In consulting with my lawyer, he pointed out that for a speculative venture with a public purpose that will incur losses to start out (such as mine), it might be difficult to convince the IRS that the venture is really a non-profit eligible for non-profit status. To ensure tax-deductibility, he advised using for-profit S-corp status, making it easy to deduct early stage losses. Does this sound reasonable?
Thanks for a very thorough review. Many would-be social entrepreneurs are confused about what constitutes the right model and your many examples will be very helpful. For a high-level, conceptual model, your readers might be interested in this simple model http://www.strategies-direction.com/?p=154 .
For those who are interested in purusing options 1 and 2, there are ways to anchor mission, protect directors, provide for greater transparency, avoid the investor control issues, raise money in the capital markets, and stay pure to the social mission (and even do it at the “bottom of the pyramid” without surrendering too much for taxes along the way. These structures are a bit complicated and involve bending the arc of traditional forms, but are certainly worth the time of an entrepreneur to consider.
I have started several for profict social enterprises (FamilyEducation Netwrok, BiddingForGood) and have found there are three main advantages to for-profit model;
1. access to capital. there is way more investor capital than grant capital. Furthermore, most non-profit funding sources only want to back pilost but are not interested in scaling. This is where the for profit model has much bigger advantages
2. ability to attract talent; with stock options and higher liveable wages the pool of mgmt candidates is just bigger
3. market discipline; with for profit model you just HAVE to deliver value or folks wont pay up.
I’ve returned several hundred million to investyors so have found it easier and easier over time to attract capital (recycling escrow payments).
This was a great article, and I appreciate Jon’s contributions as well.
Here’s our rationale. We’ve chosen the for-profit model simply because I wanted to focus my activities on meeting our social and profit goals. It was my observation while working with nonprofits that the executives were forced to spend too much time meeting requirements of government agencies and funders that diverted them from, what I believed to be, more productive use of their time. I am also much more comfortable knowing that I am responsible for producing the revenue necessary to scale my business.
We may ultimately convert to a hybrid to ensure that when we retire or sell the business,we are assured the continuation of its social component.
I have a question related to this terrific article that I hope someone can shed some light on. My question pertains to an arrangement wherein a 501(c)3, seeking a sustained and dedicated source of revenue, enters into a business arrangement with a for-profit entity. I am particularly interested in an arrangement wherein the not-for-profit sells its “brand” and all goodwill associated with it, in exchange for a pre-determined percentage of future revenue made by the for-profit. When I talk about a nonprofit “selling its brand/goodwill” what I’m getting at is essentially an exlusive and permanent IP licensing agreement. The end product of this arrangement would find the non-profit still in charge of its operations and still able to seek outside donations, with the only difference being that it would have a consistent stream of revenue from the for-profit entity. The private entity would be able to exclusively use the nonprofit’s brand (e.g. TMs, copyrights) as a source of revenue. In consideration for the purchase of the brand, the private entity would guarantee, let’s say 10% of profits, to the not-for-profit.
I am curious as to whether you know of any other examples of this type of arrangement. I am not looking for you to answer this questions in detail, but I would greatly appreciate a starting point and perhaps some good resources that I could explore.
Jim, thank you for this. It is absolutely the most frequently asked question we hear at our program in Toronto to help social entrepreneurs from those with “a really great idea”. Can you please advise how we would go about getting permission to “Canadianize” this work? We think that with some minor modifications it would be very useful to our clients. Please note, our program Social Innovation Generation (SiG) at MaRS is a non-profit, charitable organization and our programs are provided free of charge as currently this program is funded by the Province of Ontario.
Thanks,
Allyson .(JavaScript must be enabled to view this email address)
Thanks for the great article on this important topic! REDF published a paper on this topic a few years back called “If the Shoe Fits: Nonprofit or For-Profit? The Choice Matters” - readers might be interested in checking that out as well. It also includes a tool to help organizations determine their best fit.
‘This is not merely a matter of a “third sector”, but of a broad new composite reality embracing the private and public spheres, one which does not exclude profit, but instead considers it a means for achieving human and social ends. Whether such companies distribute dividends or not, whether their juridical structure corresponds to one or other of the established forms, becomes secondary in relation to their willingness to view profit as a means of achieving the goal of a more humane market and society’
From the 2009 Papal encyclical, Caritas in Veritate.
