Deciding the best legal structure for a social enterprise can seem like a daunting, high-stakes task. 

This post is designed to help social entrepreneurs and their attorney progress through a clear process for understanding how to structure their organization to maximize their social / environmental impact. I’ve developed and refined this method by working with hundreds of social entrepreneurs, getting input from fellow attorneys in the field, research and teaching the topic since 2008. Though this decision is never simple, the goal of this process is to reduce complexity, confusion and give the social entrepreneur a few clear options.

Progressing through the process will help narrow down the potential legal structures from 7 to 2 or 3.

Form Follows Function

First and foremost, there is no one-size-fits-all legal structure for social enterprise. The structure a social entrepreneur selects must be informed by what the organization is actually doing. In the same way a good architect understands what will be happening in the building before sitting down at the drafting table, a good social enterprise attorney take time to understand what impact the social enterprise is setting out to achieve and how they intend to create that impact. Form follows function.

Business Model

Before we dive into the types and categories of social enterprise business models, it will be helpful to define what exactly a business model is, and how a social enterprise business model may differ from the traditional of a business model.

According to Joan Margretta’s Harvard Business Review article Why Business Models Matter, business models are, “at heart, stories—stories that explain how enterprises work. A good business model answers Peter Drucker’s age-old questions: Who is the customer? And what does the customer value? It also answers the fundamental questions every manager must ask: How do we make money in this business? What is the underlying economic logic that explains how we can deliver value to customers at an appropriate cost?” Michael Lewis in his book The New, New Thing offers a simple definition, “All it really meant was how you planned to make money.”

For the social entrepreneur, the business model is all of that, plus how the organization plans to create impact. So, the definition of a social enterprise business model may be how an organization’s operations generate both financial benefits as well as mission-related benefits. In other words, a social enterprise business model is the means by which it pursues both profit and purpose.

I’ve identified a few of the 12 most common social business models. This list of business models is certainly not comprehensive, it’s a good starting place. (Please let me know if you have something to add to the list.)

 

Business ModelHow it WorksExamples
Buy One Give OneCharge customers a market rate that allows donation to beneficiaryTOMS, Warby Parker, Leesa, Parachute
Cross-SubsidizationOffer free/low cost products services to beneficiaries and pay for it by charging other customers a higher price Dial 1298
Public Service OutsourcingSelling products / services to the public sector to increase innovation and efficient y of public servicesEdTech
Bottom of the PyramidCreate a low-cost product / service that solves a specific problem for low-income populationsD-Rev, Embrace, Bridge International Academy; Grameenphone; Microfinance; D.Light
Two-Sided MarketplaceProvide platform or services that connect beneficiaries to new market opportunitiesEtsy; Kickstarter; GoFundMe
Sharing Economy Providing beneficiaries access to capital intensive productsZipcar
Ethical Supply ChainIncorporate social and environmental sustainability into service/productionMethod; Merge4; Mandala Naturals, Maiyet, Burt’s Bees, Method
Shared OwnershipAllow employees or customers to take an ownership interest in companyKing Arthur’s Flour; Persephone Brewing; Equal Exchange
Direct EmploymentHire beneficiaries that are traditionally underemployedHotbread Kitchen
Consulting Services to Mission-Driven OrgsProvide services to improve or scale social impactFSG; Arabella Advisors; Bridgespan, Phil Communications; Geneva Global, Westaway
Environmental SustainabilitySell products/services that improve energy efficiency and sustainabilitySolar City, HomeSol Building Solutions; 5 Lakes Energy; Power Dash Inc.
Donor SupportedRevenue is generated from grants / donationscharity: water, donorschoose.org, BUILD

All of these specific business models fall into one of three business model types below.

 

Profit-Purpose TensionProfit-Purpose AlignmentPhilanthropic
Buy One Give OneFreemiumDonor Supported
Ethical Supply ChainBottom of the Pyramid
Direct EmploymentTwo-Sided Marketplace
Shared OwnershipSharing Economy
Cross-SubsidizationConsulting Services to Mission-Driven Orgs
Environmental Sustainability

 

Profit-Purpose Tension

The Profit-Purpose Tension (PPT) business model is what generally comes to mind when people think about a social enterprise. In this business model there is a trade-off between doing good and making money, the social entrepreneur is forgoing some money in order to do good. In that sense, there is a negative correlation between profit and purpose generated in the organization – the more good you do, the less money you make.

