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Wednesday
Jan262011

Starting a social enterprise: the conventional alternative

The advice I can give about the most suitable form of social enterprise is not legal advice, but advice about the economic and political environment for setting up a cause-driven business.

You may know that a social enterprise is a non-dividend distributing organisation which is run to address a social cause, but how you relate to it as a legal entity is a topic of considerable debate.

The traditional dichotomy of the social enterprise is the discrepancy between the social - societal consequences, and the enterprise, or business upshots, of the organisation. But in a deflationary economy and a frugal public expenditure regime I suggest that the most important distinction for a social enterprise is not, however, the dichotomy between private and voluntary organisations but between governmental and non-governmental.

Not just a question of social or business, but governmental or non-governmental

Let’s consider your own organisation’s income - do you generate added economic value by creating a desirable condition for other people to exchange their earnings with you, for your product (or service), or do you redistribute the benefits of capital collected from all citizens who pay taxes to a subset of people?

If your organisation does the former, you are non-governmental. If your organisation does that the latter, as a social enterprise, you have taken on a trio of:

  • Ethical business obligations to operate in the public interest
  • Economic constraints to provide products which are not discretionary in government budgets, and
  • Political responsibilities to conduct your organisation with transparency, efficiency and austerity.

 

Public funding comes with responsibilities attached

As a young social entrepreneur, I currently trade on a self-employed (SE) basis. In the past decade, I have incorporated three companies limited by shares (CLS), as well as a community interest company (CIC) and a company limited by guarantee (CLG) which is now a registered charity in England & Wales. 

Others have suggested that having a variety of legal forms in which to register a social enterprise is, in principal, negative. I do not believe that most of the problems are with the legal structures themselves, but rather with the social business advice surrounding their adoption by founders. At each juncture I would have valued additional knowledge to support my making an evidence-based decision on the most suitable legal structure. I have found it important to identify accountants who can demonstrate, through one or more case studies, the value of their advice to a local social enterprise.

It is not always financially practical during the early evaluation of legal structures for a startup social business to take this type of advice. A comparison table showing legal structures suitable for civil society organisations would be useful. Perhaps there is one you could recommend? To be most helpful, such a table would include key distinctions between the current legal forms of organisation under comparison. It would be useful if the social enterprise comparison provided indications of the respective regulators’ monitoring powers and support roles as well as upcoming options for new organisations. If this is what you are looking for, I can recommend the decision making tool from the National Council for Voluntary Organisations (NCVO) which is available on the Get Legal website.

Connect what you are doing to generate income with a standard legal structure

Decision making tools aside, the most important thing is to decide what you are going to do, before you decide what type of legal form you are going to set-up. In my responsibilities as a venture philanthropist, and social enterprise funder, some of the questions I have asked of social enterprises are:

  • What is the story behind your organisation?
  • What is the most exciting part of your organisation’s ethos or product?
  • What proof can you show me that you know your industry (rather than just telling me)?
  • What will the financial position of your social enterprise be if you receive the income you are asking me for and if you don’t?

Answering these questions should help you focus on what you will do and what your targeted outcomes are, beyond survival, which must include a sound financial strategy, beyond what type of legal entity you will have.

You can do well by doing good

In terms of which legal structure is right for you and your team, I think there are two established models for setting up a social enterprise in the UK today, which can be combined to allow you to seek profit and donations, pay dividends and collect gift aid.

First ask yourself: “How will I trade?” Your main consideration could be about who you trade with and what type of contract you will use. Secondly, ask yourself: “How will I raise finance for growth?”.

If your answer to these two questions is: (i) selling products/services to customers, (ii) investing capital in return for a share of the outcomes, I would recommend registering a company limited by shares (CLS), which is the typical structure for a UK Company. In this situation you are accepting that ‘the customer is always right’, rather than being sometimes right except…when donors think they are wrong! It’s about not splitting interests. With this approach, business investors typically expect capital to generate a return on investment through shares.

If your answer to the previous two questions is: (i) giving products/services, (ii) fundraising through supporters’ grants and donations, I would recommend registering a company limited by guarantee (CLG) and seeking registration with the Charity Commission. This is because funders of organisations looking to raise finance via voluntary income most often demand a structure which locks the value into the pursuit of defined social outcomes.

The catch, if there is one, is you can’t walk both paths at once - I suggest that you really should choose to either put society before profit, or profit before society, when you start a social enterprise. It is worth remembering that Charity law and Company law have had hundreds of years to become established in the public consciousness. Therefore, a ‘profit for purpose’, social enterprise approach is most easily explained and operated where the social entrepreneurs are operating a business first and a social campaign second. In this respect, I suggest that social enterprises give priority to the customer, adopting the customer service mind-set, over the promotion of philanthropic activities which seek to reproduce the interests of donors.

