Trust and Scale in Global Social Enterprise Law

(Illustration by John Whitlock) 

Social enterprises aim to use business methods to solve social problems.¹ As with any venture, they need both capital and confidence to achieve their ambitions. But pursuing these dual needs can be particularly difficult for social enterprises to reconcile. Commercial operations and access to investment markets can unlock resources to expand organizational scale and magnify social impact, yet adopting these tools of business raises concerns that social enterprises will prioritize private gains over social objectives. Social enterprises must allay these fears, persuading funders, employees, consumers, and the public to trust that their social commitments are genuine and durable.

Legal frameworks help communicate that social enterprises can be trusted.² Traditional for-profit or nonprofit law serves this function when a jurisdiction’s corporate, cooperative, or charitable forms accommodate a venture’s desired social mission, as well as its choice of business methods. If not, social enterprises worldwide might choose from a growing number of legal forms and certifications designed specifically with their needs in mind. Governments create new legal forms, which reach only entities operating within a single jurisdiction. Certifications, crafted by governments or private institutions, instead create labels that brand ventures as social enterprises regardless of legal form and may apply across borders.

Both types of specialized legal frameworks function as social enterprise identifiers, demarcating the appropriate space for social enterprise and broadcasting a signal of trustworthiness for entities that qualify.³ Audiences as diverse as employees, consumers, investors, and regulators can use these identifiers to differentiate trustworthy social enterprises in the marketplace for their talent, resources, and confidence. Some techniques they employ to engender trust, however, will also curtail access to capital, triggering the familiar trade-off between trust and scale.

In a new global research project, my collaborators and I reveal a sharp dichotomy in the ways in which governments and private legal innovators respond to this dilemma.⁴ The wide array of identifiers now available to social enterprises divides neatly into two groups: those that impose limits on the distribution of profits or assets to qualifying entities’ investors or insiders, and those that do not. Belgium exemplifies the first approach. Its federally certified social enterprises may distribute profits only up to a specified rate of return for investor contributions (currently 6 percent). On dissolution, investors may have their historical contributions returned, but no more. All other residual profits must remain devoted to the social purpose or purposes of the dissolving social enterprise.

The second group of identifiers rejects any such constraints on distribution as part of their qualifying criteria. Ceilings on distribution play no part in Colombia’s Beneficio e Interés Colectivo (BICs), or companies of collective benefit, for example. Firms qualifying for BIC certification may distribute their profits and assets as any other business would.

Distribution constraints like Belgium’s signal trustworthiness. Caps on midstream and residual profit distribution diminish insiders’ and investors’ ability to extract profits for themselves, in turn reducing their incentives to divert effort and attention from a venture’s social mission. But they simultaneously make investment less financially attractive, decreasing constrained firms’ access to private capital and capacity for scale. For identifiers like Colombia’s BIC, this cost proves too great. They instead prioritize investor appeal, forgoing the additional trust that distribution-constrained alternatives provide in favor of promoting capital formation. Like the social enterprises they seek to advance, identifiers across the globe confront difficult trade-offs between trust and scale and reach two quite different points of compromise.

A Spectrum of Distribution Constraints

Distribution constraints exist on a spectrum. The most sweeping version bars distribution of midstream profits and residual assets altogether. Legal systems worldwide associate nonprofit or charitable status with just this type of comprehensive distribution constraint. Nonprofits (or charities, depending on the jurisdiction) may not declare dividends and must reinvest all their profits into their organizations and their missions. On dissolution, they must transfer their remaining assets to similarly constrained entities, ensuring that those resources will be dedicated to nonprofit or charitable purposes forever. As legal scholar Henry Hansmann described decades ago, the prohibition on nonprofit charities sharing their profits with insiders engenders trust. Donors and patrons of a nonprofit charity rely on it for reassurance that their contributions will be devoted to the charitable mission and not diverted for private gain.⁵

Funders, employees, customers, and the public likewise need assurances that they can rely on the prosocial commitments that social enterprises espouse. Yet trust represents only one crucial ingredient for social enterprise. Ventures formed to pursue social goals using business methods also seek capital to thrive, expand their scale, and magnify their impact. Specialized legal forms and certifications resolve this tension in one of two ways: imposing only partial distribution constraints, like Belgium’s certified social enterprise, or forgoing constraints altogether, like Colombia’s BIC. These two positions along the spectrum of distribution constraints represent remarkably different approaches to delivering both trust and scale.

