On March 20, 2012, I attended "Doing Well & Doing Good: Hybrid Models for Social Impact," an event co-sponsored by the Foundation Center - San Francisco, UpStart Bay Area,the Hub Bay Area, the Social Enterprise Alliance San Francisco Bay Area Chapter, and the Stanford Social Innovation Review. Here is the introduction to the webcast event provided by the organizers:
The wall separating purpose from profit is a thing of the past, as entrepreneurs and investors build newer, more nuanced organizational models combining social impact with market mechanisms and returns.
Social entrepreneurs and their financial supporters – including social investors, foundations, and philanthropists – face a dizzying array of choices. Whether, for instance, to operate as a nonprofit, a benefit corporation, an L3C, or a flexible purpose corporation; or whether to fund through a grant, a loan, or one of dozens of investment options. These are just some of the possibilities available to those seeking to create social impact.
Our panel of experts from across the fields of law, philanthropy, impact investing, and social business, will address key considerations that social entrepreneurs, funders, and investors must take into account when making decisions about how best to pursue social impact, including:
- How do you decide which organizational and investment forms are right for you?
- What are the opportunities, limitations, and risks of the various hybrid models?
- Can hybrid models truly be used to attract more capital and increase the impact of social ventures?
Here are some of the highlights:
Moderator Paul Lamb, Man on a Mission Consulting, noted that we've come a long way since the 1970s when it was thought the only social responsibility of companies was to make money for its shareholders. A recent study stated that there was $120 billion worth of potential investment in mission driven companies from wealthy investors.
David Levitt, Adler & Colvin, briefly summarized 3 hybrid models (benefit corporation, flexible purpose corporation, low-profit limited liability company) and differentiated the term “hybrid” from "tandems” (operating affiliated nonprofits and for-profits).
David discussed his recent article co-authored with his partner Robert Wexler, Using New Hybrid Legal Forms: Three Case Studies, Four Important Questions, and a Bunch of Analysis, which provides examples of the steps taken in deciding on the appropriate form of entity. The four important initial questions:
- Who are you?
- What is the precise social enterprise activity that you want to develop?
- Why are you starting this enterprise?
- Where is the money for this new activity going to come from and how much is needed?
The seven follow-up analysis questions:
- Does the client need a new legal entity?
- If we decide that the client needs a new legal entity, can the entity qualify as a tax-exempt entity?
- If an organization could qualify for exemption, should it nonetheless form as a for-profit entity, based on other factors?
- If the entity is to be for-profit, should it be a corporation or an LLC?
- If the entity should be a corporation, should it adopt one of the new hybrid corporate forms, such as a flexible purpose corporation or a benefit corporation?
- If the entity is best served by being an LLC, should it be an L3C?
- Is there any reason to have two entities, one for-profit and one nonprofit (tandems)?
Dan Crisafulli, Potrero Impact Advisors, mentioned that tandem structures predated the "hybrids" referenced earlier. David called the audience's attention to an article written by his colleagues Ingrid Mittermaier and Joey Neugart: Operating in Two Worlds: Tandem Structures in Social Enterprise. The article raises several important points:
- Charities must further a recognized charitable [or other exempt] purpose
- Be careful using pass-through entities or single-member LLCs for the for-profit [activities unrelated to the charity's exempt purpose carried on by the for-profit might be attributed to the charity and potentially jeopardize the charity's tax-exempt status]
- Consider carefully who will control each entity: Avoid 100 percent overlap on boards
- Special issues where a charity holds a controlling share of the stock of a for-profit [among them, unrelated business income tax consequences and Form 990 disclosure rules]
- The two entities must respect their separate legal status
- The charity must demonstrate independence in its operations
- Be aware of restrictions on the use of charitable capital
- The charity should attempt to avoid private foundation status
- Charities cannot unduly benefit private actors, especially insiders
- Getting assets back out of an entity can be difficult [David noted to one member of the audience to be particularly careful of putting in a valuable intellectual property asset into a nonprofit entity before the plan is really fully fleshed out because of the signficant loss in flexibility that would result from such action]
Paula Goldman, Omidyar Network, noted that the hybrid pathway was still very new and experimental with nascent capital models. Of the 100 organizations in the Omidyar Network portfolio of organizations that harness the power of markets to catalyze broad, positive social impact, only one is a benefit corporation, one is toying with the idea of spinning off a hybrid, and a couple are merely thinking about it. Paula stated that the interest in hybrids come from three major places:
- Where the product offered is a cause but does not fit the charitable model (e.g., CouchSurfing)
- Where a nonprofit has a substantial for-profit revenue stream that needs to be spun off (e.g., Global Integrity)
- Where the benefits of being a hybrid are advantageous for pure business reasons (employment retention, engagement, and motivation may be a bigger advantage to many than increased attractiveness to consumers)
Maureen Sedonaen, Revolution Foods, discussed her company's decision to operate as benefit corporation. She provided the real-life example of making the decision on form based on size, scale, scope, investors (who want a return but more than just a market rate return), and who was to benefit from the choice of form (her company's employees are also owners). In six years, Revolution Foods went from making 500 lunches a day to 125,000 lunches a day.
Dan followed up on the discussion of investors and their impact on the form of social enterprise. Institutional investors are looking for positive impact but little money is getting into the space because of a mismatch of scale, scalability, and return. In response to a question, Dan noted that Community Interest Companies (CICs) in the U.K. have been around about 10 years and have preferential tax treatment but have also not attracted investors in a very substantial way (in part because of the tradeoffs required for the tax benefits).
You can read more about the three hybrid forms on our previous posts: