Unique opportunities for social enterprises with a for-profit legal form

A social entrepreneur recently called me for some advice.

He had started a “social enterprise” with a for-profit legal form – a private company (“PTY”).

He had managed to secure the South African licence to sell a very promising product that serves the people at the “bottom-of-the-pyramid”. I think this product has potential and serves a pressing social need.

He then approached some local foundations and corporate social investment (CSI) departments for funding. They said that he had to first create a non-profit company (NPC) and then use this vehicle to submit a funding proposal. In other words, these donors were suggesting that he create a hybrid social enterprise.

We had a short and productive discussion about where the best opportunities for his business were to be found. I explained that creating a hybrid model in this instance is most probably a bad idea. We also discussed how the strategic path for social enterprises with a for-profit legal form is different from those that are non-profit organizations. Trying to apply the strategy, business model and thinking of the one to the other is likely to be very difficult.

Since I have this type of conversation quite regularly with social entrepreneurs, I decided to share and elaborate upon the six opportunities we discussed. These points will be familiar to many of my readers; I’ve just applied them to the situation this entrepreneur found himself in.

1. Consider your personality when choosing legal form

I’ve written and spoken about how social entrepreneurs should reflect on their personality when choosing the best legal form for their social enterprise. This is a factor that is often overlooked in the conversation about legal forms.

Some entrepreneurs, like myself, much prefer to run something that we own and control. Others are happy to run something on behalf of a cause. The best option will depend on who you are and what you are trying to achieve.

2. Investigate enterprise development funding

A social enterprise with a for-profit legal form will struggle to access the same funding sources as a non-profit organization. Trying to follow this path is likely to cause frustration.

I often notice how social entrepreneurs fail to explore all the features of the legal form they’ve chosen, hence the desire to rapidly establish a hybrid model and create more bureaucracy for themselves.

Part of this is because of the 10 common confusions surrounding legal forms for social enterprises, something which I’ve worked hard to dispel.

The social entrepreneur who called me is a black South African. This means that he can gain the full benefits of the B-BBEE Codes of Good Practice – a set of policies that the government has introduced to promote economic transformation. For a start, he should become very skilled at navigating the Enterprise & Supplier Development Code where large businesses are encouraged to spend 2% of their annual turnover on supplier development (i.e. developing black-owned businesses in their supply chain), and 1% on enterprise development (i.e. developing black-owned businesses within their broader industry or sector).

I can see his business becoming an “Enterprise Development Beneficiary” in terms of the B-BBEE Codes, whereby he’ll be able to benefit from funding, business support and help finding customers.

Furthermore, there is always the possibility of pursuing impact investment funding, especially since the legal form he has chosen has equity (i.e. shareholding). We’ve recently seen an upsurge of this in South Africa, with organizations such as Impact Amplifier and the Bertha Centre for Social Innovation & Entrepreneurship taking the lead. I can also think of several competitions and incubators from which he may benefit – those run by the SAB Foundation and Social Enterprise Academy spring to mind.

A cautionary note. It is easily possible for social entrepreneurs and their “start-ups” to be trapped in a cycle of incubators and training programmes, and never emerge to create an established enterprise with a reliable business model.

3. Running an ethical and impactful business is good enough

In “How a business can become a social enterprise, I’ve looked at how businesses can learn from social enterprises, and take steps to integrate social enterprise elements into how they operate.

Remember that organizations exist along a spectrum. On one side, are the non-profit organizations that rely on donor funding to change the world; on the other side are the traditional businesses that exist solely to make a profit at all costs.

What I do want to mention, however, is that I believe its ok to make profits; it just depends on how we earn the money and how we use the money. There is nothing dishonourable about making a profit while running an ethical business. We need many more of these in the world. Not every business needs to become a social or high-impact enterprise.

4. Be careful of setting up a hybrid social enterprise

I’m in agreement with Nicole Copley from NGO Law SA that it can be a bad idea for a social or high-impact enterprise with a for-profit legal form to register a non-profit organization and create the technically difficult hybrid relationship.

In this scenario, the desire is typically to establish the non-profit organization as a funding conduit – to raise funds and then spend the money supporting the business or buying from the business. To make this work we must navigate the conflicts of interest, create ethical governance structures, include independent board members, and help the social entrepreneur to realize that one cannot “own” a non-profit organization.

