REDF Legal Structures for Workforce Development Social

Transcription

REDF Legal Structures for Workforce Development Social
Legal structure options for employment-focused social enterprises:
REDF Portfolio Webinar
The information contained in this presentation is for informational purposes
only. REDF is not providing legal or tax advice to the readers of this
presentation. Readers should consult with their own advisors for such advice.
Project Overview
Project Objectives
• To understand which legal structure(s) are most suitable for social enterprises whose
Project Goals
• Better understanding of legal structures across key criteria and recommendation on trade-
mission is to employ people facing barriers to work
•
•
•
offs and recommendations
Identify relevant case studies and literature
Interview industry experts and/or social enterprises operating within each of the identified
legal structures
Identify additional legal questions/considerations which will need to be answered by
lawyers
Project Approach
• Examine legal structures currently used by social enterprises across the key criteria
Output
• Recommendations on legal structures best suited for workforce development social
(outlined in Slide 4)
•
enterprises, including tradeoffs
Types of social enterprise legal structures to consider (including information about how to
qualify or limitations associated with each legal structure)
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Which criteria will be used to analyze various legal structure
options?
 Contracting preferences
 Organizational dynamics - e.g., compensation, talent management
 Access to capital
 Tax implications/ tax incentives
 Liability implications for parent non-profit
 Cost and timeline for setting up the structure
 Supports accomplishment of organization’s social mission
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Interviews Conducted
•Practitioners
Shawna Smith – Executive Director, Taller San Jose
Lee Zimmerman – CEO, Evergreen Lodge
David DeLeonardis – President/CEO, Crossroads Diversified Services, Inc.
•Experts in the field
Robert Wexler – Principal Attorney, Adler & Colvin
Gene Takagi – Attorney, NEO Law Group
Marc J. Lane – Attorney, Marc J. Lane Wealth Group
Ted Howard – Cleveland Foundation, Evergreen Cooperatives, The Democracy Collaborative
•Other
REDF Staff
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What are the different ways in which a social enterprise, operated by a nonprofit, can be structured?
Social
Enterprise,
operated by
nonprofit
Separate
entity?
Yes
Ownership
Partially
Tax
owned
Exempt2
Wholly
owned
Wholly or partially
owned nonprofit
subsidiary
Tax Status
No
Social mission
in by-laws?
Corporation
Corporation
•
•
Worker
No
owned
Yes
Program/
division of
nonprofit
Taxable
Structure?
Structure?
LLC
Standard
LLC
No
•
•
Corporation
•
•
Worker Cooperative
Corporation1
Business Corporation
LLC
Decision
Standard LLC
Other LLCs (series
LLC, etc.)
Social mission
in by-laws?
Yes
Legal structure
Benefit
Corporation1
Social Purpose
Corporation1
L3C1
Examples (not limited to nonprofits operating a social enterprise)
 This chart addresses the business activities of the social enterprise. Support services provided to social enterprise employees is sometimes
retained within the parent nonprofit, even if the business activities are legally separated into a subsidiary. Alternatively, some or all employee
support services are also outsourced to other organizations.
1Allowed
2The
in certain states (details are discussed in presentation)
distinction between state and federal nonprofits is discussed in the appendix
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Separate entity vs. keeping entity within parent organization
Relative importance of criteria – can vary by organization
Separate Entity
Within parent nonprofit
Liability
• Asset protection
• Risk
• Social enterprise is main
purpose of organization
Tax implications
• If paying significant UBIT,
better protection for
parent tax-exempt status
• Activities aligned with
mission
Cost and timeline to set
up
• Depends on structure
choice and organization
• Generally, cheaper and
faster
Organizational dynamics
• Cultural implications
• Leveraging existing
infrastructure
Supports
accomplishment of
social mission
• Capacity
• Accomplishment of
organization’s mission
• Type of operation, type of
workforce
• Considerations of
external stakeholders
• Social enterprise integral
to mission
Other
considerations
• Effect on nonprofit’s
reputation
• Revenue diversification
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Nonprofit vs. for-profit
Relative importance of criteria – can vary by organization
For-profit
Non-profit
Contracting
preferences
•
Certain contracting preferences/
designations only available to for-profits
•
Some contracts are only awarded to nonprofits
Access to capital
•
•
•
•
•
Option to offer equity
More sources of capital
Funding is generally not restricted
Easier to put “creative” capital together
Easier to get credit for new entities
•
•
•
•
Majority of funding comes from donors or grants
Fewer sources of capital
Certain funds might be “restricted”
May receive more favorable loan terms from
certain entities
Tax implications
•
Tax credits (WOTC, Enterprise zones, etc.)
•
If social enterprise activities are related to
organization’s mission, income is tax-exempt
Can possibly be exempt from sales and property
tax
•
Other considerations
•
Potential stakeholders prefer or required to
work with exempt entities
Target population
•
Cost and timeline to set
up
•
•
Depends on whether corporation or LLC
Generally for-profit entities are faster to
set up (unless bringing in multiple
investors)
•
IRS approval takes between 2 to 12 months
Supports
accomplishment of
social mission
•
Social enterprise does not qualify for an
exempt purpose
Profit is a primary goal of the enterprise
•
•
Mission of enterprise is primarily “social”
Mission of social enterprise aligns with parent
nonprofit’s mission or social enterprise qualifies
for an exempt purpose
Organizational
dynamics
•
•
Ability to attract talent with higher
compensation levels
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LLC vs. corporation
Relative importance of criteria – can vary by organization
LLC
Corporation
Other
considerations
• Less consistent treatment if
operating in multiple states
• Can elect to become L3C (if
allowed in state)
• Can elect to become a benefit
corporation or flexible purpose
corporation (if allowed in state)
Access to capital
• In some cases, members of the LLC
have to provide personal
guarantees of loans
• Banks or vendors may more readily
extend credit to corporations
Cost and timeline to
set up
• Generally simple, but depends on
how complicated Operating
Agreement between owners is
• Fewer corporate formalities than a
corporation
• Generally simple to set up unless
bringing in many outside investors
Tax implications
• Tax flexibility
• Implications for self-employment
taxes
• Difficult to receive tax-exempt
status for an LLC with few
exceptions
• Pay employment taxes on salaries, not
profits
• Income is taxed at corporate and
shareholder level
Liability
• Both structures provide business owners with liability protection
