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Choosing a Legal Structure for Social Purpose Business

The development of social entrepreneurship is greatly influenced by Canada’s current legislation and the legal structure you choose for your Social Purpose Business will impact the organization’s governance, investment options, structure, taxation, regulations and more.

Introduction

One of the challenges faced by entrepreneurs who found Social Purpose Businesses to create blended value is in making the most suitable choice from within Canada’s legal framework.

The concept of “social enterprise” refers to the use of revenue-generating business-minded activities to accomplish a socially beneficial end. While this definition is fairly broad, it is clear that there are many different structures that fit within this basic concept – from business corporations designating a portion of their profits to charitable means, to charities and non-profits establishing secondary for-profit entities to finance their non-profit purpose, to charities and non-profits conducting for-profit operations that directly advance their philanthropic purpose, to co-operatives.

Current legislation

Canada’s legislation does not currently provide a straightforward option for social entrepreneurs. The choices available are a for-profit, not-for-profit, registered charity or co-operative corporation. Before incorporating your Social Purpose Business, you need to consider the differences among these legal structure options and understand how your decision will impact your business.

A for-profit structure suits a business that anticipates levels of profit similar to a traditional commercial enterprise, if slightly less due to its commitment to blended value – the combination of financial, social and environmental value. The priority within a for-profit business is to scale your business and create significant revenues for your social cause. On the other hand, a not-for-profit framework best suits a business that intends to use all profits exclusively for promoting its stated social objectives.

A registered charity assumes that all profits go towards your social mission and all profit-making activities meet the definition of a “related business”, as determined by the Canada Revenue Agency. “Related business” includes activity related to the charity as well as unrelated activity so long as the majority of employees involved are volunteers.

A co-operative is a legally incorporated business that is jointly owned by the members who use its services. Depending on the needs of the members, co-operatives can choose to operate on a for-profit or non-profit basis. A co-op can also, should they meet the requirements under the Income Tax Act, be tax exempt and/or achieve registered Charitable Status. The unique structure, adherence to internationally established principles, and the legislative environment for co-operatives offers a business model that can be both profitable and competitive, while also keeping a strong social purpose at the center of the organization’s mandate. Co-operatives are also widely recognized for strong leadership in corporate social responsibility, ranking in the Top 50 across Canada. 1

Making the best choice

To make an informed decision about which structure best suits your business, you need some decent financial, accounting and legal knowledge. Since entrepreneurs often lack such expertise – and are too busy attending to everything else involved in founding a business – seeking legal counsel is highly recommended.

The choice you make should be based on the context of your business, including management preference, social and financial goals, stakeholders and availability of resources.1 A good way to approach the question of legal structure is to ask yourself, “What is the core nature and intent of my business’ profit-making activities?” The table briefly outlines the potential pros and cons associated with both options.

Pros and Cons Associated with For-Profit, Not-for-Profit and Co-operative Structures2

For-profit Not-for-profit Co-operative
Pros
  • Greater flexibility around profit-making activities
  • May be easier to attract traditional investment and debt financing
  • May be tax exempt or receive taxation benefits
  • May be easier to attract grants and government support
  • Is democratically controlled and owned by the members who benefit from the services
  • Can issue membership shares and investment shares to raise equity capital
  • Can operate as for-profit or as non-profit and are eligible for a range of programs
Cons
  • Restricted from some non-profit government funding
  • Accountable to shareholders, who may have concerns about profits being used to achieve social goals rather than returning to shareholders as dividends
  • Entrepreneurs and investors are restricted from extracting profits
  • Cannot issue shares or pay dividends
  • Limits on ability to raise capital
  • Ownership structure can limit options for capitalization (e.g. eligibility to programs that require 51% ownership).
  • Challenges maintaining member participation and governance within the co-op

Innovations in legislature

In recognition of the value of social enterprises, many countries are experimenting with new legal structures that can better accommodate social ventures. The United Kingdom and United States are pushing forth as global leaders in legal innovation to support social entrepreneurship, and it has been suggested by experts, researchers and policy makers that Canada refers to the experience of these forerunners and considers implementing similar legal structures.