Then entrepreneurs tend to wonder why they went down this path in the first place. It would have been much easier for them to have simply partnered with an existing non-profit organization (than trying to set up and “own” one.)

There are exceptions of course to our general rule. Four instances are common and acceptable.

The first is when a corporate establishes a non-profit organization as a method of channelling funding, running programmes and enhancing its brand. A good example is the Google Foundation.

The second is when a broad-based ownership scheme is established as part of the B-BBEE codes. This is when a Trust is established to hold shareholding in a business on behalf of a large group of people (e.g. community, beneficiaries, employees). I’m currently working with the Sishen Iron Ore Company Community Development Trust (SIOC-cdt) which was established by Kumba Iron Ore to hold shares in two mines and spend dividends on uplifting nearby communities.

The third is where a larger business establishes a non-profit organization to solve a specific social problem, and then gives up “control”. A good example is the Feel Good Project that was established by the Foschini Group to provide unemployed people with the practical skills and experience to secure a job and successful career in the retail industry. This organization has recently been given over to Learn to Earn and rebranded as Fashion for Change.

The fourth is when a social entrepreneur wants to protect their social enterprise from being consumed by business concerns and losing its way. Consider the case of Shonaquip, a social enterprise with a for-profit legal form. Shona MacDonald, the founder and owner, gave the majority of her shares to Uhambo Foundation, a non-profit organization she helped establish in 2010.

5. Think like a business, but embed social impact in your product

A common temptation is for social enterprises with a for-profit legal form to slip into the mindset of fundraising much like a traditional non-profit organization. This tends to weaken rather than strengthen the enterprise.

Many years ago, I remember reading a study by Bridgespan which discussed how social entrepreneurs are fearful of “mission drift” – this is when the business agenda hijacks the social mission of an organization. While this is a valid concern. this study found that this risk was much less than expected, provided that social mission was built into the product and that the business ran ethically and had good governance.

In other words, I encourage those social entrepreneurs that own and run social and high-impact enterprises to remember to apply business thinking to how they operate.

Ultimately, the social entrepreneur in our example will need to rely on his individual customers for most of his income. Funding is a means to an end – a method of getting established and scaling more easily. But he will need to cultivate a stable and happy base of customers and find a way to communicate and reach out to them.

6. Talk to the right departments in businesses and government

In the case of our social entrepreneur, rather than targeting CSI departments, he should strive to build relationships with enterprise development departments, procurement departments, and marketing departments. These should ideally be in businesses that operate in the same sector as his.

I’ve shown how income forms should be thought of differently from income sources. The danger where one immediately equates an immediate income source with a form. This narrows one’s thinking. For instance, it would be limiting to assume that the only means of transacting with businesses is via funding proposals to a CSI department from accredited Public Benefit Organizations. Check out this Strategy Brief to find out more about this.

A good example is Siyavula, an education technology company that has helped hundreds of thousands of learners in South Africa to practice maths and science, and pass these exams. It has received sponsorship from the marketing department of Vodacom. It did not prioritize traditional funding channels. These transactions would be construed as a wise and valid business expense for the corporate, but they also get to earn B-BBEE points for socio-economic development.

The social entrepreneur in our example might find that the Department of Education or Social Development is interested in buying some of his product in bulk. He would then have to register his enterprise on the government supplier database and respond to requests for quotes or proposals. This is a very different approach from writing funding proposals to these departments, as these funds tend to be reserved for funding welfare organizations.

The message here is to approach the right departments and have the right conversations with them.

Conclusion

Some social entrepreneurs will choose to start social enterprises with a for-profit legal form; others will choose to head down the non-profit route. Both options are valid. Both sets of legal form are versatile. Their individual features and the opportunities they create should first be thoroughly explored before one even thinks about hybrid models.

I encouraged the social entrepreneur who called me to think more like a businessman, to make the most use of impact investment funding and the opportunities created for him by South Africa’s B-BBEE Codes of Good Practice. He should accept that certain channels of funding will be closed or difficult to access (e.g. writing proposals to corporate social investment departments), but then other channels will be very much open.

He will need to learn to operate and think like an entrepreneur and follow his own best path.

Thanks to Nicole Copley (NGO Law SA) and Philip Anastasiadis for their insightful contributions to this article.

In pursuit of strategic clarity

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