Social enterprise and charity
Posted on 6 April 2018
Last year Christchurch hosted the Social Enterprise World Forum, where social enterprises from all over the world came together to share wisdom, build networks, and learn how social enterprises can be used to drive positive social change.
Social enterprise means a lot of different things to different people. Essentially, it is about organisations using commercial methods to support social or environmental goals.
The support for social enterprises has been raised as a particular issue at our Sector User Group, and I thought it would be useful to discuss how social enterprises can register as a charity.
Registering a social enterprise as a charity
First, not all “social enterprises” are charities – if the organisation provides private profit through its operations, it is not a charity. This doesn’t mean that people can’t be paid wages or a salary, but it does mean an investor or founder can’t make money from a surplus at the end of the year.
One of the big concerns for social enterprises who are not charities is the impact of investment. If social enterprises seek investor money, there is the potential for investors to drive them to stop doing so much “good” and start making more money. This is sometimes called mission drift.
So one option for social enterprises to “lock their mission” into their operations is registering as a charity.
Registered charities have to advance charitable purposes, and charitable purposes (by definition) have to be for the benefit of the public. Charities can pay market rates for services (e.g. salaries), but they can’t have a purpose to provide private profit to an individual or group.
This means if an organisation registers as a charity, it locks public benefit in its purpose. Fundraising for charitable purposes is a charitable purpose in itself, so social enterprises that fundraise for charitable purposes can register as charities.
Social enterprises themselves may also advance charitable purposes: for example, purposes to relieve poverty (e.g. providing lunches to schools), advance education (e.g. a tutoring programme) or protect the environment (e.g. a recycling initiative).
Legal structures for registering as a charity
There are different legal structures to consider for social enterprises wanting to be a charity.
Most enterprises that apply as charities use a limited company structure where shareholders are limited to charities, and/or any benefit (including dividends) is limited to charities.
Incorporated societies are a membership based organisation that may be suitable for enterprises that wish to include a democratic element to their decision making.
Charitable trusts are structures where trustees hold property for specific purposes. They have a wide range of fiduciary obligations in dealing with that money, the most important being loyalty to the purposes of the trust.
Unincorporated groups can also register (a group of people bound together by a rules document) – although this can be risky, as individuals can become separately liable for anything that goes wrong with the business.
More discussion on what legal structures may suit community groups is available on the Community Law website(external link).
Disadvantages of registering as a charity
There may be disadvantages for social enterprises registering as a charity. For one, social enterprises may wish to access investor’s money. You can’t sell shares in a charity; although charities can raise money through borrowing money (as long as any interest they pay is at market rates – or lower than market rates) or similar “debt instruments” that are pegged to a reasonable market rate.
Founders may also want to build their enterprise over time, and sell their enterprise for a profit at the end of their involvement. If they form a charity, they can’t do this (although they can lend money to the charity, and expect interest back at market rates or less).
Registration as a charity also brings with it transparency to the public and obligations around reporting that may not be suitable for all enterprises.
Charities that wish to fundraise must also demonstrate that they can raise funds for charitable purposes (and aren’t just going to operate to prop up the business). This requires objective evidence showing they are actually going to raise profits in the future. More information on how charities can do this will be in an upcoming blog.
Other options for social enterprises
Charities can also invest in social enterprises. This means investing with an expectation of return–giving grants to businesses usually won’t be charitable.
There are other legal forms that are worth considering – including limited partnerships. The Department provided an explanation of some of the forms in 2013 in the paper Legal Structures for Social Enterprise(external link).
Some groups are also advocating for a new legal form for social enterprise. This is discussed in some detail in the above paper, and social enterprise promoting charity Ākina have released a new paper(external link) on why they think a new legal form is needed.
We are always happy to talk with prospective charities about whether they want to register as a charity. We also recommend budding social entrepreneurs seek independent legal advice.