In the U.K, a Community Interest Company (CIC) structure was created in 2005 as a type of limited-liability business that can operate more commercially than a charity. The intent is to enable organizations to use their assets and profits for the benefit of the community, and to help create a known brand for social enterprises.3 While CICs can operate more “commercially” than charities, they must pass a “community interest test”, adhere to certain “asset lock” restrictions and must disclose their activities annually. As of the beginning of 2010, there were nearly 3,400 registered CICs in the U.K.2 Examples include Education Solutions Direct, a specialist education and training consultancy serving disadvantaged community members, and Gateway Family Services, which trains and develops people with barriers to learning and employment to help them gain skills to deliver new types of health and social care services.

B “Beneficial” Corporations have been implemented in the U.S. and are now expanding into Canada. Created by the not-for-profit B Lab, B Corporation is a certification rather than a new legal form of business. It helps corporations “define themselves to consumers and investors as socially and environmentally responsible businesses”.3 To become a B Corporation, a business, including co-operatives, must achieve a certain threshold score on the B Ratings System, a survey that assesses a company’s social and environmental performance based on such factors as philanthropy, political activity and environmental policies. In 2009, Better the World Inc., which raises money for charities by delivering marketing campaigns to targeted consumers, became the first B Corporation in Canada. In March 2014, The Business Development Bank of Canada become the first Canadian financial institution to receive B Corp certification and the 100th Canadian company to join the international B Corp community.

Efforts have also been made to promote Corporate Social Responsibility (CSR) principles and practices to Canadian businesses. Industry Canada, for example, provides supportive information and links on their website to help Canadian companies develop a CSR strategy. CSR helps make Canadian business more competitive by supporting operational efficiency gains, improved risk management, favourable relations with the investment community and improved access to capital, enhanced employee relations, stronger relationships with communities, an enhanced license to operate and improved reputation and branding.

Social enterprise legislation differs from one province/territory to another. To find out about what options and resources are available to you, please visit the Canada Business Network http://www.canadabusiness.ca/eng/page/4337/

You will also want to seek out legal advice to help you with this decision and to navigate the current legal landscape.

Developments in Canada

Small changes are starting to be made to the current legislation in order to better foster social entrepreneurship. In 2013, for example, British Columbia (B.C.) introduced a new category of corporations called the “Community Contribution Company”, also knows as a “CCC” or “C3s”, which combines elements of a for-profit model with those of a non-profit.

In November 2012, Nova Scotia also took a social leap forward by enacting legislation to create a new category of share capital company aimed at helping its population. Under the Community Interest Companies Act, businesses in Nova Scotia can be designated as community interest companies. This allows them to have characteristics of both a corporation and non-profit organization, combining entrepreneurship with a social purpose. In addition to the legislation, the Nova Scotia government has also introduced a Social Enterprise Loan Guarantee for local credit union loans to ‘not-for-profit, non-profit, cooperatives and social purpose businesses which are for profit but designed to fulfill a social mission.’ The guarantee covers up to 90% of loans up to $150,000 and was introduced in mid-2012 as the first step of the Province’s social enterprise strategy.

A major difference between Nova Scotia’s CICs and B.C.’s lies in their regulatory oversight. Unlike B.C., Nova Scotia has followed the U.K. model by establishing a Registrar to oversee CICs. Nova Scotia’s Registrar of Joint Stock Companies determines whether or not a company is eligible to receive a CIC designation and can de-designate any company it believes has failed its purposes.

Much more is needed, however, within Canadian and provincial legislation to help entrepreneurs build a business based on blended value. Lessons can be learned from the regulatory changes in the U.K. and U.S. and the impact they’ve had on communities, economy and environment. In learning from the innovations in other countries, it is hoped that Canada can develop a legal framework that better recognizes the value of social entrepreneurship.

Quoted References

  1. Corporate Knights. The 2014 Best Corporate Citizens in Canada, 2014 (http://www.corporateknights.com/report/2014-best-corporate-citizens-canada)
  2. Deloitte. Funding the Future: Emerging strategies in cooperative financing and capitalization, 2012. Retrieved on July 14, 2014  at http://www.intlsummit.coop/files/live/sites/somint/files/etudes-pdf/Deloitte_Funding_the_Future.pdf
  3. O’Connor, Pauline. Canada: Potential Impacts on Nonprofit Growth and Sustainability, April 2014. Retrieved on July 30, 2014 at http://afpcalgary.afpnet.org/files/ContentDocuments/AFPSocialEnterpriseRegulatoryRegime.pdf

References

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