Three legal questions to ask when founding your social enterprise

Graph via SoSense

Graph via SoSense

Social and non-profit enterprises can take a wide variety of legal forms, and the choice of structure is not always an easy one. Legal structures and requirements vary globally, but this blog outlines the key questions that you should ask before founding a social enterprise in the UK.

1. Do I need to be a charity?

Charities are designed to benefit the public. With this in mind, registration as a charity can mean reduced business rates, tax relief on income and preferential treatment for certain types of grant applications.

However, charities are also restricted in what they can do and how they must be governed. For example, in the UK there must be an independent board of trustees who report to the Charities Commission on an annual basis. It is also critical to ensure that those who run the charity do not benefit personally from their work (other than through the payment of expenses and – in the case of professional managers and trustees – a reasonable salary).

These protections mean that donors can be sure that the funds they donate will be applied for a charitable purpose: indeed, some donors will only agree to advance funds to bodies that are registered as charities. However, the restrictions which on charities would make the day-to-day running of a social enterprise more difficult and would be impossible to comply with if there are investors or directors seeking an equity-like return. For this reason, many UK social enterprises are not registered as charities.

Choosing a for- or non-profit structure will also influence your tax rates. Registered charities benefit from tax relief in the income they gain in the form of donations. However, charities cannot claim back the VAT (tax) they pay on the goods and services they consume. For many non-profits, the benefits of tax relief on income would outweigh the VAT issue: but this is not always the case, depending on the business model.

2. Do I need to incorporate?

Incorporation means that the founders of a social enterprise have limited personal liability for the debts of the business. This is an important protection for founders, even if you are aiming for non-profit status or looking to register your enterprise as a charity.

Most for-profit businesses in the UK are incorporated as private companies limited by shares. Shareholders of companies limited by shares have economic rights over the business: they have a right to dividends of the profits of the company, and the value of their shares will increase the business grows.

There is an alternative form of UK company: a company limited by guarantee. This structure takes the form of a company but does not have shareholders. Instead, each founder opts to give a limited monetary guarantee to the company (usually a small amount such as £10). Companies limited by guarantee cannot distribute profits to their members, other than in quite limited circumstances: this structure therefore communicates a strong message that the business is non-profit.

Many UK non-profits (including charities) take the legal form of companies limited by guarantee. However, some social enterprises will adopt the form of a company limited by shares, particularly if they want the flexibility to give investors or directors equity-like returns.

3. What is a Community Interest Company?

A community interest company (or CIC) is a new type of company, introduced in the UK in 2005 and designed with social enterprises in mind. It was designed to have some of the flexibility of a company form, but with protections to ensure that the assets of the company can only be used for public good.

CICs are subject to much lighter regulation than are charities and have much of the operational flexibility of a normal company. The difference between a CIC and a normal company is that a CIC must have an “asset lock” in its constitution that prevents the company from distributing its profits of assets to any other body which is not either a charity of a CIC.

CIC structures are a welcome step forward in that they recognise that the charity model is not suitable for all social enterprises. However, it is worth bearing in mind that converting to a CIC (or to a charity) is a one-way process: once the asset lock is in place it is very difficult to undo the commitment to a community only business model. As with a charity, a CIC structure would rule out offering equity-like returns to investors and constrain exit options (any remaining proceeds would need to be donated to a CIC or another charity).

4. Where can I find help?

The Charity Commission and the CIC regulator have both produced a number of useful publications outlining these issues in more detail.

Many law firms are willing to provide help and support to social enterprises on a pro bono basis. Law Works offers free legal advice for non-profit, voluntary and community organisations in the UK and are highly experienced in dealing with structural questions for social enterprises.

Katherine Murray is a lawyer and incoming member of the MBA class of 2015 at the University of Oxford Said Business School. Follow her on Twitter at @KMurrayMBA Visit The Social MBA contributors page to read more.

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