Here also, in the context of the profit for purpose approach to social innovation:
Thanks a lot for that highly informative article, especially for us who are in the NGO sector, with intentions to transform and change lives of the communities.However, we in the developing world especially in Africa, we are appreciative for the way you have given us the tips on how to run our organisations.
Our question is how can the NGO’s in America assist us in Africa, where we are grapling with financial inadequecy? How can they assist our organisations in the ares of funding.
Thanks a lot
Regards
Shalom Muwanguzi Nyenje
Chairman/ President/Founder
Shalom Evangelical and Prison Outreach Ministries [SEPRIMI]
P.O. BOX 10055 KAMPALA- UGANDA
Tel; 256 754 530900, 778 171 235.
Email:seprimi@hotmail.com
I am very impressed with the article as it contained useful information about business structures and the tax advantages. However as a new L3C, I was very surprised that many of the companies I wrote to obtain grants were hesitant to provide any funding despite the fact that an L3C bridges the gap between for-profits and non-profit business to obtain social chances. Could it be that many of the foundations have not had a chance to review the tax laws related to investing in L3C’s, or are they not clear on the PRI’s?
Please advise!
Thanks!
Hey, everybody! Thanks for all the great feedback, sorry to be slow on closing the loop. I had no idea there were all these comments!
My first point is simply, IANAL (I am not a lawyer). So, to get real legal answers, ask a real lawyer. My goal is to provide a practitioner’s point of view.
1. Eric on S status. It’s hard to give enough information to really get a handle on where your lawyer is going. If you really believe that your company is going to make real money, being a for-profit is a good option. But, I don’t hear S Corporations so much these days as LLCs for closely held for-profits. And, venture capitalists don’t like S/LLC corporate forms: they want traditional C corporations. But, if you think that your venture will lose money up front and someday maybe break-even, that sounds like a charity model (because you won’t get the original investment back).
2. Francois: I like the continuum idea (a lot)!
3. Todd: maybe a refresh after the flexible benefit corporation gets enacted in California?
4. Jon and Joe: if you can make money at it for investors, being a for-profit is probably the best option. The advantages you cite are substantial.
5. Matthew on brand licensing. Sounds like a conversation you need to have with a lawyer. I’ve read articles on this issue in the past (but couldn’t find one quickly), so you’re not the only one who is asking. But, it has real challenges.
Let me see if this posts: hasn’t worked quite yet.
6. Allyson. I think that these issues face social enterprisers in most countries, although most countries don’t offer the range of options present in the U.S. with our state-centric approach to corporate forms (although an innovation like the LLC or now L3C does get replicated). The problem I’ve heard from SEs in other countries is that charities can’t operate enterprises in their country. So, you end up with a less tax advantaged structure. But, I don’t know enough about Canadian structures to comment intelligently.
7. Jill on the “if the Shoe Fits.” I enjoyed that article, and especially the questionnaire approach with scoring. One message that I detected (and perhaps it doesn’t come across to others) was the “if you really care, you’ll be a nonprofit.” I don’t agree: if you really care about social good, you’ll pick the form that will lead to the most social good.
8. Nichole on deductibility of donations. Only your accountant knows for sure, IANAL, IANAA, but in general in the U.S., only donations to 501c3 organizations are deductible for individuals from their federal income tax returns.
9. The Pope seems to be on our side on this one!
10. Shalom, Shalom. This is less about corporate form choice and more about international cooperation among social entrepreneurs. At my organization, Benetech, we do almost all of our work in partnership with local or national groups. It’s clear that both we and our partners need money to operate, and in many of our grant applications we’re applying on behalf of Benetech and our partners. And, often our partners do the same. Generally, we do better with American donors, and our partners in the global South do better with European donors. And when revenue is involved, we often have similar split conversations.
11. Sheree on the L3C. I think you’ve put your finger on the issue with the L3C. The number one advantage of the L3C is that it makes a strong statement that the purpose should meet the test for a PRI from a foundation (there are critics who argue it doesn’t do much for this, but let’s assume they’re wrong). OK, so now you’re an L3C: where is all the PRI money? Well, the fact is, there isn’t that much PRI money. And, the existence of the L3C is not causing foundations that traditionally did few (or no) PRIs to suddenly become fountains of PRI money. Personally, I probably wouldn’t start an L3C unless I had a foundation on the hook to fund it with a PRI beforehand. Just starting an L3C doesn’t create funding, just like starting a 501c3 doesn’t create a donation funding stream.
