Social Entrepreneurship: Structures & Sectors

Week 4: Nuts & Bolts-

Structures & Sectors

KIEI 452

Gabrielle Lyon, PhD

WEEK 3: What is Social?

How & When: Action Plan

Meet with Client (1) (2) (2) (3) (4)

Conduct background

research

Conduct interviews

Agree on recommendations

Fill in research holes

Build client implementation

plan

Finalize presentation and

present

WEEK: 1 2 3 4 5 6 7 8 9 10

(1) Understand business (2) Update on progress (3) Review findings (4) Final presentation

Gabrielle Lyon-KIEI452-Week 4

Change.org


K/W/L

• What makes a non profit a nonprofit?

• What do we WANT to know about the distinctions of for-profit/non-

profit?

• Why do these things matter to understanding Social

Entrepreneurship?


Structure Spectrum

Philanthropy

Profits

100% Donations

30% Returns

Non-profit

Profit


Commercial vs. Social?

History Runs Deep

• 17th Century & Puritan Ethic:

– business and commercial activity is a sin.

– To atone do charitable work & keep it clean of any “taint” of

commerciality.

• Charitable and business sectors are fundamentally distinct in terms

of legal and regulation oversight.

– Charity is supposed to be about mission and not about money

• no profit-sharing, limits on compensation

– For-profit businesses, all about money and not about mission

• maximizing profit, no social responsibility obligations,

shareholder primacy)


Commercial Vs. Social

For profits

– Focus on stakeholders and distribute returns to investors

– Customers

NPOs

– Pursue charitable purposes and get tax benefits (ie don’t pay

taxes).

– Benefit from social legitimacy, good will, probono services,

donations

– Service beneficiaries


PURPOSE: Form Follows Function

NPOs

• Mission = public benefit activities ≠ primarily profit

– Organized for a non-pecuniary purpose.

• No person owns shares; property/profit are not distributed to

owners; recycled back into the public benefit mission

– Non-profits are tax-exempt entity:

• Formed under state law

• Tax exemption is a federal law

For Profit

Set up for the sole purpose of making a profit


What is a “charitable purpose?”

Exempt Purposes - Internal Revenue Code Section 501(c)(3)

• “exempt purposes set forth in section 501(c)(3) are charitable,

religious, educational, scientific, literary, testing for public safety,

fostering national or international amateur sports competition, and

preventing cruelty to children or animals. The term charitable is

used in its generally accepted legal sense and includes relief of the

poor, the distressed, or the underprivileged; advancement of

religion; advancement of education or science; erecting or

maintaining public buildings, monuments, or works; lessening the

burdens of government; lessening neighborhood tensions;

eliminating prejudice and discrimination; defending human and civil

rights secured by law; and combating community deterioration and

juvenile delinquency.” IRS.gov


GOVERNANCE & CONTROL

Non Profit Organizations - No one person, not even the founder, controls the destiny of a nonprofit organization. NPO control is exercised by a governing board of directors or trustees.

Board of Directors Responsibilities:

• Ensure resources are used to fulfill the mission

• Hire and fire the executive

• Fiduciary duties – sign 990s, oversee audit, review financial statements

• (D&O insurance)

• Ensure adequate resources

Other characteristics:

• Boards have to act as a group, not as individuals. No permanent tenure.

• Members are not usually compensated

• Bylaws outline the unique governance rules/responsibilities

• Traditionally play critical roles in the success of the organization

– Sctive role in fundraising

– Technical expertise (legal services, hr, financial management-related expertise)


Board Membership

Boards typically have a nominating committee

• More self-perpetuating than for-profit boards

• Stakeholders, governance watchdogs, media can create public

relations problems if there is a bad board

Term limits ensure some turnover

– Most boards recruit new members through their own networks

Roles for service recipients, institutional funders, or local affiliates (in a

networked organization) to select board members or have seats on the

board


Governance

For Profit Companies:

• Boards hire/fire/compensate CEO, oversee audit, approve major

decisions

• Fiduciary duty to corporation – generally this means shareholders,

except in financial distress where value of corporation and value of

equity can diverge significantly


Context for Decision Making

• For-profit: Get done what is needed in order to maintain the

financial bottom line

• NPOs: Balance between board of directors and executive director

– Board hires the ED; ED hires everyone else

– Board approves the budget; ED manages the budget

• Public Sector: Lots of constraints on decision-making

– Legislative & regulatory

– Political framework (managers vs. elected officials)


Actual Decision-Making

For Profit:

– Top down

NPOs:

– Might be top-down; sometimes bottom-up.

– Still need to interface with the board. (If nothing else they have to approve the budget.)

Public Sector:

– Financial managers often have to navigate competing interest groups.

– Important financial decisions require coalition building & support.

– Decisions can’t usually be passed along without some sort of public sanction or approval.


ACCOUNTABILITY

For Profit:

• Shareholders

NPOs

• File IRS form 990s; report finances, salaries of 5 most highly paid

employees

• 990s have to be made available to the public (see Guidestar)

• NPOs usually overseen by the state’s Attorney General’s office.


