This is a writeup of our journey over the last several months through the various entity types that we might choose with the aim of becoming an organization that focuses on creating social good in the field of volunteerism.
For-profit:
We don't want to take on investors who have extremely high expecatations for rate of return. We're going to err in favor of doing more good than earning more profit. And that line of business doesn't often fly (unless we get lucky with just the right investor, which is certainly possible). What's great about this range of entity types, however, is its flexibility... a true asset.
Non-profit:
This entity type feels right. We're an organization that helps nonprofits get the most out of the people who want to help them. We're a nonprofit facilitator - seeking to use crowdsourcing to provide greater human resources for social causes. But there are a lot of problems with being a c3. There are strict laws surrounding what kind of business you can and can't do - and who you can and can not work with. Here's a quote from the tax code:
"To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates." Source
The legislation part is a bummer. I'd rather be able to work on behalf of causes in which I believe. And often, they're political in nature. And then there is the lower pay scale and lack of financial incentive system, which prevents us from hiring great people and from getting the best out of them. And while there are financial advantages in being able to fundraise from foundations, they're mitigated by the amount of work it takes to apply for and manage grants. All around, having run a nonprofit for the last 5 years, I'm not a fan of this entity. Especially when we're going to be competing with companies in this space, it feels like we'd be hamstrung by the entity type.
Hybrid:
Too confusing. There are laws surrounding the separation of the for and non-profit that make daily life (as a small hybrid) a big grind. Did you just use the stapler that belongs to the nonprofit for the forprofit? Magnify the stapler issue 100 times/day. And the worst part is that success of the nonprofit can't "shine a light" on the forprofit. So just make a great achievement or win an award for the nonprofit... well, you can't mention the forprofit, because it's not allowed to benefit. It's the worst of both worlds.
NEW TYPES
Thanks to some savvy friends (Erich/Alex), I've been introduced into the world of alternate entity types. I had no idea that these existed, but have been doing research. Here's what I've got so far. Send me any additional information if you've got it in a comment, please.
L3C or Low-profit Limited Liability Company
This entity type seems to solve a lot of problems - and it's brand spanking new - just out for a little over a year. It's currently only available in Vermont, but similar to how every C-Corp is incorporated in Delaware, one can register from any state. Returns seem to be capped at 5%.
"The low-profit, limited liability company, or L3C, is a hybrid of a nonprofit and for-profit organization. More specifically, it is a new type of limited liability company (LLC) designed to attract private investments and philanthropic capital in ventures designed to provide a social benefit. Unlike a standard LLC, the L3C has an explicit primary charitable mission and only a secondary profit concern. But unlike a charity, the L3C is free to distribute the profits, after taxes, to owners or investors...
A principal advantage of the L3C is its qualification as a program related investment (PRI), an investment with a socially beneficial purpose that is consistent with and furthers a foundation’s mission... An L3C’s operating agreement [makes]... it easier for foundations to identify social-purpose businesses as well as helping to ensure that their tax-exemptions remain secure...
By addressing these current investment challenges to PRIs, L3Cs are able to attract a greater influx of private capital from various sources of wealth in order to serve their charitable or education goals."
Source
Here's another good summary quote from Social Edge:
"L3Cs could generate modest profit, while pursuing charitable or educational aims. The new tax structure would make it much easier for foundations to make use of a little-used but already established vehicle—called Program-Related Investments (PRIs)" Source
Another laurel:
"The economic realities of connecting social needs with capital markets is leading to innovations like the L3C form. As the problems that social ventures try to solve get bigger and more widespread, hopefully these types of innovations will keep pace." Source
Problem is that the entity still can't pursue political aims. Damn.
"(C) No purpose of the company is to accomplish one or more political or legislative purposes within the meaning of Section 170(c)(2)(D) of the IRS code of 1986, 26 U.S.C. Section 170(c)(2)(D). "
Relevant Links:
Questions:
What are the negatives associated with capping ROI at 5%? Are there any other than narrowing the pool of potential investors? Does it negatively affect business in any other way? Do foundations really fund this entity type more easily? Or is that just the idea behind the entity that hasn't yet come true in reality. Certainly, it seems like a real boon.