Identifiers that adopt partial distribution constraints allow qualifying entities to distribute profits or assets to some degree or at some times. Some of these legal forms and certifications offer greater reassurance of adopting firms’ trustworthiness by imposing nearly (but not quite) comprehensive constraints. Others permit much more distribution as an incentive for investment, establishing far narrower limitations. All of the identifiers taking this middle path, though, rule out the unfettered profit and asset distribution available to ordinary for-profit firms.

Reinvestment mandates instill trust by turning abstract social commitments into concrete percentages but also present challenges of design and measurement. To effectively signal trust, reinvestment mandates’ metrics must be both clear and relevant.

Dividend caps like Belgium’s are one popular technique for partially constraining distributions. Firms issue dividends to share midstream profits with their investors. This financial upside, available during a company’s life, rather than only on its dissolution, creates an incentive to invest. In standard for-profit settings, company leaders hold considerable discretion over whether to issue dividends and in what amounts—so long as they do not endanger firm viability. Dividend caps limit this discretion, imposing a ceiling on the portion of profits that may be shared with a firm’s investors regardless of its profitability. Dividend caps may thereby suppress a social enterprise’s access to capital but do so to reinforce its mission.

Setting a dividend cap tips the balance between trust and scale. In 2017, Italy responded to concerns about capital access by fixing a relatively high cap for social enterprise dividends: 50 percent of annual profits or operating surpluses. The UK’s dedicated Community Interest Company (CIC) Regulator loosened its dividend restrictions twice in just five years, in 2010 and 2014, in an explicit effort to stimulate investor interest. The CIC dividend cap now sits at 35 percent of annual profits, the same level applied to firms earning Danish registered social enterprise (RSV) certification.

Reinvestment mandates constrain midstream profit distribution too, but indirectly. They require a social enterprise to reinvest a significant portion of its surplus or profit, thereby making this share unavailable for distribution to investors. Levels of restriction run the gamut. Romania requires firms with social enterprise status to allocate at least 70 percent of their profits or surplus toward pursuit of their social purposes. French firms that obtain économie sociale et solidaire (ESS) status must ensure that 50 percent of profits are carried over or allocated to reserves, and private certifications from both Social Enterprise Mark (SEM) in Ireland and the United Kingdom and Australia’s Social Traders require social expenditures to predominate.⁶ To qualify under the primary social enterprise framework available in Singapore, firms must allocate only 20 percent of their resources to social-impact generation.

Reinvestment mandates instill trust by turning abstract social commitments into concrete percentages but also present challenges of design and measurement. To effectively signal trust, reinvestment mandates’ metrics must be both clear and relevant. The French carryover or reserve requirement is easily tracked using ordinary accounting standards but relies exclusively on other features of ESS status for substantive guidance on the use of these resources. Certifications cast in terms of resources devoted to social goals or purposes must then define the bounds of social versus other expenditures and establish appropriate metrics. For example, to assess whether a firm dedicates at least 50 percent of its prior-year annual profits to meeting its social goals, Social Traders developed a series of metrics suited to different impact models. Labor costs matter most for work-integration social enterprises—those that engage in some kind of business primarily to offer work training to target populations—but for social enterprises pursuing impact by donating their profits, contribution size determines compliance.⁷

Asset locks can add to dividend caps or reinvestment mandates further protection against diversion of social enterprise resources, as in the Belgian regime. Applied at dissolution, these constraints require any assets remaining after creditor claims are satisfied to be distributed to other entities pursuing purposes similar to those of the dissolving social enterprise. True to their name, asset locks lock value into the social sector, but they likewise permanently withdraw private access to that value—including for potential investors. Investors in an asset-locked enterprise are not residual claimants, and their upside is severely restricted. Choosing an asset lock sends two equally powerful signals: that incentives for deviating from a social mission have been reduced, but also that investor returns will be limited.

