Social Enterprise Legal Entity Choice

People who are starting a social enterprise sometimes ask if there is some special legal entity for social enterprises.

Their past experience in a nonprofit has left them disenchanted, and they want to do something different, and they also do not want to become an extractive for-profit corporation that is so profit-driven that it is willing to engage in harmful behavior.

So they wonder if there is something else.

There is no single “social enterprise” legal entity. Social enterprises choose one or more of the available legal entities under state law, and these are: cooperative, benefit corporation, general business corporation, limited liability company, low-profit limited liability company, or non-profit corporation. (Cooperatives can include general cooperative corporation, agricultural cooperative corporation, and limited cooperative association. Illinois has a limited worker cooperative association.) The choice among these depends on which goal is most important to you.

A cooperative prioritizes shared ownership. Cooperatives are owned and democratically governed by their members, and members are people who do some kind of business with the cooperative. Members share in profits or savings in proportion to their relative quantity or value of business done with the cooperative (their "patronage"). This could mean that workers democratically govern their workplace and share in profits on the basis of how much they worked. Or it could mean that all customers or users have a vote, and net income is returned to customers as a refund. Co-op founders often have the attitude that member ownership puts the entity in a right relationship with its workers, producers, customers, or users, and this is deeper and more important than being a benefit corporation.

A benefit corporation prioritizes the commitment to creating a social benefit or reducing a harm, and to being accountable for trying to create that benefit or reduce that harm. The legal meaning of a benefit corporation is that directors have a duty to consider many factors such as creating the benefit, and doing good rather than harm to employees, the community, the environment, etc. Directors are not supposed to make decisions based only on financial gain, and they are not liable to shareholders for making decisions in which the goal of creating profit is balanced against the attempt to do good. (Cooperatives are certainly also allowed to, and do, make decisions with the interests of workers, customers, the community, and the environment, in mind.)

The limited liability company (LLC) is a general-purpose, flexible entity. The financial and governance rights of owners can be customized in the operating agreement. An LLC can be a good fit for any profit-generating enterprise that has a small number of owners, or that wants customized ownership and financial rights that don’t fit corporate law requirements. An LLC is often used for small worker cooperatives.

Note: There is generally little harm done if a start-up founder forms their own LLC to start. The downside is the cost of having a partnership tax return prepared, and legal fees to convert to a corporation later if necessary. In contrast, if a founder starts forms their own corporation, and if the corporation has assets, you cannot "go back to" pass-through tax status without the assets being deemed distributed to owners for tax purposes.

A non-profit prioritizes being able to receive grants, if it has a charitable purpose and applies for charitable tax status with the IRS on Form 1023. Charitable organizations can pay salaries to employees, but cannot pay dividends or share profits with anyone. If receiving tax-deductible grants is most important, and if there is no need to distribute profits above salaries, then consider a non-profit corporation.

Let’s boil it down: Is receiving charitable gifts and grants important? If yes - consider a non-profit. If no, will you have a founder-owned company that is committed to creating a benefit, and willing to back up that commitment with public reports? That sounds like a benefit corporation. Or, will you have a worker-owned entity where all workers have a path to membership and share profit on the basis of how much they work? That is a worker cooperative. Or is this a cooperative to be owned by customers, or producers?  That is a consumer co-op or an agricultural co-op. Or maybe a general-purpose legal entity does the job, and you can carry on your social enterprise with your trusted business partners using an LLC or corporation.

There are layers of detail that don’t fit into a short blog post, so if you would like to discuss legal entity choice for a social enterprise, feel free to reach out.

This is general information, not legal advice.