As a Design Management student at Parsons The New School For Design. I can understand all the legal/ethical issues that arise from deciding to wether be registered as a profit or non-profit. This article is very clean, and on point with what factors one should consider. As for myself i’m interested in creating social change through events//music, and think I would lean more towards a for-profit venture. A for-profit venture, just in a way I feel can encompass to appeal to the masses, as with non-profits it might not work, think a for-proift venture is more flexible, and less hassle to have to keep corresponding to the codes of what constitutes a non-profit.—I’m more interested in creating ephemeral experiences that bring money, to raise awareness towards social change, that’s what I would use the money for, to appeal to people who have more money.
Thank you so much for this informative and helpful article. We will begin distributing this to students in our course on social enterprise to help them better understand how the non-profit sector operates.
Thank you Jim for answering all my questions. In my research on this topic, I ran into bcorporation.net, an alliance that helps for-profits “use the power of business to solve social and environmental problems”. To apply you must meet their impact standards, and a questionnaire can be taken online.
This is a clear and informative article. I worked till recently with training and placing underprivileged rural and tribal youth in organised sector jobs. Now, in a pioneering fashion, I focus on doing the same with disabled youth. The work is challenging and transformational and gives us great joy. I am transiting from being the head of an organisation to setting up my own . So I have, in the last week, been weighing the advantages of for-profit and non-profit formats in India. ....Thanks
Hi Jim, Interesting piece. I am a potential social entrepreneur, exploring ideas and models to set up a venture; in the media training space/ development space. This is very useful.
This info is so dated. I believe an L3C is the hybrid of choice for any social justice venture. Even though not all states have adopted this organizational form, most states that have (legislated the L3C) also have provisions for out-of-state or “foreign” incorporation.
I disagree, Nancy, that the L3C is the hybrid of choice for any or even most social ventures. It was established primarily to make it easier for a private foundation to make a program related investment in an LLC. I think this is a pretty narrow opportunity for most social enterprises (translation: most social enterprises will never get this kind of funding). What is it about L3C that you feel is superior to other forms and why?
Thanks to the folks who I attended my webinar today. Look forward to answering any questions you had that didn’t get answered. I’ll check in periodically and respond if I can help!
Quite informative and self explanatory. I am mentoring Non Profits since last two decades in India. The mentorship include; formulation, development (Legal, Admnistartive, Technical, & Financil - LATF), fund mobilization, monitoring & evaluation. I am happy with Non profits and in some cases adding the for profit to work together for achieving SOCIAL CHANGE effectively & efficiently with better SUSTAINABILITY.
COMMENTS
BY Eric Hellman
ON February 23, 2011 09:55 PM
In consulting with my lawyer, he pointed out that for a speculative venture with a public purpose that will incur losses to start out (such as mine), it might be difficult to convince the IRS that the venture is really a non-profit eligible for non-profit status. To ensure tax-deductibility, he advised using for-profit S-corp status, making it easy to deduct early stage losses. Does this sound reasonable?
BY Francois Couillard
ON March 3, 2011 06:04 AM
Thanks for a very thorough review. Many would-be social entrepreneurs are confused about what constitutes the right model and your many examples will be very helpful. For a high-level, conceptual model, your readers might be interested in this simple model http://www.strategies-direction.com/?p=154 .
BY R. Todd Johnson
ON March 3, 2011 01:07 PM
Way to go, Jim! As usual, you nail it!
For those who are interested in purusing options 1 and 2, there are ways to anchor mission, protect directors, provide for greater transparency, avoid the investor control issues, raise money in the capital markets, and stay pure to the social mission (and even do it at the “bottom of the pyramid” without surrendering too much for taxes along the way. These structures are a bit complicated and involve bending the arc of traditional forms, but are certainly worth the time of an entrepreneur to consider.
Perhaps another article?