Even among identifiers that partially constrain distribution, asset locks are not universal. Reinvestment mandates under Kazakhstan’s national certification for subjects of social enterprise, Abu Dhabi’s local social enterprise certification in the United Arab Emirates, and Social Traders’ private certification in Australia all operate without accompanying asset locks. These certifications retain the possibility of financial return for investors on dissolution, albeit in the context of midstream distribution constraints, but they are the exception. Most identifiers that impose partial distribution constraints in fact double down, pairing dividend caps or reinvestment mandates with asset locks, as in the Belgian example. Despite their potential to dampen investor appeal, powerful distribution constraints appear indispensable for identifiers in this group.

Opting Out

Another group of legal forms and certifications designed to identify social enterprises assesses the values of engendering trust and enabling scale very differently. Like Colombia’s BIC certification, these identifiers reject distribution constraints entirely. This choice can be understood as a decision that constraints of any kind—including dividend caps, reinvestment mandates, or asset locks—pose an unacceptable risk to capital formation, whatever assurances of trust they might provide.

Some of the proliferation of this unconstrained vision for social enterprise can be traced to B Lab. This private US nonprofit pursues a mission “to harness the power of business as a force for good,” its website states. B Lab offers its proprietary B Corp certification to “for-profit companies that want to consider additional stakeholders, morals or missions in addition to making a profit for their shareholders”⁸ in jurisdictions worldwide. B Corp-certified firms face no restrictions on distributing their profits or assets beyond those applicable to other for-profit entities. Certification instead relies on detailed and highly complex program and purpose requirements in B Lab’s evolving B Impact Assessment, together with governance mandates and disclosure obligations.

Along with its regional spin-offs like Sistema B in Latin America, B Lab has advocated for jurisdictions around the world to establish identifiers aligned with its unconstrained social enterprise ideal, with considerable success. Its B Corp certification and broader legal reform efforts have informed the development of several other legal forms and certifications that conform to this pattern.⁹ Along with Colombia’s and Peru’s BIC certifications, the benefit company in Canada’s British Columbia province, the Delaware public benefit corporation (PBC), and the benefit corporation form now available in most other US states all adopt elements of the B Lab vision, including its omission of distribution constraints.

But not every unconstrained identifier can be traced to B Lab’s influence. In response to domestic pressures, Chinese certifications evolved to uniformly reject distribution constraints over time. When four Chinese cities independently developed local social enterprise certifications between 2015 and 2018, they reflected a mix of approaches to distribution constraints. Beijing and Chengdu proceeded without any constraints whatsoever, but Shenzhen’s and Shunde’s certifications included bright-line reinvestment mandates. Shunde’s certification imposed an asset lock, too.

None of these constraints remains in place today. Certifying entities in Shenzhen and Shunde jettisoned them during early revisions designed to make their standards more flexible and accessible in the Chinese environment. Taiwan faces a stark choice between these alternatives today. It is simultaneously considering competing proposals for a “public-interest company” form, which would constrain distributions, and a “benefit company” form, which would impose no such limits.

