by Chris Way

As you build a solution to a challenge society faces, probably one of the last things on your mind is what form your social enterprise should take. A social enterprise after all, is generally a venture that solves a social problem. As you build that solution the answer may seem obvious, and so does not need much thought.

But let’s close our eyes and picture a social enterprise together. Ok, we’re reading so maybe open them back up. A social enterprise does good in the community. It’s founded by and staffed by individuals that care about making a difference. Everybody’s smiling, all the people helped and helping. It charges a fee for its goods or services and makes a nice income suitable to sustain its operations, compensate its contributors, and build funds for future work. OBVIOUSLY, this organization is… a … for profit business? No, a nonprofit? Should it be a public charity?

The substance of your social enterprise, your solution to a societal challenge, is an important question to resolve. But just as important is the form of the enterprise you will use to solve that problem.

This decision is harder than it may initially seem because the lines between for profits and nonprofits & charities have become blurred in some ways. Plenty of for-profit enterprises do good in their communities and have missions that include activities traditionally considered charitable. Correspondingly, plenty of nonprofits and public charities solve problems and charge fees for their goods or services.

Should My Social Enterprise be For-Profit or Nonprofit?

As you plan a social venture, this is one of the first questions you need answer. While there’s no easy answer, we can home in on the right answer by asking ourselves (and our team) some important questions. Let’s begin. To do that, we need to explore your needs relating to a few factors.

Non-Profit vs. Public Charity

Before we begin, we must first address an important piece of nomenclature: the distinction between nonprofits and public charities. A nonprofit corporation, or nonstock corporation in Virginia and other states, is a corporation that does not exist for the purpose of distributing profits to shareholders. That’s it. It is not necessarily one that is in pursuit of any charitable, or public service mission. It is not exempt from the payment of federal income tax. It is simply a structure where the income remaining after the payment of expenses is not meant to be distributed to any ownership group.

A public charity is distinct from a nonprofit. A public charity is a nonprofit organization that has taken the additional step of being recognized by the IRS as meeting the criteria applicable to public charities under Section 501(c)(3) of the Internal Revenue Code and its related regulations. These criteria include the organizational test and the operational test, which I will explain in detail in a future article.

For now, we can keep the distinction straight as follows: All public charities are some form of nonprofit organization (a nonstock corporation, a nonprofit LLC for certain states with very specific laws creating that entity type, etc.). But not all nonprofits are public charities. Nonprofits may simply be nonprofits as I’ve described above, or they may tax exempt under a different part of Section 501(c).

Our focus today is on determining whether an enterprise with a socially good, charitable mission should be organized as a for-profit entity or as a public charity.

The Need for Flexibility & Innovation

We begin with a brief consideration of compliance. That’s not the primary focus of any deliberations between being a for-profit enterprise or a charitable one. But it is important to visualize at the outset in one specific capacity. The need for flexibility.

One of the beautiful things about for-profit business enterprises is their ability to innovate. Corporation, partnership, and limited liability company pose little restriction on the ability of management to adapt to create solutions to marketplace problems and adapt to changing conditions. Public charities on the other hand, can innovate solutions, but their ability to do so is hampered by the need to comply with public charity law. This body of law can impose significant restrictions on the what’s and how’s of a charitable organization’s activities.

The more you’d like flexibility or room to innovate new business models, products, and services, etc. the more favorable a for profit becomes as it will give you more room to make moves and adjustments.

The Need for Control

Related to flexibility, you must consider how much control you and your co-founders need over the organization and its operations. The more control you need, which can aid how nimble and flexible you are, the more a for profit becomes attractive. Public charities are required to act in the public interest in pursuit of charitable purposes. This requires the appointment of a board of directors that act as the stewards of the organization on behalf of the public. While you can be on your board, you will need individuals that are independent of you.

The Need for Subject Matter Expertise

Your next consideration is how many people you need to incorporate into advisory concerns and how you are best suited to incorporate these people into the operations. It is typically a bit easier to recruit experts to serve on a board for a public charity than a for profit. With a public charity, you can recruit a board through their love of the mission. Public charity directors typically serve as volunteers. Conversely, for profit advisors and directors are generally paid for their time. No matter how much they may care about the mission, if someone is profiting from the enterprise’s activity and they are providing advice, guidance, and oversight that helps create those profits, they’re likely to want to be compensated. With a charity, if you only need a few hours a week or month of subject matter expertise, you can find many qualified individuals that may be willing to donate their time.

