Legal forms for social enterprises

Readiness for scale implies a variety of questions and challenges for a start-up company. Not only is a validated product or service, viability, impact measurement etc. essential to attract necessary investments that permit growth (BENHAYOUNE, 2017). One important point is also the legal structure of a company providing a legal status with certain rights and protections, but also responsibilities and liabilities. follThough finding and obtaining the right legal structure for a start-up is not an easy task. The choice of a suitable legal form depends on local laws and regulations, and has therefore to be investigated individually for each country a safe water enterprise is or wants to become active in (OSINOWO, 2016). An overview of different legal company structures around the globe can be found here.

In some countries, the procedures to register a business are complicated, time-consuming and rather costly (WORLDBANK, 2018). Specifically establishing a social enterprise primarily intending to pursue social impact while being financially viable and expecting some tax reductions for example is not yet a widely spread legal structure. Even though Mohamed Yunus is advocating for social entrepreneurship, there is still little evidence on how to implement such concepts in practical terms. As Milton Friedman has put it: “The business of business is business” and still today “the guiding principle of business value creation is a refreshingly simple construct: companies that grow and earn a return on capital that exceeds their cost of capital, create value” (GOEDHART, KOLLER & WESSELS, 2015). If a social enterprise wants to create other value it may enter into problems with its shareholders or investors. Finding a legal structure that can harmonize these seemingly contradictory goals of profit and social impact may need innovative ways allowing a compromise. (GOEDHART, KOLLER & WESSELS, 2015). There might also be the need to identify a second best solution that is suitable for the specific context of action in the country of your operation.

Choosing the right legal form is important for every start-up that is planning for scale. Depending on the legal structure obtained, enterprises show a different business majority, purpose and also security to potential investors. The right legal structure provides on the other hand also security for the entrepreneur. For example, in case of a failing business – it can protect the entrepreneur from personal bankruptcy. (LAURIC, 2014).

To facilitate the process of finding and registering the most suitable legal form for your company, different aspects have to be kept in mind. Legal forms and procedures are always context specific and differ from country to country.

Subsequently a range of criteria and questions are provided in order to facilitate a safe water company’s path of planning, identifying and obtaining the most suitable legal structure. The first criteria to choose a legal structure depends on the needs of the business, and for this, the World Bank has defined some general criteria (WORLD BANK GROUP, 2017).

Defining the criteria for your legal form

• Decide in which country to set up your company
• Get an overview of possible legal forms to obtain in your specific country of action
• Depending on your requirements (ownership, social purpose, image, management, financial needs and financial goals, legal protection, credibility, tax advantages, attractiveness for investors) take a decision for a specific legal form.
• A working group from the University of St.Gallen in Switzerland developed 9 criteria for a social enterprise that should be considered for setting up a social enterprise. These criteria are summarized below (ARBTER, WELLSTEIN & ATASOY, 2015):
  1. Obligation to pursue a social mission: This criterion elaborates the link of the enterprise to the social mission. The legal form conditions the pursuit of a social mission or whether other orientations can be subordinated to the specific legal form too, reflecting the dual mission dilemma between social impact and financial profit and the challenge to adhere to the mission.
  2. Mission stability: this second criteria builds upon the first and defines how stable the social mission is prescribed in order to prevent a mission drift (pursuing other than the initially defined mission, e.g. total focus on profit rather than on fulfilling for example the mission of improving access to safe water).
  3. Transparency of the business activity: Reporting is more demanding for a social enterprise and needs to at least implement a triple bottom line statement that describes not only the financial but also the social and environmental impact.
  4. Tax advantages: For some social enterprises it makes sense for the State to lower the tax burden if the social goal is in line with the goals of the Government, for example to achieve the Sustainable Development Goals (SDGs).
  5. Means of financing: Social Enterprises are financed by a combination of different types of market resources (resulting from the sale of goods and services), non-market resources (government subsidies and private donations) and non-monetary resources (volunteer work). This array of possibilities to finance the business is impacted by the choice of a legal structure. Investors, such as foundations, might accordingly prefer to invest in more charitable causes than banks do. Hence, reflections upon which investors are attracted by the respective legal structures are important to conclude potential means of financing.
  6. Signaling effect: A signaling effect by a legal structure can be important both for investors as also other donors and underlines the credibility of an operation, be it to create trust in the social mission and/or also in the financial sustainability.
  7. Costs and effort of founding: Depending on the local laws and regulations, it may be more difficult and costly to setup a specific legal entity. For example, creating a foundation or a trust may be more cumbersome in some countries, but in the long run, it may still be worth the effort to have a suitable legal entity.
  8. Scaling-up the business: This criterion takes into consideration the growth perspectives of a social enterprise: whether it can attract sufficient funds for scaling may be an important consideration.
  9. Corporate Governance: Choosing the right Corporate Governance form from the beginning is also an important criterion for the growth potential. Usually, social enterprises are started by a charismatic individual, but it may be needed to involve other shareholders as investors and even more importantly some of the stakeholders (e.g. the water committee) in the governance structures.

ARBTER, WELLSTEIN & ATASOY (2015) applied the criteria on the following 5 case studies:

1. L3C: Low-Profit Limited Liability Company: This is the best-known hybrid company under the US Trust law and is characterised by 3 Ls: “low profit”, “limited” and “liability”.
2. FPC: Flexible Purpose Company: The flexible purpose company is another form of social enterprise accepted first in California under the Trust Law and later on also in other States.
3. CIC: Community Interest Company: the CIC is a hybrid legal form in the United Kingdom and has similar characteristics, but a special feature is that the social mission (community interest) is supervised by a regulator.
4. Tandem Structure: This is the most pragmatic form of combining a for-profit enterprise (for the economic part of the activities) with a foundation type of legal structure that is explicitly non-profit.
5. B-Corporation: Is a new form of certification of companies by the non-profit organization “B-lab” that helps defining and measuring the social mission of private organizations.

All these different forms have advantages and disadvantages. For example, only the tandem form can assure some limited tax benefits. For a detailed analysis, we refer to the full study. A synthesis of advantages and disadvantages can be seen in the tables bellow.

For registering a (social) enterprise the following aspects should be kept in mind (UNLTD, 2017; KRISHNAN, 2012):

• Implementation planning and time

Finding the suitable specific legal form for your business will take time. In certain countries entrepreneurs need to consider months to obtain the registration of your legal form. Make a planning for obtaining your legal form to avoid problems from the beginning.

• Procedures and legal requirements
  • The World Bank compiled an exhaustive database on the ease of doing business around the globe. The platform offers broad insights into legal procedures in different countries, provides case studies and reports on different business-related topics and rankings (The World Bank Group, 2017).
  • Check need of licenses, insurances, VAT registration, general terms and conditions, retirement funds for your employees, definition and registration of your business name etc. with the local authorities.

• Costs

Different costs will occur during the founding process. Keep in mind costs for lawyer or notary services, permits, certificates etc.

• Support
  • The local chamber of commerce is usually helpful in supporting you for establishing a new legally registered company.
  • If you want to establish a legal entity in a foreign country, the economic services of your Embassy will in most cases provide you with assistance and guidance on the local procedures.
  • Consider the support of a local law firm or an agency that offers company establishment support.

In the accompanying case study of Tinkisso provides insights on the procedures and process the safe water NGO underwent in order to create a private sector entity. Additional lessons learned can be drawn from ECCA’s strategy to run a private sector arm in Nepal.