One of the most important decisions to be made before launching a social enterprise is choosing a legal structure.
Why is this important? There are a number of reasons and implications as to why it is important to pay attention to legal structure. Some of them are: how the social enterprise gets funded, how the profits (if any) get distributed, governance structure, reporting responsibilities, tax liabilities, and ownership pattern.
India, unlike many other countries – like the US and the UK – does not have plenty of leeway in terms of legally structuring a social enterprise. In the US, for example, there are many options, which have been specially carved out keeping the needs of a social enterprise in mind. They are low-profit limited liability company (L3C), Benefit Corporations, Certified Benefit Corporations (B Corps) and Flexible Purpose Corporations.
India, on the other hand, has limited options in terms of legal structure. Broadly speaking, there are four types of legal structures that social enterprise can opt for. We give you a gist of each one of them, along with the pros and cons.
Non-profit or public charitable organization:
Non-profits can register as a Trust (under the Indian Trusts Act, 1882), a Section 25 company (under of the Companies Act, 1956) or as a Society (pertaining to societies registration, of the concerned state). The biggest benefit of registering as a non-profit is the eligibility to get tax benefits under the Income Tax Act of 1961 and they can also accept foreign donations under the Foreign Contribution (Regulation) Act.
The non-profit model is best suited for start-ups that do not expect revenues from their activities or have a long gestation period before they start to accrue revenues. Examples of non-profits include Agastya Foundation, Teach for India, Digital Green and Akshaya Patra Foundation. They strive to achieve scale and replicate their work across many geographies using commercial strategies. Their way of sustaining themselves financially is through grants and donations. One of the problems with this model is that perhaps the inability to hire top-class talent or invest in latest technology and infrastructure.
Pros: Ability to focus solely on creating social impact without the pressure of financial return.
Cons: Constant need to raise funds.
The for-profit social enterprise:
In India there are many choices when it comes to setting up a for-profit social enterprise. Broadly, there are five different types of for-profits: sole proprietorship, partnership, limited liability partnership, private firm and co-operative.
This type of legal structure is perhaps best suited for social enterprises that are looking for growth and profitability. It comes as no surprise, according to a study by Intellecap , Indian social enterprises 80 per cent of those polled, structure themselves as for-profit private limited companies (PLCs). Examples of for profit social enterprises include Vaatsalya Healthcare, Ujjivan Microfinance and dLight. These social enterprises have usually cracked the market, and have a product or service that consumers have accepted, and are willing to pay money for. Also, because of their for-profit structure, they have the ability to accepting funding from VCs and issue shares and go public.
Pros: Ability to attract funding from VCs, pay top dollar for good talent and invest in technology and infrastructure.
Cons: Sometimes focus on profits leads to mission drift that makes the original shareholders and stakeholders unhappy.
The hybrid model:
These type of social enterprises start off as a non-profit or for-profit and then launch an exact opposite twin. Some of the reasons are fairly straight-forward. As funds start to dry up for non-profits they are under pressure from their funders to focus on revenue generating activities. This leads to them launching a for-profit sister entity. Head Held High Foundation, for example is a non-profit that promotes rural entrepreneurship, under its fold are two for-profit organizations- Head Held High Services Pvt. Ltd and Magic Wand Empowerment. The Times of India wrote about the hybrid model in a November, 2013 article, highlighting companies like Fractal Foundation, Waste Wise Trust and Under The Mango Tree. When it comes to for-profit social enterprises, they launch a non-profit so that they can attract donations and grants, which can be used for activities like training, research or subsidizing a product or service.
Clearly this is a great model that ensures that social enterprises can both attract donations and grants, and still be able to have access to social venture funding.
Pros: This is the best of both worlds, allowing a social enterprise to separate the social and revenue generating activities.
Focusing on both types of entities could be a problem and so the issue of building a common culture.
Disclaimer: Our aim is provide you with a broad understanding of legal structures, please consult with legal and tax experts before making a decision.