Trust and Scale

The positions that particular legal forms and certifications stake out along the spectrum of distribution constraints reflect differing views on balancing trust and scale. Partial distribution constraints serve to reassure investors, along with consumers, employees, and regulators, that a social enterprise can be trusted to live up to its social commitments. By stopping short of comprehensively banning distributions, they combine these assurances with investor access to limited financial returns. While investors in partially constrained social enterprises forgo the unlimited potential upside of a traditional equity investment, they retain some ability to profit from their ventures’ financial success. How much they can share depends on the intensity of dividend caps and reinvestment mandates and whether they are paired with asset locks or operate in isolation. The universe of investors willing to make the sacrifice required to fund a Belgian-certified social enterprise may not be as large as those willing to purchase traditional equities, but limiting insiders’ ability to enrich themselves reassures those who do invest that their trust will not be misplaced. Investors who opt in also thereby signal their own commitment to the enterprise’s social mission to other important stakeholders.

Unconstrained identifiers like the Colombian BIC balance the competing goals of trust and scale differently. Governments and private players designing these legal forms and certifications recognize distribution constraints’ potential to bolster trust, but they value scale more. Social enterprises are pitched to solve massive and enduring societal challenges. Unlimited profit distribution opens the door to full equity participation, with all its potential for greater scale, to finance these ambitious social missions. Constraining distribution—even partially—dulls the power of equity to drive capital formation. The Shenzhen and Shunde certifications’ turnarounds and the CIC Regulator’s dividend cap escalations reflect this reality. Unwilling to impede access to scale, unconstrained identifiers resolve to rely on other mechanisms to secure trust.

Commonalities Across Identifiers

Putting aside the striking dichotomy between constrained and unconstrained identifiers in the broad range of jurisdictions we studied, we observed widespread convergence across their other key attributes. Although each framework our team of experts described reflects the particular cultural, political, and legal environment to which it is adapted,¹⁰ nearly all rely on some combination of purpose requirements, governance mandates, and disclosure obligations to define the social enterprise category.

(Illustration by John Whitlock) 

Purpose or program requirements confine qualifying firms to industries or activities focused on social impact. Some identifiers envision a capacious, industry-agnostic range of permissible endeavors, like the broad set of social or environmental purposes acceptable for an organization to qualify as a Belgian-certified social enterprise or Peruvian Sociedad BIC or to obtain Ākina impact supplier certification in New Zealand.¹¹ And in the United Kingdom, a firm seeking to adopt the CIC form must meet the “community interest test,” which requires only that “a reasonable person might consider that [the firm’s] activities are being carried on for the benefit of the community.”¹²

Other identifiers more narrowly limit the purposes or programs that qualify. Amendments enacted soon after the initial adoption of the Colombian BIC certification require each qualifying firm to specify the socially beneficial nature of its business model and labor and environmental practices in its corporate documents. The most extreme identifiers confine their application to entities serving a single purpose, like the Hungarian social cooperative’s sole focus on work integration. Restricting access to social enterprise forms or certifications based on purposes or programs that their designers deem appropriate reassures the public that qualifying firms truly embrace social goals.

Governance mandates enlist parties inside social enterprises to safeguard their missions—bolstering accountability from within. The Belgian-certified social enterprise form is available to cooperatives only, relying especially heavily on democratic governance to ensure that the relevant ventures uphold their social commitments. The social cooperative forms available in numerous other European jurisdictions likewise expect members, beneficiaries, or both to ensure that qualifying firms remain trustworthy. Italian social enterprise certification requires the creation of a supervisory board to play this key governance role and mandates the largest certified social enterprises to empower their stakeholders to elect one of the board’s members. The UK CIC, Denmark’s RSV certification, and gold-level certification from SEM require the participation of stakeholders in governance, though without prescribing particular structures or processes.

Specialized corporate forms proliferating in the United States rely particularly heavily on governance mandates. The Delaware PBC imposes three obligations on fiduciaries of adopting firms, who must balance “the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation’s conduct, and the specific public benefit or public benefits identified in its certificate of incorporation.”¹³ Benefit corporation statutes in other US states require directors to consider a laundry list of stakeholder impacts in their deliberations, and BIC directors in Colombia must consider collective benefit and interest when making decisions.

