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Incorporation 101 for the Social Enterprise

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There has been a great deal of discussion lately in the social enterprise community about how to legally structure an entity that combines social mission with profit-making activities. Traditionally, it was difficult to serve these two purposes in a single entity. An entrepreneur had the option to either create a nonprofit organization, which must be operated exclusively for charitable purposes and comply with limitations on commercial activity, or create a for-profit entity and risk losing sight of the social mission.

Recently, several states introduced new corporate forms, namely L3Cs, Benefit Corporations, and Flexible Purpose Corporations, each of which closely resembles a traditional for-profit entity, but is designed to legally allow for the pursuit of both social mission and profit-making. Social entrepreneurs are also increasingly creating joint venture arrangements between nonprofit and for-profit entities (see Allen Bromberger’s article A New Type of Hybrid ) which allows them to combine the best attributes of each type of entity.

Given the wide range of options and the impact that an entity’s legal structure will have on what it can legally do, it is crucial that key decisions regarding the entity’s goals, purposes, funding, management and operations be made before any decision is made as to legal structure. Ideally, incorporation should occur after you have completed your initial planning stage, but well before you need to have a legal entity capable of taking corporate action, such as opening a bank account, accepting a loan, or entering into a contract.

During the planning stage, analyze your business plan and determine your specific strategic imperatives—the things your enterprise needs to do to succeed. You should know where the initial and ongoing funding will come from. If you intend to rely on earned revenue for the bulk of your funding, a nonprofit organization may not be the right choice—even if you intend to put all of your profits back into the entity to increase your social impact—due to the restrictions on commercial activity. Nonprofits have the advantage of being able to accept tax-deductible donations from individuals, corporations, and foundations, and they can also raise capital through loans, but they cannot accept certain other types of funding, such as equity investments. If you are considering a for-profit or joint venture, be sure to discuss your legal structure with potential investors, as your investors may be restricted from investing in certain kinds of entities, due to the tax consequences or for other reasons.

You must also decide who will manage the entity and, in the case of a for-profit, the ownership structure. Develop a clear business plan that articulates your goals for creating social impact and achieving profitability, the steps you must take to accomplish these goals, and how you will know when you have succeeded. If you plan to start a nonprofit organization, make sure you have a clearly-defined charitable purpose, and that your entity is likely to qualify for tax-exempt status. However, at the moment, the IRS can take up to a year or more to process your application for tax-exempt status, so make sure you are absolutely certain that creating a nonprofit is the best way to accomplish your goals.  (See Allen Bromberger’s blog post Delays at the IRS.)

Once you have made these key decisions, a lawyer can help you select the best structure for your entity. The process to incorporate a legal entity is relatively straightforward—your lawyer will draft  Articles of Incorporation and file them with the Secretary of State. If you incorporate in a state other than your home state, you may need to file additional paperwork to qualify to do business in your home state. Depending on the state, this process can take anywhere from a few days to several weeks, so be sure to allow ample time.

The list of questions below is a guide to help ensure you’ve answered all the key questions during the planning process.

  1. Who are the founders?
  2. What is your social mission?
  3. What problem are you trying to solve?
  4. What impact do you want to have?
  5. What is your business plan and how will it address the problem you are trying solve?
  6. Is your organization likely to qualify for tax-exempt status?
  7. Where will you get your initial and ongoing funding?
  8. Who are your funders/investors/shareholders?
  9. Who are your beneficiaries/customers/stakeholders?
  10. Who will control and manage the organization?
  11. What are your personal and financial goals in starting this organization?
  12. How long do you intend the organization to exist and what are your goals for the end of its existence?

The answers to these questions will help you and your lawyer determine which structure is right for your organization. Taking the time to answer them before you incorporate will save you hours of time and hassle once your organization is up and running.


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