BY Jon Carson, CEO, BiddingForGood
ON March 3, 2011 01:41 PM
I have started several for profict social enterprises (FamilyEducation Netwrok, BiddingForGood) and have found there are three main advantages to for-profit model;
1. access to capital. there is way more investor capital than grant capital. Furthermore, most non-profit funding sources only want to back pilost but are not interested in scaling. This is where the for profit model has much bigger advantages
2. ability to attract talent; with stock options and higher liveable wages the pool of mgmt candidates is just bigger
3. market discipline; with for profit model you just HAVE to deliver value or folks wont pay up.
I’ve returned several hundred million to investyors so have found it easier and easier over time to attract capital (recycling escrow payments).
For what it’s worth.
BY Joe Hunt, Managing Director, Workforce Enterprises
ON March 4, 2011 01:03 PM
This was a great article, and I appreciate Jon’s contributions as well.
Here’s our rationale. We’ve chosen the for-profit model simply because I wanted to focus my activities on meeting our social and profit goals. It was my observation while working with nonprofits that the executives were forced to spend too much time meeting requirements of government agencies and funders that diverted them from, what I believed to be, more productive use of their time. I am also much more comfortable knowing that I am responsible for producing the revenue necessary to scale my business.
We may ultimately convert to a hybrid to ensure that when we retire or sell the business,we are assured the continuation of its social component.
BY Matthew
ON March 4, 2011 08:02 PM
I have a question related to this terrific article that I hope someone can shed some light on. My question pertains to an arrangement wherein a 501(c)3, seeking a sustained and dedicated source of revenue, enters into a business arrangement with a for-profit entity. I am particularly interested in an arrangement wherein the not-for-profit sells its “brand” and all goodwill associated with it, in exchange for a pre-determined percentage of future revenue made by the for-profit. When I talk about a nonprofit “selling its brand/goodwill” what I’m getting at is essentially an exlusive and permanent IP licensing agreement. The end product of this arrangement would find the non-profit still in charge of its operations and still able to seek outside donations, with the only difference being that it would have a consistent stream of revenue from the for-profit entity. The private entity would be able to exclusively use the nonprofit’s brand (e.g. TMs, copyrights) as a source of revenue. In consideration for the purchase of the brand, the private entity would guarantee, let’s say 10% of profits, to the not-for-profit.
I am curious as to whether you know of any other examples of this type of arrangement. I am not looking for you to answer this questions in detail, but I would greatly appreciate a starting point and perhaps some good resources that I could explore.
BY Allyson Hewitt
ON March 6, 2011 07:04 AM
Jim, thank you for this. It is absolutely the most frequently asked question we hear at our program in Toronto to help social entrepreneurs from those with “a really great idea”. Can you please advise how we would go about getting permission to “Canadianize” this work? We think that with some minor modifications it would be very useful to our clients. Please note, our program Social Innovation Generation (SiG) at MaRS is a non-profit, charitable organization and our programs are provided free of charge as currently this program is funded by the Province of Ontario.
Thanks,
Allyson
.(JavaScript must be enabled to view this email address)
BY Jill Niehuser
ON March 7, 2011 11:48 AM
Thanks for the great article on this important topic! REDF published a paper on this topic a few years back called “If the Shoe Fits: Nonprofit or For-Profit? The Choice Matters” - readers might be interested in checking that out as well. It also includes a tool to help organizations determine their best fit.
http://www.redf.org/learn-from-redf/publications/123
BY Nichole Slabach
ON March 8, 2011 06:29 AM
Are donations made to a “For-Profit with a Social Overlay” considered tax deductible as they are with a 501(c)(3) company/charity?
BY Jeff Mowatt
ON March 8, 2011 12:31 PM
‘This is not merely a matter of a “third sector”, but of a broad new composite reality embracing the private and public spheres, one which does not exclude profit, but instead considers it a means for achieving human and social ends. Whether such companies distribute dividends or not, whether their juridical structure corresponds to one or other of the established forms, becomes secondary in relation to their willingness to view profit as a means of achieving the goal of a more humane market and society’
From the 2009 Papal encyclical, Caritas in Veritate.
Here also, in the context of the profit for purpose approach to social innovation:
http://socialbusiness.socialgo.com/magazine/read/you-me-we-ethics-and-people-centered-economics_5.html
BY Reverend Shalom Muwanguzi Nyenje
ON March 12, 2011 05:19 AM
Thanks a lot for that highly informative article, especially for us who are in the NGO sector, with intentions to transform and change lives of the communities.However, we in the developing world especially in Africa, we are appreciative for the way you have given us the tips on how to run our organisations.
Our question is how can the NGO’s in America assist us in Africa, where we are grapling with financial inadequecy? How can they assist our organisations in the ares of funding.
Thanks a lot
Regards
Shalom Muwanguzi Nyenje
Chairman/ President/Founder
Shalom Evangelical and Prison Outreach Ministries [SEPRIMI]
P.O. BOX 10055 KAMPALA- UGANDA
Tel; 256 754 530900, 778 171 235.
Email:seprimi@hotmail.com
BY Sheree McLaughlin
ON March 12, 2011 10:38 AM
I am very impressed with the article as it contained useful information about business structures and the tax advantages. However as a new L3C, I was very surprised that many of the companies I wrote to obtain grants were hesitant to provide any funding despite the fact that an L3C bridges the gap between for-profits and non-profit business to obtain social chances. Could it be that many of the foundations have not had a chance to review the tax laws related to investing in L3C’s, or are they not clear on the PRI’s?
Please advise!
Thanks!
BY Jim Fruchterman, Benetech
ON March 26, 2011 03:54 PM
Hey, everybody! Thanks for all the great feedback, sorry to be slow on closing the loop. I had no idea there were all these comments!
My first point is simply, IANAL (I am not a lawyer). So, to get real legal answers, ask a real lawyer. My goal is to provide a practitioner’s point of view.
1. Eric on S status. It’s hard to give enough information to really get a handle on where your lawyer is going. If you really believe that your company is going to make real money, being a for-profit is a good option. But, I don’t hear S Corporations so much these days as LLCs for closely held for-profits. And, venture capitalists don’t like S/LLC corporate forms: they want traditional C corporations. But, if you think that your venture will lose money up front and someday maybe break-even, that sounds like a charity model (because you won’t get the original investment back).
2. Francois: I like the continuum idea (a lot)!
3. Todd: maybe a refresh after the flexible benefit corporation gets enacted in California?
4. Jon and Joe: if you can make money at it for investors, being a for-profit is probably the best option. The advantages you cite are substantial.
5. Matthew on brand licensing. Sounds like a conversation you need to have with a lawyer. I’ve read articles on this issue in the past (but couldn’t find one quickly), so you’re not the only one who is asking. But, it has real challenges.
Let me see if this posts: hasn’t worked quite yet.
BY Jim Fruchterman, Benetech
ON March 26, 2011 04:13 PM
And to continue!
6. Allyson. I think that these issues face social enterprisers in most countries, although most countries don’t offer the range of options present in the U.S. with our state-centric approach to corporate forms (although an innovation like the LLC or now L3C does get replicated). The problem I’ve heard from SEs in other countries is that charities can’t operate enterprises in their country. So, you end up with a less tax advantaged structure. But, I don’t know enough about Canadian structures to comment intelligently.
7. Jill on the “if the Shoe Fits.” I enjoyed that article, and especially the questionnaire approach with scoring. One message that I detected (and perhaps it doesn’t come across to others) was the “if you really care, you’ll be a nonprofit.” I don’t agree: if you really care about social good, you’ll pick the form that will lead to the most social good.
8. Nichole on deductibility of donations. Only your accountant knows for sure, IANAL, IANAA, but in general in the U.S., only donations to 501c3 organizations are deductible for individuals from their federal income tax returns.
9. The Pope seems to be on our side on this one!
10. Shalom, Shalom. This is less about corporate form choice and more about international cooperation among social entrepreneurs. At my organization, Benetech, we do almost all of our work in partnership with local or national groups. It’s clear that both we and our partners need money to operate, and in many of our grant applications we’re applying on behalf of Benetech and our partners. And, often our partners do the same. Generally, we do better with American donors, and our partners in the global South do better with European donors. And when revenue is involved, we often have similar split conversations.