PBC and benefit corporation shareholders in the United States can enforce directors’ governance obligations through litigation, while Colombia instead empowers both shareholders and anyone else harmed by a BIC to petition the government to decertify noncompliant firms. As in all Delaware corporations, a majority of a PBC’s shareholders must also approve amendments to the certificate of incorporation. For a PBC, this means that shareholders must authorize changes to the public benefit purpose enshrined in that certificate. Benefit corporation statutes in other states also require that changes in corporate purpose must secure shareholder approval, sometimes by a supermajority. Utilizing either the PBC or the benefit corporation form will also satisfy B Lab’s governance criteria for US firms seeking its B Corp certification. These varied governance solutions serve a single goal: to assure that qualifying entities can be trusted to adhere to their social missions.

Disclosure obligations rely on transparency to enhance trust. Reporting requirements allow shareholders, other stakeholders, regulators, or the public to observe social enterprises’ activities and verify their claims. Indeed, in Colombia, shareholders must not only receive but approve BICs’ required annual impact reports. Access to these reports varies considerably elsewhere. Benefit companies in British Columbia and most benefit corporations in US states must publish annual reports on their websites, recounting how they conduct their business and pursue public benefit. Delaware PBCs must produce similar reports every two years but are required to provide them only to their shareholders. The UK CIC and certified RSVs in Denmark instead submit annual reports to regulators, which facilitate public access.

Notably, few of these regimes include enforcement resources or even penalties for failures to complete required reporting. Early evidence suggests that noncompliance is alarmingly frequent.¹⁴ Moreover, social metrics remain highly contested. Embedding transparency in social enterprise identifiers can foster trust only when disclosures are accessible and informative and compliance is widespread.

Specialized forms and certifications define legal categories upon which potential capital providers, stakeholders, and the public can rely, improving access to the resources and goodwill social enterprises need to thrive. Weaving purpose, governance, and transparency requirements into the fabric of these identifiers amplifies their signals of trustworthiness. These criteria appear again and again, in high-, middle-, and low-income economies, and in legal systems with common law or civil law traditions, regardless of whether the identifiers that impose them embrace or reject distribution constraints.

Social Enterprise Incentives

Governments can also support social enterprises beyond the indirect assistance that identifiers provide.¹⁵ Specialized legal forms and certifications signal that others should feel comfortable investing in, purchasing from, working for, or otherwise engaging with a particular social enterprise. More direct support might come from public subsidies or benefits to increase social enterprises’ resources or reduce their costs. Jurisdictions are just beginning to experiment with this approach.

Social enterprises need to persuade myriad audiences to trust them. Governments, private-sector capital providers, consumers, employees, and the public will not bestow their trust and treasure on social enterprises without sufficient assurances.

Tax relief can flow to social enterprises or their supporters. Switzerland directs its limited tax relief to social enterprise firms themselves. Companies that are irrevocably dedicated to “idealistic purposes,” rather than pursuing profits for shareholders, and that produce low profits avoid taxes on profits up to approximately $20,000. Taiwan’s proposed public-interest company form also targets firms and would grant discounted income tax rates to those who qualify. From 2016 to 2022, the US city of Philadelphia offered 50 (in later years, 75) certified B Corps a $4,000 credit toward their business income tax liability.¹⁶

Other experiments with tax relief target not social enterprises themselves, but their investors. Belgium currently exempts from income taxation the first 200 euros ($216) of interest paid to investors by certain certified social enterprises. Debt or equity investments in UK CICs qualified for that country’s Social Investment Tax Relief (SITR) scheme beginning in 2014. SITR allowed taxpayers to deduct 30 percent of the cost of qualified investments from their income tax liability and to avoid capital gains tax on resulting gains. Parliament extended the scheme past its original sunset date to April 2023, but it was not further renewed.¹⁷