6/09/09 Update:
We've talked with a lot of people about this entity type and most say the same thing - that the entity type is unproven - that funders and investors are unfamiliar with it and that if we're forging new ground with our business model, we shouldn't risk doing the same with our entity form. Also, some question that the L3C really does what it sets out to do - make it easier to land a PRI.
Social Business
In his book "Creating a World Without Poverty," Dr. Yunus outlines a business that is for-profit, but not "Profit Maximizing" - a critical distinction. It doesn't rely on foundation funding or charity. Instead it pays for itself and pays back investors (at very low rates of return). He wraps up some elements of the B-Corp ... perhaps providing the inspiration for such. Check out our longer post on this form of business. This is what we want to be. Problem is that there's no legal entity type that is a social business - so we've gotta pick something and then fashion ourselves around Yunu's principles.
B-Corp
Here's another new 'entity' - a so called Benevolent Corporation with a slick Website and brand identity. The entity can be a C-Corp, LLC, or S-Corp, but one that ammends its governing documents to reflect values outlined in this declaration:
"We envision a new sector of the economy which harnesses the power of private enterprise to create public benefit. This sector is comprised of a new type of corporation the B Corporation
which is purpose-driven and creates benefit for all stakeholders, not just shareholders." Source
The process entails filling out a survey, ammending the corp governing documents, signing a term sheet, and submitting to a yearly audit. It has a tiered pricing model which can be found
here. Here's the description of the who and how the legal framework was created:
"The B Corporation legal framework is the result of eleven months work by a team of attorneys from two national law firms: Linklaters and Jones Day. Linklaters completed an extensive state-by-state analysis that focused on the corporate statutes and judicial case law in each state. This analysis identified a list of states that have the optimal combination of existing legislative and judicial environments." Source
Current corporate structures make it difficult for good businesses to consider stakeholder interests-those of their community, employees, and environment. Because they are legally required to maximize shareholder value, profitable, high-impact businesses find it difficult to scale and create liquidity without compromising their mission.
Ok, so I'm getting some clarity. If we want to be a social business - one that earns its own keep, doesn't rely on charity, and that can compete with any number of the businesses that will emerge in this space, it's sounding like becoming a B-Corp is the most viable legally binding method available to us. It will legally permit us to deliver value to our stakeholders at the expense of shareholders. At the same time, it has an auditing process in place that delivers some assurance to outsiders that we're doing what we say we're doing - and are transparent with where our money is going.
More on being a business
Initially, we had some concerns about being a profit-earning business in the field of volunteerism. How might people feel about helping our business grow as a result of their labor? After some deep thought here, we came to this set of thoughts:
If we can run a business that enables social good organizations do more social good, it's good for everyone. Why?
- We don't take money out of the charity pool, so we're not competing for cash that can go towards other causes.
- We get to spend all of our time focused on making a great product, rather than on raising money from foundations.
- We hope to attract top talent - and to say to them that they don't have to take a cut in pay to come work for us - that we're as viable an option as any other for-profit out there.
- We have the opportunity to show that Yunus' model can work - that a business can be focused on stakeholder value - while competing with other for-profit businesses that don't necessarily have stakeholder value at the core of their mission.
- Like Yunus, we hope to inspire other entrepreneurs to focus their ROI in terms of social good.
- And finally, the better we do as a business, the more we're able to offer to the sector.
I think you have more leeway than you might realize as a 501c3. The definition of 'substantial' is a little loose. You can't work directly for a candidate, but you can organize around the issues that a candidate espouses... You can also do unrelated business and pay income tax on it while maintaining c3 status. But I'll have to check out the Yunus book.
Posted by: OwenL | March 20, 2009 at 12:39 PM