Ownership

NPOs

No one person ‘controls’ the organization. The assets are dedicated to

the mission. Assets are PERMANENTLY dedicated to exempt

purposes.

(DEFINITION: EXEMPT - Educational; Literary; Scientific; Religious)

NOTE:

If the organization dissolves or merges (after debts/liabilities) assets

have to go to another NPO.


Financial Management

Private & NPOs

• Bound by Generally Accepted Accounting Principals (GAAP)

Public Sector

GAAP might be used but might also deviate; public sector financial

managers are not necessarily bound by accrual accounting


Legal Structures & Issues That Follow…

Non-profit:

• Should not pursue profit (certainly not capital gains)

• Profit-seeking activities restricted

• Donations (individuals, grants)

• Sponsorships

• Earned Income

• Debt

• UBIT

They can’t raise equity. Why?

For-profit:

• Primary duty is to maximize profits

• Pursuing a social mission could be a distraction or limit profits and violate fiduciary duty


BLENDED VALUE

• Social mission ‘baked in’

• “Any commercial activity or venture that is operated to achieve

business and social goals simultaneously.”


How to ‘Embed’ Social Purpose

in a For-Profit??

• Can you make social impact an integral part of a company?

• Is there a legal formation that will bind social impact to a corporate entity?

• Ben & Jerry’s

• Newman’s Own


Create Multiple Entities

Example 1: Urban Education Institute (Uchicago)

• Start as non-profit: Use donations and grants for initial salaries, R&D, and launch.

• Resulting product or service for profit entity to raise expansion funds from the capital markets & public sector funds (i.e. UChicagoImpact & 6-16)

Example 2: Bain

• For-profit

• Then set up non-profit, Bridgespan

Example 3: National Geographic Channel

• Joint venture controlled by a non-profit parent (National Geographic & FOX)


Use Existing Legal Structures

Limited Liability Corporation (LLC)

• More flexibility. Social purposes can be integrated throughout the

operating agreement

• If number of investors increases especially through an IPO – then need to

go to a C corp.

C Corporation

– Basic legal structure used by public companies and many privately

owned companies

• Organizational document – articles of incorporation

• Writing in a social mission would authorize the corporation to pursue a

social benefit but would not require it.


Where the conversation is headed…


Hybrid “Ideal”

• Everything produces BOTH social value and commercial value

• NOT commercial VS social; social value & commercial revenue are

indivisible.

Ex. Microfinance

• When the loan is managed well both parties benefit


Hybrid Organizations

• Nonprofit/For Profit are distinct operating models

(Social Sector vs. the Commercial Sector)

What happens IN PRACTICE when you put them together?


B Corp “Benefit Corporations”

B Lab is the certifying (nonprofit) agency

• Take the B Lab impact assessment test

• Adopt the B Corp legal framework

• Sign a term sheet that makes the certification

official

Laws passed in 26 states (was only 7 in 2012)

• 1,128 companies registered as B Corps

globally in 33 countries

• 20 B Corps in Illinois


B Corps…

• Must spell out their values in their charters

• Report annually on activities that benefit the public

• Submit to third-party auditing of their social impact.

• Approval of two-thirds of shareholders

Issues

• Accountable to shareholders?

• Some states don't even allow companies to add stakeholder

interests to their articles of incorporation;

• Are amendments legally binding? Need to be tested in court

• Is amendment even necessary?


Low-Profit Limited Liability Corp. (L3C)

“A LLC that is organized to further one or more charitable

or educational purposes within the meaning of the

Internal Revenue Code.”

1. To encourage investment into non-profit and for-profit social

ventures by simplifying compliance to the IRS rules for PRIs.

• Binds the three characteristics of Program Related

Investments (PRIs) from the tax code with a LLC legal

structure.

• Allows for-profit seeking investors to access investment from tax-

exempt sources (like private foundations)


Low-Profit Limited Liability Corp. (L3C)

Issues:

1. Tax consequences are not yet known

• At the federal level “no one has signed off”

• State-created mechanisms

2. Unnecessary

• LLCs offer flexibility already

• Does not remove the burden of higher levels of due diligence,

reporting and accountability required for investments in for-

profit social ventures.


Hybrids challenges (or ARE they?)

• Legal Structure

• Financing

• Customers? Beneficiaries?

• Culture and Talent Development


“Executives of NPOs should not be encouraged to search for a holy

grail of earned income…Sending social service agencies down that

path jeopardizes those who benefit from their programs-and it harms

society itself, which depends for its well-being on a vibrant and

mission-driven nonprofit sector.” (1)

“Hybrids face the special challenge of building an organizational

culture committed to both social mission and effective operations.” (2)

Based on your experiences with your clients what do you think

about these generalizations?

1) Foster, Bradach. Harvard Business Review, 2005

2) Battilana, Lee, Walker & Dorsey. SSRI, 2012)

Break-evenPhilanthropy

Profits

100% Donations

30% Returns

Non-profit

Profit

Venture Philanthropy

Impact Investing

The Impact Financing Continuum

Philanthropy

VC Funding

Small Business & Entrepreneurship

Social Entrepreneurship: Structures & Sectors