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L3Cs, Benefit Corporations, and Social Purpose Corporations are all new
“hybrid” structures that share similarities
Currently, which states allow for which hybrid structures?
•
Overall benefits of hybrid corps for social
enterprises:
•
Broader access to different sources
of capital
•
Allows higher compensation levels
•
Locks-in social mission in
organization documents
•
Provides potential exit strategies
•
Biggest risks:
•
No national standard or reciprocity
across states
•
Very new structures with unknown
risks
Tax Implications:
•
For now, these structures will be
taxed the same as for-profit
corporations, though advocates plan
to ask the Internal Revenue Service
to consider tax breaks for the
hybrids in the future
•
Liability - protects directors from
liability for considering a social
purpose
WA
OR
MN
ID
MI
WY
NV
CA
UT
NE
IL
CO
AZ
AR
ME
VT NH
NY MA
RI
CT
PA NJ
DE
WVVA MD
DC
SC
LA
FL
HI
Social purpose corporation
A hybrid legal entity that blends
elements of non-profit and forprofit corporations. It is a
corporation that must state a
specific social purpose for which it
is formed. It is taxed like a
corporation. It protects directors
from liability for any decisions that
involve balancing the corporation’s
special purpose against its
financial condition. Social Purpose
Corporations are also subject to
additional reporting requirements
assessing its performance in
achieving its special purpose.
Benefit Corporation
A hybrid legal entity that blends
elements of non-profit and for-profit
corporations. Essentially a corporation
that must be organized and operated
for the purpose of “creating a general
public benefit.” It is taxed like a
corporation. It protects directors from
liability for pursuing a social objective
instead of simply profit. Benefit
Corporations are also subject to
additional reporting requirements
relating to its performance in creating
a general public benefit and its
performance against a third-party
standard.
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L3C
A hybrid legal
entity that
blends elements
of non-profit and
for-profit entities.
It is essentially
an LLC that must
be organized and
operated for a
social purpose
and profit must
not be a
significant
purpose
•
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Why choose a hybrid form of entity?
Relative importance of criteria – can vary by organization
Hybrid entity
Supports
accomplishment
of social mission
• Allows directors and officers to
consider social mission in making
decisions
Liability
• Liability protection to its directors
and officers to consider interests
other than profits
Traditional entity
• Social mission is only a minor part of
the organization’s purpose/ culture
Organizational
Dynamics
• Stakeholders are fully aware of
mission and its impact on the
business
• Ties future “owners” to the same
mission
Contracting
Preferences
• Potential preference in contracting,
especially as these structures
become more common
Access to capital
• Unclear how lenders and investors
may view these entities
• L3C may make it slightly easier to
access PRIs
Tax implications
• No tax benefits to organizations with social mission in articles/ operating
document
Cost and timeline to
set up
• L3Cs, Benefit Corps and Social
Purpose Corps are only allowed in
certain states
• New legal forms
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• Established entity form – will likely
mean more consistent treatment from
lenders and investors
• Established legal form – relatively easy
to set up
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Overview of legal entity options for Social Enterprise1
Corporation
Business Corporation
Social Purpose/
Benefit Corporation
LLC
Nonprofit Corporation
501(c)(3)
LLC
L3C
Availability
All 50 states
Social Purpose: 3
states / Benefit Corp:
27 states + DC
All 50 states
All 50 states
8 states2, 2 tribes
Purposes
For-profit only (may
consider parties other
than shareholders in
some states)
Dual purpose (profit/
social)
Charitable purposes only
(profit on exempt
activities or unrelated
business activities is
allowed but may be
required to pay UBIT)
For profit, defined by
Operating Agreement
No significant
purpose for profit or
production of
income
Equity
Shares
Shares
None
Member interests
Member interests
Tax on Profit
Yes, at corporate level
Yes, at corporate and
shareholder levels
Tax exempt, except on
unrelated business
Yes, at member level
Yes, at member level
Management
and control
Board elected by
shareholders
Board elected by
shareholders
Board of directors,
chosen by members,
designators or selfelected
Per Operating Agreement
Per Operating
Agreement
Profit
Distribution
Share repurchases,
dividends
Share repurchases,
dividends
None. All profit must be
reinvested to fulfilling
the mission
As defined by agreement of
investors; most operating
agreements provide that a
member’s distributive
share is in proportion to his
percentage interest in the
business
As defined by
agreement of
investors
Capital Sources
Sell shares, debt
Sell shares, debt ->
potentially more
attractive to impact
investors
Grants, donations, loans,
tax-exempt bond
financing, earned income
Sell membership interests,
debt
Sell membership
shares, debt
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1Source:
2NC
http://www.adlercolvin.com/pdf/tax_treatment/Beyond_Taxation_A_Guide_to_Social_Enterprise_Vehicles_(00302967).pdf, irs.gov, benefitcorp.net
repealed L3C statue effective 1/1/14
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Sources of capital/ funding
Corporation
LLC
Business
Corporation
Social Purpose/
Benefit Corporation
Nonprofit
Corporation
(501(c)3)
LLC
L3C
Shares/ Equity
Yes
Yes
No
Membership
contributions
Membership
contributions
Government
Grants
Yes
Yes
Yes
Yes
Yes
Other grants
(foundations)
Not common (often
done through PRI)
Not common (often
done through PRI)
Yes
Not common (often
done through PRI)
Not common (often
done through PRI)
PRI
Yes, but more
difficult than other
entities1
Yes
Yes
Yes
Yes1
Bank loans
Yes
Yes
Yes (might be harder
to get loans when
starting up vs. a “forprofit” business)
Yes (might be harder
than for a
corporation and
owners may have to
provide personal
guarantees)
Yes (same as LLC)
SBA Guaranteed
Loans and Grants
Yes (small
businesses as
determined by
criteria)
Yes (same as
business
corporation)
No
Yes (same as bank
loans)
Yes (same as LLC)
1IRS
policy on program-related investments - it is more difficult for a for-profit entity to qualify because production of income cannot be a significant purpose and has to further a charitable
purpose. See http://www.irs.gov/charities/foundations/article/0,,id=137793,00.html. See also http://www.irs.gov/charities/article/0,,id=256679,00.html.
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Reasons to consider a social enterprise that is a program/ division of
nonprofit
If the majority of the following is true:
Social enterprise is critical to fulfilling organization’s mission
Social enterprise activity is the majority of what the organization does
Mission of social enterprise is primarily “social”
Majority of organization’s assets and liabilities are related to the social
enterprise
 Social enterprise activities are tax-exempt
 Grant funding is and will remain an important revenue source for the enterprise