An example of social enterprise that has a PPT business model is Warby Parker an eyewear company that distributes a pair of glasses to people in need in the developing world for every pair it sells. Let’s assume the cost of the pair of glasses they distribute is $20. Let’s also assume that the profit on each pair of glasses sold is $40. By pursuing their purpose – distributing glasses to those in need – they are decreasing their per unit profit from $40 to $20. Thus the negative correlation between profit and purpose.

In a PPT business model the tension really exists between the investor and the social entrepreneur. The investor is seeking a financial return and the social entrepreneur is seeking to create social and/or environmental impact. Investors may pressure, and in extreme cases sue, the social entrepreneur forcing them to scale back their purpose in order to maximize profit.

That’s why in a PPT business model, it’s essential to protect the purpose of the company. There are a few emerging legal structures designed to address this Profit-Purpose tension, so the PPT social enterprise should consider:

Benefit Corporation

Social Purpose Corporation

L3C

Profit-Purpose Alignment

Many people assume that all social enterprises are forgoing some profitability in their pursuit of purpose. That’s not necessarily true. In some business models there is a positive correlation between profit and purpose such that the more good you do, the more you see your profits increase.

The Profit-Purpose Alignment (PPA) business model is the opposite of PPT. In this business model there is alignment between doing good and making money. In that sense, there is a positive correlation between profit and purpose generated in the organization – the more good you do, the more money you make.

For example, consider M-KOPA, a solar company with a mission of providing low-income, off-the-grid households a clean supply of electricity. They offer a solar home system that allows families to light their home, run small appliances or charge their mobile phones. Furthermore, they’ve figured out a way to structure the payment of this system in such a way to make it affordable for their target demographic. M-KOPA has connected more than 375,000 homes in Kenya, Tanzania and Uganda to solar power with over 550 new homes being added every day.

So, in M-KOPA’s case, the more solar systems they sell, the more they are achieving their social and environmental missions, but also the more profit they are making.

In a PPA business model, there is no (or much less) tension between the the investor and the social entrepreneur because by nature the more good the company does, the more money they make. Thus, misson protection is less essential than in a PPT business model. So, the PPA social entrepreneur should consider more traditional legal structures such as:

Corporation

LLC

 

Profit–Purpose Neutral

The Profit-Purpose Neutral (PPN) business model is a model where there is no (or very weak) correlation between the good that an organization does and the revenue that they make. In the social enterprise context, this is usually an organization that is donor-funded. In a traditional nonprofit, there is no direct correlation between the good being done and the revenue being generated. Typically the ability to generate strong revenue is based on the quality of the development team in the organization, not necessarily the program team.

For instance, consider an orphanage. There is no correlation between the number of children they house and the amount of revenues. Instead, the revenue may be tied to how savvy their “sponsor a child” marketing is executed.

The PPN business model should consider:

Nonprofit

Making the Choice

So, the process for choosing the optimal legal structure for impact is:

1. Identify the social enterprise business model.

2. Identify the social enterprise business model type.

Steps 1 and 2 will narrow down your options to no more than 3 potential legal structures, at which point, the social entrepreneur and their attorney will have to examine the costs and benefits of each legal structure given their specific context.

 

Blended Business Models

Though many social enterprises will fit cleanly into one of the above business model categories above, some will be a blend of business models. For instance, a social enterprise that sells products to the Bottom of the Pyramid, but are produced from environmentally friendly materials. This social enterprise would fit both into the PPA category (BoP) and the PPT category (environmental sustainability). So, what legal structures are relevant for such an enterprise?

If the blended business model is a combination of the PPA and PPT categories, then the entrepreneur should consider benefit corporation, social purpose corporation or L3C. Even if the whole business model isn’t in tension, some tension will exist, which has the potential to compromise the purpose over the long-term, so it’s best to err on the side of caution and select a legal structure designed to protect the purpose.

If the blended business model is a combination of either the PPT or PPA and PPN, then select either the non-profit or dual entity structures. Though it is possible to accept grants into a for-profit, it happens so rarely and is typically a one-off grant, not an ongoing source of revenue. So, if you are going to house revenue generation and donor funding in one entity, it will likely need to be a nonprofit in order to attract grants and donations. Depending on the specifics of the activities and revenues, it a dual entity for-profit / non-profit structure may be optimal.