11. Sheree on the L3C. I think you’ve put your finger on the issue with the L3C. The number one advantage of the L3C is that it makes a strong statement that the purpose should meet the test for a PRI from a foundation (there are critics who argue it doesn’t do much for this, but let’s assume they’re wrong). OK, so now you’re an L3C: where is all the PRI money? Well, the fact is, there isn’t that much PRI money. And, the existence of the L3C is not causing foundations that traditionally did few (or no) PRIs to suddenly become fountains of PRI money. Personally, I probably wouldn’t start an L3C unless I had a foundation on the hook to fund it with a PRI beforehand. Just starting an L3C doesn’t create funding, just like starting a 501c3 doesn’t create a donation funding stream.
Thanks for your patience: this has been great!!
BY sindy v
ON April 16, 2011 11:18 AM
As a Design Management student at Parsons The New School For Design. I can understand all the legal/ethical issues that arise from deciding to wether be registered as a profit or non-profit. This article is very clean, and on point with what factors one should consider. As for myself i’m interested in creating social change through events//music, and think I would lean more towards a for-profit venture. A for-profit venture, just in a way I feel can encompass to appeal to the masses, as with non-profits it might not work, think a for-proift venture is more flexible, and less hassle to have to keep corresponding to the codes of what constitutes a non-profit.—I’m more interested in creating ephemeral experiences that bring money, to raise awareness towards social change, that’s what I would use the money for, to appeal to people who have more money.
BY Neil
ON April 17, 2011 11:06 PM
Thank you so much for this informative and helpful article. We will begin distributing this to students in our course on social enterprise to help them better understand how the non-profit sector operates.
BY lisa sandbank
ON May 24, 2011 12:11 PM
Thank you Jim for answering all my questions. In my research on this topic, I ran into bcorporation.net, an alliance that helps for-profits “use the power of business to solve social and environmental problems”. To apply you must meet their impact standards, and a questionnaire can be taken online.
BY Jim Fruchterman, Benetech
ON May 30, 2011 01:26 PM
Glad to hear this has been helpful to people. Looking forward to working with the SSIR team to revisit this in the fall: it’s a perennial issue!
BY Meera Shenoy Youth4Jobs Foundation
ON July 7, 2011 06:25 AM
Jim,
This is a clear and informative article. I worked till recently with training and placing underprivileged rural and tribal youth in organised sector jobs. Now, in a pioneering fashion, I focus on doing the same with disabled youth. The work is challenging and transformational and gives us great joy. I am transiting from being the head of an organisation to setting up my own . So I have, in the last week, been weighing the advantages of for-profit and non-profit formats in India. ....Thanks
BY Sabith khan
ON July 21, 2011 02:11 PM
Hi Jim, Interesting piece. I am a potential social entrepreneur, exploring ideas and models to set up a venture; in the media training space/ development space. This is very useful.
regards
Sabith khan
Syracuse, NY
BY Nancy
ON August 18, 2011 03:17 PM
This info is so dated. I believe an L3C is the hybrid of choice for any social justice venture. Even though not all states have adopted this organizational form, most states that have (legislated the L3C) also have provisions for out-of-state or “foreign” incorporation.
BY Jim Fruchterman, Benetech
ON August 23, 2011 05:53 PM
I disagree, Nancy, that the L3C is the hybrid of choice for any or even most social ventures. It was established primarily to make it easier for a private foundation to make a program related investment in an LLC. I think this is a pretty narrow opportunity for most social enterprises (translation: most social enterprises will never get this kind of funding). What is it about L3C that you feel is superior to other forms and why?
BY Jim Fruchterman, Benetech
ON September 22, 2011 04:58 PM
Thanks to the folks who I attended my webinar today. Look forward to answering any questions you had that didn’t get answered. I’ll check in periodically and respond if I can help!
BY Patrick J. Fischer
ON January 21, 2016 04:45 AM
Thank you for sharing Jim!
BY LAKSHMI NARAYANA NAGISETTY
ON August 31, 2020 10:37 PM
Quite informative and self explanatory. I am mentoring Non Profits since last two decades in India. The mentorship include; formulation, development (Legal, Admnistartive, Technical, & Financil - LATF), fund mobilization, monitoring & evaluation. I am happy with Non profits and in some cases adding the for profit to work together for achieving SOCIAL CHANGE effectively & efficiently with better SUSTAINABILITY.