Structuring and Defining Social Enterprise

This article draws upon research conducted by Anna Triponel and Natalia Agapitova for the Social Enterprise Innovations Program, Leadership, Learning and Innovation Vice Presidency of the World Bank Group. See Triponel, Anna; Agapitova, Natalia. 2017. Legal Frameworks for Social Enterprise : Lessons from a Comparative Study of Italy, Malaysia, South Korea, United Kingdom, and United States. World Bank, Washington, DC. © World Bank. https://openknowledge.worldbank.org/handle/10986/26397 License: CC BY 3.0 IGO

Introduction

Social enterprises (SE) typically draw upon a range of laws to govern their creation, day-to-day management, tax arrangements and dissolution. In particular, business law can offer corporate structures that attract capital from the private sector; and non-profit law can provide structures that promote charitable interests while benefiting from tax advantages. At the same time, founders of social enterprise typically face difficulties when working within the confines of traditional laws: business law can inhibit the enterprise’s ability to prioritize a social mission over the interests of shareholders, while non-profit law can hinder the use of enterprise and restrict access to private sector financing.

Indeed, social enterprise sits at the inter-section of the for-profit and non-profit sectors, and it performs best when it benefits from a tailored legal framework. Policy makers seeking to encourage social enterprise are therefore faced with the following question:

What is an appropriate legal framework to encourage social enterprise in a particular country?

 In particular, should government seek to define social enterprise, or leave the definition to academics, practitioners and other commentators? Should government create specific structures (i.e., legal forms) for social enterprise, or leave it to social entrepreneurs to tailor existing legal forms to suit their needs?

A range of different approaches exist. A country can:

  • not define social enterprise, and leave it to social entrepreneurs to adapt pre-existing structures to social enterprise (e.g., Malaysia);
  • not define social enterprise, while creating a range of legal forms that can be used for social enterprise (e.g., U.S.);
  • adopt a working definition of social enterprise (which is adopted by the executive branch) and complement this working definition with a legal form specifically created for social enterprise (e.g., UK); or
  • adopt a legal definition of social enterprise (which is adopted by the legislative branch) and complement this with a legal form that can be used for social enterprise (e.g., Italy, South Korea).

The preferred approach for each country will inevitably be country-driven and depend on a wide range of factors. For instance, a legally defined approach to social enterprise which enables entities that have been certified as social enterprise to benefit from support may be suitable for Italy but not for the U.S. Nonetheless, it is possible to extract some key lessons learned from these different approaches that can be helpful to policy makers moving forward in this field.

Defining social enterprise

Questions that can be helpful for policy makers to consider when considering defining social enterprise are:

Questions to Consider Comments
Should the government seek to adopt a legal definition of social enterprise? Adopting a legal definition allows for a rigorous parliamentary debate on a country’s specific approach to social enterprise. It further provides clarity to founders of social enterprise of what is expected for them to qualify as social enterprises. This in turn can provide comfort to stakeholders, including investors and governmental actors, of the entity’s social mission. The adoption of a legal definition in South Korea allowed for a dynamic discussion on the elements to draw from in the American, UK and continental European approaches to social enterprise. The result is a model which is heavily influenced by the UK and Italy, but with some elements from the U.S. approach.

At the same time, legal definitions can add a layer of formality and administration that may hinder social enterprise. An entity can miss out on valuable support if it is pursuing a worthwhile activity which may not meet the specific components of the legal definition. In Italy, the social cooperative, a legal form created in 1991, does not automatically meet the legal definition for social enterprise adopted in 2006, and yet remains significantly more popular for social enterprise activities than entities that are registered as social enterprises with the government.

Should the government seek to adopt a working definition of social enterprise? A working definition provides similar advantages to a legal definition. In addition, since a parliamentary revision process is not required, it can more easily evolve over time to encompass features that were not envisioned at the outset. A number of changes have been made over time by the UK’s Department for Business, Innovation & Skills (BIS) to its working definition of social enterprise. A social enterprise can now be a business with primarily environmental objectives (in addition to a business with primarily social objectives) and 75% or more of turnover of social enterprises must now be derived from trading (as opposed to 25% previously).
Should the government not seek to define social enterprise? Where countries choose not to offer a legal or working definition, it can be difficult for social enterprise founders to describe what they are seeking to achieve. This in turn can hinder financial and governmental support to social enterprise and pushes founders to look elsewhere for inspiration. This phenomenon has been reported in Malaysia where social enterprises are finding it difficult to get assistance and are increasingly resorting to an external definition of social enterprise, that adopted in the UK, to explain their activities publicly.

At the same time, governments that choose not to define social enterprise can still stimulate social enterprise through the creation of legal forms that are appropriate for social enterprise. In this context, the components of the legal form demonstrate in practice what is viewed as important for that state. For instance, the legal forms of benefit corporations and social purpose corporations have been created by U.S. state legislatures to enable companies to prioritize a social mission over shareholder wealth.