Procurement preferences can provide social enterprises with both material support and proof of concept by building a customer base for their goods or services. European social cooperatives and Danish RSVs can qualify for preferences under the EU’s procurement directive, as implemented by member states. Romania allows public authorities to reserve contracts for firms with social enterprise status. Two US counties offer limited bid preferences to benefit corporations or B Corps.¹⁸ Colombia will also prioritize BIC bidders, but only when they receive otherwise equivalent scores. Social Traders and Ākina developed their private certifications specifically to enable social enterprises to capture the value of procurement priority. They custom-built their certified social enterprise and impact supplier frameworks to identify firms qualified for preferences in Australia and New Zealand, respectively.

Experimentation with social enterprise incentives is only just emerging. Their initial trajectory appears to track the split between constrained and unconstrained identifiers. Most experiments with social enterprise tax relief and most procurement preferences are tied to legal forms or certifications that constrain distribution to reinforce the trustworthiness of qualifying entities. The Swiss company with idealistic purposes; Taiwan’s public-interest company; the UK CIC; social cooperatives across the EU; and the Danish RSV, Social Traders, and Ākina certifications all include dividend caps, reinvestment mandates, asset locks, or some combination of these restrictions.

For identifiers without these protections, substantial public incentives remain rare. Jurisdictions like China, Colombia, Peru, and states and provinces in the United States and Canada, have seen robust development of social enterprise forms and certifications without distribution constraints. As yet, these jurisdictions have shown less appetite for linking them to significant tax relief and procurement preferences.

It would be inappropriate to draw firm conclusions from our incomplete global dataset of early experiments. Still, the emerging connection between distribution constraints and public incentives reinforces the importance of balancing trust and scale. To grant social enterprises tax relief or procurement preferences, legislators must be assured that public resources will not be misspent. Purpose and program requirements, governance mandates, and disclosure obligations all signal that a social enterprise’s mission commitments can be trusted. Even partial distribution constraints appear to deliver powerful further assurance for legislators and voters who are concerned that public funds may be wasted. Moreover, linking constrained identifiers to public incentives may mitigate the costs to capital they exact.

This mix of distribution constraints and public resources represents a compromise to engender trust while still enabling scale. Understanding this compromise underscores the need to explore other ways to pursue this balance. Governments could also bolster even unconstrained identifiers with investments in regulation and enforcement. Reassurances that the government is watching could help persuade both legislators and citizens that social enterprises’ missions can be trusted and might even justify public incentives to further stimulate growth. Private players can also make meaningful contributions. Private certifications are already operating as vouchers of trust in jurisdictions around the world. Additional private solutions, such as creative finance, consumer contracting, and employment structures, can all shore up trust without sacrificing scale.

Many Ways Forward

Social enterprises promise to deploy the tools of business in response to the world’s greatest challenges. To meet these commitments, they need to persuade myriad audiences to entrust them with their confidence and their resources. Governments, private-sector capital providers, consumers, employees, and the public will not bestow their trust and treasure on social enterprises without sufficient assurances. Standard legal frameworks will sometimes instill sufficient confidence. Specialized legal forms and certifications can do so when they miss the mark. Crafting these identifiers requires attention to the extant legal and political paradigms in which they will reside, as well as thoughtful resolution of the trade-off between signaling trust and enabling scale.

Grasping the centrality of this trade-off in fashioning legal frameworks for social enterprise will help policy makers, advocates, and researchers promote the social enterprise sector and its impact. Legislators and regulators can focus on identifying their preferences around bolstering trust versus facilitating scale and thereby frame more apt legal forms and certifications. Advocates can likewise sharpen their arguments and interventions, proposing public models or creating private certifications attuned to their own policy preferences. Future research can use the trust-scale divide to create a taxonomy of legal options to identify social enterprises. A viable sorting tool makes empirical testing of the various strategies far more feasible and may even inform future iterations of current legal frameworks.

Read more stories by Dana Brakman Reiser.