limited by Shares
This is the most common legal structure, and is adopted by many of our clients. With a Board of Directors, a company can pay dividends to its shareholders, and shareholders are only liable to the amount of their contribution. However, directors can still be liable for negligence or fraud.
The company must be registered with Companies House, submit annual returns and register its Directors.
For many businesses focused on impact, this allows them to access traditional forms of investment, such as equity. There is nothing in this legal structure, however, that ties a company to social or environmental impact – although entrepreneurs can choose to include these commitments in a constitution. These kinds of companies may struggle to raise grants or philanthropic funds and are ineligible for social investment tax relief (but will be eligible for EIS and SEIS reliefs).
Industrial and Provident Societies (IPS) and Community Benefit Societies (BenComs)
All co-operative organisations operate under the ICA co-operative values and principles.
IPS and Co-op structures are run and owned by their members, while management teams control BenComs. An IPS co-operative is set up to benefit its members, whereas a BenCom is set up to benefit the community more widely, whether people are members or not.
Both these co-operative forms are there to support impact, whether for members or society at large, so some businesses choose these legal structures to help embed impact into their growth.
So there’s a whole lot of choice. In the end, entrepreneurs will have to decide what kind of finance they will need to help them grow (grants vs. investment, for example), and who they would like to control that growth. Once they have decided on this, choosing a legal structure will simply be about supporting the best growth of the organisation as and the best growth of its impact too.
And if you’re still not sure, we’d recommend this brilliant summary table by UnLtd to help visualise benefits and disadvantages for each.
Image: Flickr / Creative Commons: Hans and Carolyn