Where policy makers decide to adopt a definition of social enterprise, decisions will need to be reached on a wide range of factors, including how to define the purpose of the social enterprise; the extent to which it can distribute dividends to shareholders; the nature of its economic activity; whether the entity’s assets should be protected for its social mission in the form of an asset lock; and whether some form of transparency and stakeholder participation in governance should be mandated.

Structuring social enterprise

A number of different legal forms can be used for social enterprise, ranging from companies and partnerships to cooperatives and charities. Similarly, where governments have defined social enterprise, any legal form can typically be used for social enterprise, so long as it can be tailored to meet the needs of social enterprise.

At the same time, country experience demonstrates that creating a specific legal form that is adapted to the needs of social enterprise provides two clear advantages:

  • It enables the country to respond to the specific challenges faced by social enterprise in that country. In the U.S., the creation of new legal forms was driven by the need to enable those governing the entity to consider the social/ environmental mission alongside the need for shareholder returns. In the UK, it was driven by the need to ensure that the owners could not privatize the social enterprise and gain from assets originally intended for the social purpose (i.e., the need to lock up the entity’s assets). In Italy and South Korea, there was a need to enable non-profits and social cooperatives to benefit from enhanced flexibility to pursue social enterprise missions; and
  • It removes the complexity of seeking to adapt pre-existing forms to social enterprise. This helps provide comfort to founders of social enterprise that they do indeed qualify as social enterprise and helps them to attract ‘patient capital’ (whereby shareholders are rewarded for investing in social enterprise with some limited dividends). In the UK, there has been rapid uptake in the legal form created for social enterprise, the Community Interest Companies (CICs). Although the government initially estimated it would register 200 CICs a year, it registered its 10,000th CIC in November 2014 and 268 CICs were created in the month of April 2016 alone. A number of changes have been made to the CIC to assist in attracting additional private sector financing.

Questions that can be helpful for policy makers to consider when considering the creation of new legal forms for social enterprise are:

Questions to Consider Comments
Which form should this new legal form follow? Legal forms for social enterprise tend to be companies although this is not necessarily the case. The UK CIC is a company and the Italian social cooperative relies on the company form (whether public or private). In contrast, the South Korean legal form is a non-profit form which reflects the history of civil society organizations adopting a more market-oriented approach to providing services.
Should the purpose of the legal form be clearly defined or left open? Governments can decide to clearly define the category of activities within which this legal form can operate (as in South Korea and Italy) or provide for a more general purpose.
Should this new legal form clarify the responsibilities of those governing the entity? This has proven particularly helpful where social enterprises have faced threats of lawsuits by shareholders. In the U.S., shareholders of special purpose corporations and benefit corporations cannot expect the same fiduciary duty of directors as of directors of traditional corporations. In the UK, the CIC Regulator is empowered to act where he/she deems that the CIC has not adequately prioritized community interests.
Should this legal form allow for specific accountability provisions in the event the social mission is not prioritized? Legal forms based on company forms tend not to provide direct recourse to stakeholders who may wish to contest director decisions. One example, however, is in the U.S. benefit corporation where the company can bring a ‘benefit enforcement proceeding’ against a director or officer to ensure furtherance of the general public benefit.
Should this legal form require specific participatory governance? Participatory governance tends to be encouraged, although not technically required. The South Korean social cooperative however provides for participatory governance.
Should this legal form have a specific oversight mechanism? The legal form can benefit from a specific regulator or be subject to the authority of the relevant business authority as for any other company. A UK CIC Regulator, which sits within BIS, oversees CICs to maintain integrity in the CIC brand.
Should the distribution of dividends be restricted and if so, how? Governments may or may not choose to cap the dividends that can be transferred to shareholders. This is the case in Italy. This was the case in the UK before 2014, although the maximum aggregate dividend cap remains. The Italian social co-operative allows dividends to be distributed, with a cap on the maximum amount of dividends payable. (This is in contrast to the Italian legal definition of social enterprise which prohibits the distribution of profits.) UK CICs are unable to distribute over 35% of their profits as dividends, ensuring that 65% of the profits are reinvested back into the community or used for the community it is serving.
What kind of transparency with regard to the entity’s mission should be prescribed? Governments typically require some form of transparency with regard to the social mission involved. For instance, the U.S. benefit corporation has to produce a report of social and environmental performance assessed against a third party standard.

Conclusion

Legal frameworks have a critical role to play to support the creation, effectiveness and sustainability of social enterprise. The crafting of a working definition that is generally accepted by government, social enterprises and commentators in a particular country has proven helpful to stimulate the growth of the sector. This growth can be further encouraged if the country offers a tailored legal form designed to respond to the specific challenges faced by social enterprise. This can be combined with other changes to a country’s legal framework, such as encouraging government procurement from social enterprises and creating tax incentives for investors financing social enterprise.

 

 

 

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