The Need for Funding

Beyond your ideas and efforts, your social enterprise needs capital to get going. As you consider whether to be a for profit or a public charity, consider how you see the funding developing. Do you see a larger group or a smaller one? What do you see as what your backers are expecting in return? What entices them? A financial return? The chance to help the community? The chance to fulfill their own social mission? The possibility of a tax deduction for their financial support? Are there grants available for the activity you intend to conduct, and what qualifies you for them?

There’s no simple answer to determining what types of funding are best for your venture. However, asking yourself these questions will allow you to see what you need more clearly.

The Need to Exit

None of us entrepreneurs will run our businesses forever. As you consider the form of your venture, consider how you want to exit one day. A for profit enterprise can be sold to new stakeholders when it comes time for you to exit. A public charity cannot, and your exit would be more akin to retirement or changing jobs. With a public charity you’re creating something that you’re giving to the community. You might be the steward of it for a bit or for a long time, but ultimately a public charity belongs to the public. The longer you want to or plan to be involved the more attractive a for profit may become because it allows you to be around, remain in control, and benefit financially. If you might be around a lot in the beginning, but ultimately want a lot of operations and growth efforts to come from others an NP could be, but is not necessarily, more favorable.

The Need to Assess the Marketplace and Public Perception

Consider what you want public perception to be and what’s the marketplace like? Generally speaking, nonprofits and public charities have a better public perception in certain types of activities than for profit enterprises, but that’s not universal. Look at what others in the space are structured as. If you’re finding the space is almost entirely occupied by public charities and nonprofit organizations, then being a for profit could make it hard to compete or even operate. If there are many for profits in the market, then you could go either way.

The Need for Revenue: Who Pays for Your Services

Business operations have a cost, whether you are for profit or nonprofit. So, you must consider who will bear that cost. Can your revenue needs, as necessary to cover your costs, be supported by the recipients of your goods and services? If the goods and services need to be subsidized or paid for by some party other than the end users, then it may be easier to structure your venture as a public charity. There donors can provide the funding needed so that the intended recipients of your services or users of your goods can access them with less need to be able to directly pay for them.

Another way of looking at the previous question, is the cost of servicing the market higher than the market’s ability to pay? Or do all the potential costs of the enterprise exceed the potential revenue for the foreseeable future? Nonprofit doesn’t mean no income, but the thinner the margins the more sustainable a public charity can be because it’s easier to get financial support from other sources. For profit ventures can of course operate with a loss, but generally that’s only when the financial backers have a model that shows the loss is for the short term only and future profits are much higher.

So, as you visualize this factor, remember that your end users may not be your only customer stakeholders. It is entirely possible that there are alternative sources of revenue like government programs, corporations, and private foundation, that may be able to provide funding that supports the costs of your activities.

The Need for a Workforce

Our next consideration is what kind of employees do you need to be able to compete in the market? The more specialized your staff needs are or the more the market values a particular skill set and requires higher pay, the more we need to account for staffing in the decision. There’s no easy answer here. Both for profits and public charities can offer competitive salaries. But if you notice that for profits can pay a higher salary than public charities in the industry, with a big gap between the two, then for profits may have an advantage in recruiting staff.

The Need for Other Resources

Our final consideration, for this non-exhaustive list, is what kind of non-personnel, non-financial resources and support does the venture need? While money and personnel and important to any business venture, they are not the only resources a business enterprise may need to accomplish its purpose. Consider what you need to accomplish your mission and how to get it. By considering these, you may find that one form has advantage over the other in its ability to procure certain things. For example, you may find a public charity has an advantage because it can receive certain resources through donations. For example, a business may be willing to provide its older office furniture to a public charity as a donation, where they may not do so for a for profit business. A public charity may be restricted from participating in certain kinds of activities related to certain resources.

Concluding Thoughts

While there are no easy answers, these questions should help you find the right balance for your social enterprise and determine which way to go. And remember, you’re not alone. As you plan out your organization, your mission, and your activities, the team at Way Law is always here to be a resource and help you move forward!