NON-PROFIT, FOR-PROFIT VENTURES

Non-profit, For-profit Ventures 

U.S. law does not currently recognize any single legal entity that can simultaneously accept tax-deductible donated capital (charitable contributions and grants); invested capital (equity investment for which investors seek a market rate of return); and quasi-invested capital (such as loans or program-related investments [PRI] from foundations that are structured as investments but in which the funder has a strong philanthropic motive and neither expects nor demands a market rate of return). As a result, social entrepreneurs choose between for-profit and nonprofit models that require them to compromise their social vision and restrict their ability to finance and operate their ventures in a way that meets the founders’ own needs as well as those of their investors, customers, employees, and other stakeholders.

 

Hybrid Structures for Nonprofit and For-profit Business Models

Some entrepreneurs, however (especially the most intrepid ones), have found ways to combine the best of the for-profit and nonprofit models. They have done this by creating a hybrid structure: separate nonprofit and for-profit organizations that are bound together through governance or legal agreements. Hybrids, of course, are not new. They have been around for decades (consider Children’s Television Workshop, owners of the Sesame Street characters). For the most part, hybrids have been created by an existing nonprofit or for-profit to meet a new objective that could not be met under its existing legal structure. A for-profit corporation might create a nonprofit foundation to manage its philanthropic work. Or a nonprofit museum might create a for-profit retailer to sell posters, jewelry, and other merchandise.

The “Contract Hybrid” 

In recent years, however, social entrepreneurs have taken the hybrid model to a new level, crafting it into what is in effect a single structure that can operate as both a for-profit and a nonprofit. Social entrepreneurs are now creating complex hybrid structures from the start, ones that use contracts to intimately tie together nonprofit and for-profit organizations. I call these new entities “contract hybrids.”

Charitable Legal Structures and For-Profits with Social Missions

Creating a hybrid entity that can serve both charitable goals and business objectives simultaneously may sound simple, but from a legal perspective it is very complex. For-profit businesses have the pursuit of profit for the benefit of their owners as their primary objective. Directors and managers of a for-profit business have a fiduciary duty to maximize shareholder return, and if pursuit of a social mission interferes with that primary duty, the directors and officers can face legal jeopardy.

Nonprofits, on the other hand, have as their primary objective the accomplishment of a social or public mission. Nonprofit directors and managers must run the enterprise to further public rather than private interests. If they confer private benefits on individuals (other than reasonable compensation for services rendered, itself a touchy subject), they may face legal liability. And they generally cannot engage in profit-sharing arrangements with private investors or businesses. To put it another way, businesses and nonprofits are fundamentally single-purpose entities. Although the law allows them to stretch toward each other, a complete synthesis is not possible, and the further each model is stretched, the more legally uncertain the venture becomes.

 

B Corporations, B Lab, Benefit Corporations, and L3Cs

 

Three popular models are the B corporation, benefit corporation, and low-profit limited liability company (L3C). The B corporation is a brand, certified by B Lab (itself a nonprofit), rather than a legal form in the eyes of the IRS. To be certified a B corporation, the owners and managers of the organization voluntarily submit themselves to a rigorous battery of questions and tests that measure their commitment to social values and socially and environmentally responsible practices. B Lab makes the results of these tests public, so that consumers can find out what these companies stand for and how their claims of social responsibility are put into practice. B Lab promotes B corporations as a group, which gives them a marketing advantage and provides further incentive for them to justify social mission as a business strategy.

The benefit corporation, which is officially recognized in Maryland (and Vermont beginning April 2011) and is under consideration in several other states, is often confused with the B corporation but is actually distinct. Whereas the B corporation is essentially a brand, a benefit corporation is a legally distinct type of business corporation that is committed to accomplishing one or more social or public purposes. A benefit corporation must specify in its charter that it is formed to pursue a social purpose, it must have at least one “benefit” member on its board whose sole duty is to protect mission rather than profit, it must be certified by an independent third party as complying with standards promulgated by the certifying agency, and it must produce an annual report that explains what it has done during the prior year to accomplish its social mission. In return, the directors of the benefit corporation are protected from liability for decisions that further the social mission, even if they impair profitability.

The L3C, which has been legally recognized in several states and is under consideration in several others, is essentially a limited liability company (LLC) whose purpose is limited to “low profit” activities that further a charitable purpose, and the generation of income is not a significant purpose of the venture. The L3C was originally designed to be a special purpose vehicle to which private foundations could more easily make PRIs. Practitioners argue whether or not the L3C has any utility at all in this regard (because foundations can already make PRIs in for-profits), but the brand has caught on and many people now regard it as a way to signal their intent to place mission at a level that is equal to or greater than profit, while still enjoying the advantages of a business structure (the ability to accept private investment and enter into a broad range of business relationships). The B corporation, benefit corporation, and L3C do not qualify for tax-exempt status; they are all firmly in the for-profit sphere.

Collaborations Between Nonprofits and For-profit Companies

 

In the absence of a legal form specifically designed to allow the pursuit of mission and profit simultaneously, practitioners are often forced to create structures that combine for-profit and nonprofit entities in ways that allow each to do what it does best. The contract hybrid is one approach that has been specifically designed to overcome the obstacles that current law imposes on partnerships and collaborations between nonprofits and for-profits.

The contract hybrid can be complicated to create and maintain, and it will not work in all situations, particularly where the rules are difficult or impossible to follow. In situations where a nonprofit or a business can accomplish its goals without the need for a hybrid legal structure (for example, where a business can accomplish its social goals by making donations, or a charity can establish a business venture using a subsidiary that does not require outside investors), those approaches may be preferable.

The concepts and techniques that form the foundation of the contract hybrid are, however, well established in law, and a number of experienced lawyers have agreed that the contract hybrid is a useful approach. Done correctly, it can offer the opportunity for charities and businesses to do things that they cannot do independentaly. Although not the final answer, the contract hybrid represents an important step in the evolution of legal structures for social ventures.