The Company and Charity models are well established for distinct activities

I would add a reminder that the majority of funds available for social enterprises come in the form of grants for less than five thousand pounds. The focus of a social enterprise should be on the available sources of funding. This does not mean that you need to sacrifice flexibility to accommodate a change in focus at a later stage, from customer to donor, or vice versa, over the organisation’s lifespan. I said that I think there are two sound legal structures for setting up a social enterprise in the UK today, which can be combined to allow you to seek profit and donations, pay dividends and collect gift aid. This is not possible with either of these legal structures, but with a combination of both.

If your organisation’s brand (the legal ‘personality’ of your organisation) seeks to change or divide its focus in order to thrive, I recommend that you then set-up the other half of the structure. If you decided, firstly, to incorporate a company limited by guarantee (CLG) as a registered Charity, you may now set-up your trading arm. The trading arm can be incorporated as a company limited by shares (CLS) as a wholly owned subsidiary of the Charity. If you decided to establish a company limited by shares first, then now you can set-up the company limited by guarantee, register it as a Charity and sign your organisation’s shares over to it.

You could think of this approach as creating two purebreds, or specialised tools, each most suitable for their purpose. This helps prevent conflicting interests, which can appear as if you are singing ‘One Song to the Tune of Another’. This avoids what others have referred to as ‘twisting the rules’ to shoehorn charitable objectives into the Company model, or profit generating objectives into the Charity model.

You will need to explain what you do and what you are

Perhaps if it were simpler to takeover a social enterprise when they are failing or dormant, then the cost of setting up a social enterprise up might also be reduced. Perhaps the sector is in need of greater emphasis on transfer of ownership and local coalitions which support existing social enterprises and social entrepreneurs.

In terms of the evolution of social enterprise regulations, I believe in strong definitions of organisational structures, but a strong definition does not have to narrow the range of possible structures – the range of legal forms can be broad and clearly defined. Diversity is very desirable for the resilience of the UK definition of social enterprise in terms of public trust and the reputation of the collective mark.

Think twice before starting a social enterprise assuming government funding

Which ever you decide on as the most suitable form of social enterprise in terms of legal structure, your focus might be best directed towards your sources of funding in the economic and political environment when setting up a cause-driven business in 2011.  @davidpidsley

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References (5)

References allow you to track sources for this article, as well as articles that were written in response to this article.
  • Source
    Which legal structure best suits your new social enterprise? Does it fit your long-term vision for the business? Ask our panel of experts on 20 January
  • Related
    The Co-operative Enterprise Hub aims to expand the co-operative economy by creating strong, ethically-led businesses with a deep sense of social responsibility. We offer a package of advice, training and finance to help new and existing co-operatives become more sustainable businesses.
  • Related
    The free online reference and decision-making tool for charities, social enterprises and co-operative organisations.
  • Related
    Co-operative & Community Finance provides sympathetic loan finance to help people take control of their economic lives and create social benefit.
  • Related
    Related: UnLtd
    UnLtd is a charity which supports social entrepreneurs - people with vision, drive, commitment and passion who want to change the world for the better. We do this by providing a complete package of funding and support, to help these individuals make their ideas a reality.

Reader Comments (2)

My business was once structured as as a CIC and a ltd company things got really difficult fo rme due to the inability of finding decent directors as well as costs involved. I feel I rushed into it and I needed to have a fully established business before I even tried to find that needed second director.
At the moment I am bulidng tthe blocks again as a self employed social entrepreneuer and once there is a really frim foundation I feel I will be more successful in setting a new company and social enterprise.
It's might not be easy going it alone but if you have determination to suceed and with a vison to help others then I believe everything will slip into place when the time is right.

Finding sources of funding are difficlut... and that's why as a social enterpreneur I intend to help. :-)

David,

I noticed you mentioned you'd already been involved with a CiC, but on reading further I was surprised not to find that form of company formation expanded upon. Was that deliberate and/or implied some kind of negative opinion or was it just an oversight? Likewise, the above comment alludes to a CiC and difficulties but does not explain, so of course my curiosity is tweaked.

I am just at the outset of setting up both a NFP foundation and NPO operating arm, so am looking for guidance, any help I can get and experienced hands.

May 30, 2011 | Unregistered CommenterTerence Milbourn

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