Social Impact Organizations: Form and Function
Commonly referred to as Business with Social Purpose, Social Enterprise, Social Innovation, Business for Social Good, B Corp or Benefit Corporation
When clients ask me about any of the terms above, they are typically envisioning an organization using commercial strategies to address a public need or create a public benefit.
Often these businesses hold corporate social responsibility as part of the core of their operation. Wanting to avoid fundraising challenges associated with philanthropy and restrictions on tax exempt business activities, many don’t want to organize as a nonprofit. Typically the business plan contemplates sustainable, income generating, and profit driven business activities, which will then fund social purpose activities in some respect. TOMS shoes has inspired many of these plans.
In recent years, advocates have worked with state legislatures to create a new business organization, a legal vehicle for a social purpose organizations, to clarify questions of law, including:
1) Is the sole purpose of business to generate shareholder profits?
2) Can businesses legally build in a broader range of stakeholder interests (its employees, customers, investors, supply chain, the environment, communities)?
3) Are there legal standards for corporate transparency?
4) How can businesses legally be held accountable to multiple stakeholders?
5) How can we legally protect social purpose businesses from un-likeminded corporate takeovers or changes in ownership?
These topics are trendy and sources of enormous entrepreneurial inspiration. I see a range of missions and strategies tested in this new for profit space. Many are focused on human or environmental well-being.
While a business with a social purpose can take any legal form, it’s common for founders to believe there is a way it must be done. I wish it were that simple. The choice often turns on the business plan, sources of capital, management, liability, tax, and other stakeholders.
Texas for profit social purpose organizations may choose to be a: 1) corporation, 2) limited liability company (the “LLC”), or 3) cooperative association. And there are other variations of business organizations suitable for social purpose organizations under other state laws.
Social Purpose For Profit Corporation
In 2013, Texas added social purposes into its corporations statute, the Business Organizations Code, authorizing a conventional C Corp to include a “social purpose.” In Texas:
"Social purposes" means one or more purposes of a for-profit corporation that are specified in the corporation's certificate of formation and consist of promoting one or more positive impacts on society or the environment or of minimizing one or more adverse impacts of the corporation's activities on society or the environment. Those impacts may include:
(A) providing low-income or underserved individuals or communities with beneficial products or services;
(B) promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business;
(C) preserving the environment;
(D) improving human health;
(E) promoting the arts, sciences, or advancement of knowledge;
(F) increasing the flow of capital to entities with a social purpose; and
(G) conferring any particular benefit on society or the environment."
At the time of the legislative amendment, Texas did consider the the model language drafted and proposed by B Lab, but elected to modify the Texas Business Organizations Code to allow for social purpose organizations within the existing corporations framework. Texas did not adopt the aspect of B Lab model language that requires the organization to be certified by B Lab.
Texas social purpose corporations are accountable to their stated business purpose and its directors are entitled to consider the social purposes. Texas social purpose corporations are not prevented from obtaining third party certifications, and could make an election to require it of themselves by embedding it in the corporation’s bylaws.
Since this is a new law, founders of social purpose corporations and their lawyers will not have established legal precedent to rely on as legal questions arise. It will be many years, if not decades, for this to develop. So it is currently unknown how Texas courts will address a stakeholder lawsuit against a founder. This space of legal uncertainty is not unique to Texas.
Limited Liability Company ("LLC")
The LLC is another corporate form that allows for a social purpose to be built into the organization. This can occur by private contract among the owners in the company's operating agreement.
There are many factors to consider when selecting whether to organize as a corporation or an LLC. An LLC is often chosen when there are just a few owners, or the founders are not seeking private equity investors.
Functionally, building a social purpose into the LLC would be similar to the for profit corporation. The LLC could elect for a third party certification but it is not required. Again, because this area of law is new, there is uncertainty as to what legal issues will arise and how they will be resolved in Texas courts.
Social enterprise often turns on how the founders define it. Cooperative associations are an interesting vehicle for organizing groups of people, whether it be workers, individuals within a common industry, or a group of buyers, to pool resources for a collective benefit. To me, Cooperative Associations fit the bill for social impact. They are fascinating to consider in planning for business succession when a retiring business owner may desire to "leave" the company to the employees.
A cooperative is authorized under Chapter 251 of the Texas Business Organizations Code for a broad range of purposes. Cooperatives may be nonprofit or for-profit corporations operating on a cooperative basis. The defining characteristic of a cooperative is its obligation to distribute net proceeds to its members.
Cooperative associations have a unique tax advantage in Texas in that they are exempt from the Texas Franchise taxes.
Perhaps a Tax Disadvantage
While for profit entities may receive some tax benefits for their charitable behavior, such as the charitable donation deduction, the IRS does not currently provide an equal amount of tax benefits for charitable behavior when performed by a for profit (social purpose or benefit corporation) as it does for a 501(c)(3).
Currently the IRS only recognizes for profit organizations for charitable contributions made by giving money to tax exempt organizations. The analysis is complicated and should be worked through with your financial advisor. For the sake of simplicity, bear in mind that generally, the IRS code views all activities of the corporation to be profit-maximizing, and that for a charitable contribution to be deductible it must be made as a gift, and not in exchange for any economic benefit. It's worthwhile to consider the impact of corporate tax on profits used on a social purpose. In addition to federal taxation, Texas corporations and LLCs are subject to the Texas Franchise Tax.
Here's a detailed academic article on benefits expenses published by William & Mary Law Review, Benefits Expenses: How the Benefit Corporation's Social Purpose Changes the Ordinary and Necessary. Jump to Section III for the federal tax policy discussion.
Other State Laws Exist
For now, we focused on Texas. We hope this cleared up some of the confusion about what is or is not allowed in Texas. We'd love to hear what you think, and what questions come to your mind. Please call or send us a note if you'd like to discuss them.
In a later post we'll discuss options under other state organizations laws.