Hybrid Organizations Allow Entrepreneurs to Pursue Both Profit and Social Good

December 3, 2015

Can a business make money and make a difference?  During the holiday season, some may be considering how they can incorporate charitable goals into their lives and businesses all year long.  Historically, a dichotomy existed between nonprofit and for-profit corporations with little overlap.  For-profit corporations sought profit for shareholders while nonprofits sought to alleviate societal problems.  Today, a growing number of entrepreneurs and business owners want to use their businesses to pursue social benefits in their communities while turning a profit.  There are several options for those seeking to start a socially-conscious organization or pursue social goals with an existing business, each with its own benefits and drawbacks.

For those who want to pursue social objectives exclusively, a 501(c)(3) nonprofit corporation is the customary choice.  Organizing a nonprofit corporation under state law does not guarantee the entity will receive 501(c)(3) tax-exempt status under federal law.  Because 501(c)(3) organizations are limited in the types of activities they may pursue and cannot seek private profit or benefit specific individuals, a nonprofit 501(c)(3) may not be the best type of entity to achieve an organization’s goals.

The socially-minded businessperson who also wants to turn a profit has several options, including traditional business entities, benefit corporations, and low-profit LLCs.  Social objectives are permitted for traditional entity types at the discretion of the shareholders, members, or partners. For example, Mark Zuckerburg recently announced that he and his wife will utilize an LLC to pursue charitable purposes, funding the LLC with 99% of Zuckerburg’s Facebook shares.  Zuckerburg chose an LLC as opposed to a nonprofit corporation or foundation so that he could invest in for-profit companies, lobby for legislation, and influence public policy.  Among traditional entity forms, LLCs are typically preferred to corporations for social enterprises in order to avoid double taxation.  LLCs also provide greater flexibility to distribute profits to members.

However, a traditional business entity may not be the best option in some cases.  If some of the shareholders or members of an organization do not agree to pursue the social goals, or later change their minds, the dissenting shareholders may sue the corporation’s directors and managers for failing to act in the best interest (i.e., profit interest) of the shareholders.  A shareholder’s agreement or operating agreement can clarify and authorize directors or members to pursue social goals, but ownership may change and such agreements can stifle the entity’s ability to adapt in a changing economy.  Furthermore, while partnerships offer the most flexibility in governance and management and have the lowest start-up costs, such entities do not provide liability protection for partners and one partner’s decisions automatically bind the other partners.

In addition to utilizing traditional business entities as vehicles for social entrepreneurship, there are new business types that seek to combine the social motives of nonprofits with the profit goals of for-profits.  If a for profit business already exists, it may convert to one of the new entity types.  A benefit corporation, or b-corp, is one such option for businesses seeking to create recognition as a socially conscious company.  Well known examples of b-corps include Ben & Jerry’s, New Belgium Brewing, Etsy, and Patagonia.  Thirty-one states have enacted legislation to authorize b-corps.  B-corps typically have two additional obligations that for-profit corporations do not.  First, b-corps must have a material, positive impact on society and the environment.  Second, b-corps are required to report their social and environmental performance annually.  Companies electing to organize as a b-corp are attractive to consumers because it provides proof of the company’s commitment to social goals, especially as it becomes increasingly popular for companies to tout their products as sustainable, green, or otherwise socially conscious.  Similarly, while less common, a low-profit limited liability company, or L3C, is the LLC equivalent of the b-corp.  L3Cs may be attractive investments for for-profit investors and private foundations that are willing to accept a lower rate of return in exchange for the community benefits the L3C provides.  Although b-corps and L3Cs cannot currently be organized as Wisconsin entities, either type of entity may be organized in another state and registered in Wisconsin as a foreign entity.

Given the variety of options available, the decision to form an entity to provide social benefits should be thoroughly considered.  Each entity type has different strengths and weaknesses, and thoughtful evaluation of the goals of the entity will help ensure that the new organization is positioned to succeed.

If you have any questions about how the information in this article may affect you or your business, please contact Diana Eisenberg at deisenberg@stroudlaw.com or (608) 257‑2281 or your Stroud attorney.

DISCLAIMER: The information in this article is provided for general informational purposes only, is not necessarily updated to account for changes in the law, and should not be considered tax or legal advice.  This article is not intended to create, nor does the receipt of it constitute, an attorney-client relationship.  You should consult with your own legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.