Five Things to Consider Before Selecting a Legal Structure for your Social Enterprise

Written by: Kristina Roberts, JD 2018

Disclaimer: The information provided in this blog article is NOT LEGAL ADVICE.  This information has been provided by a recent law school graduate, not a student-at-law registered with the Law Society of Alberta or a lawyer. If you need advice with respect to a specific legal matter, contact a lawyer. In Alberta, you can do so by calling the Lawyer Referral Service at: 1-800-661-1095.

Individuals starting a social enterprise sometimes don’t realize how important it is to select the right legal structure for the organization. The legal structure sets out the parameters within which an organization can operate, and can influence incentives, decision-making and outcomes. The first step for a budding social entrepreneur looking to start a business is to clarify his or her goals; this should take place prior to seeking legal advice or deciding upon a structure. A social entrepreneur should have a clear idea of their business strategy, vision, and the social/environmental impact they wish to achieve. Without taking these factors into consideration, there is a risk that the structure chosen will dictate the path that the enterprise takes, regardless of what the social entrepreneur originally envisioned.

Social Innovation Generation published a description of four basic issues that social entrepreneurs must address before deciding on the appropriate structure: motivation, control, capital and market.  An additional consideration for those considering the possibility of a co-operative structure is the existence of a member base.

1) Motivation

While it may be clear that a social entrepreneur wants to pursue a dual social and economic mandate, it is important for the entrepreneur to decide which motivation is primary–social or economic.  There will inevitably be times when these two mandates come into conflict with one another, so the enterprise needs to be structured in such a way that the entrepreneur’s primary motivation will win the day.

The motivation of an entrepreneur is one of the most important factors in selecting a legal structure. A study published by the California Management Review identified 48 “hybrid organizations” around the world, and concluded that it was common for social enterprises to change the legal structure of their organizations after having already begun operations. Of the organizations whose initial legal structure was selected based on alignment with the founder’s values, 45% had made changes the legal structure since the organization’s inception. In contrast, 75% of structures that were chosen to fit with a product, and 65% of structures that were chosen to raise capital had changed their legal structure. This suggests that organizations whose initial legal form was selected for personal reasons, such as alignment with the founder’s values and motivations, may be more stable than organizations that chose a legal form for strategic reasons.

2) Control

It is necessary for an entrepreneur to consider how much control he or she wishes to maintain over the organization. Generally, entrepreneurs have the most control over private corporations. When a corporation goes public, or control rights are split, the differing interests and priorities of the groups with control may come into conflict. For organizations that receive favourable tax treatment, such as non-profits, there are limitations around how resources can be allocated, and the level of disclosure and administrative requirements are heightened.

3) Capital

A major challenge for all social enterprises, regardless of their legal form, is securing financial resources. Social entrepreneurs need to have a strong gauge on their need for outside capital, both in the start-up phase as well as during ongoing operations. A different, but related, consideration is the tax treatment of different organizational forms, and the ability to offer tax benefits to funders.

4) Market

It is critical for anyone who engages in entrepreneurial activities to understand their value proposition, and who they are targeting with their activities. The size and growth potential of a particular market, as well as the saturation of competitors in the market, may have an impact on the type of legal structure which makes sense for a particular enterprise.

5) Member Base

If an organization is focused on benefitting a specific community, the existence of a potential member base makes it possible for the social enterprise to be structured under the co-operative model. Co-ops are an attractive model for many social entrepreneurs because they make it possible to build a social purpose directly into the organization’s legal structure, while also retaining the attractive features of the for-profit corporate form, such as financing options and a reduced administrative burden. However, a co-op can only function if it involves a group of highly engaged members who are willing to participate and collaborate. As such, assessing whether a potential member base exists is an important preliminary consideration for a social entrepreneur.

 

This blog article is the first in a series designed to provide information on legal structures to social entrepreneurs who are contemplating starting a new social venture.
 
This series is based on a directed research paper I wrote titled “Legal Possibilities for Social Entrepreneurs in Alberta.” I was excited to have the opportunity to incorporate my passion for social enterprise into my legal studies, and to continue on my quest to discover how business can create a positive impact in society.

About the author: Kristina became enthralled with social enterprise business models after completing business school and working in community investment consulting. In 2014, she participated in Simon Fraser University’s certificate program in Community Economic Development (hosted by Thrive). Recognizing that there would be a need for lawyers who could navigate the grey area between traditional for-profit and non-profit models, Kristina decided to attend law school at the University of Calgary. Kristina recently finished her studies, and hopes to integrate her knowledge and interest in innovative, sustainable business models into her legal career.