Potential downsides
•
•
Lose access to certain contracting preferences only available to for-profits (SBA
loans, minority or women owned certification, local small business
certification)
Customers may view social enterprise as a nonprofit rather than a business
which could lead to certain perceptions such an an expectation for lower
pricing
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Reasons to consider a social enterprise that is a wholly-owned
nonprofit subsidiary
If the majority of the following is true:




Social enterprise is only part of organization’s activities
Social enterprise activities could pose liability issues for parent nonprofit
Social enterprise activities are tax-exempt
Grant funding is and will remain an important revenue source for the
enterprise
Potential downsides
•
•
•
Costs for setting up a new entity can be expensive
Ongoing costs for a new entity can also be very expensive i.e., (sustaining
infrastructure)
Need to ensure proper separation of two entities to truly protect assets of parent
nonprofit – otherwise, the parents assets will be more vulnerable to debts and
liabilities of the subsidiary, also known as “piercing the corporate veil”
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Reasons to consider a social enterprise that is a wholly owned
for-profit subsidiary/ benefit or social purpose corporation
If the majority of the following is true:
Social enterprise activities could pose liability issues for parent nonprofit
Social enterprise activities are not tax-exempt
Social enterprise requires outside capital
Social enterprise operates in an industry that is difficult for a nonprofit to operate in – e.g.,
construction
 Primary motivation of social enterprise is profit
 Social enterprise can benefit from licenses, certifications and tax credits that are only
applicable to for-profit structure
 Social enterprise can benefit from contracting preferences only available to for-profits




Potential downsides
• Might be harder to access grant funding
• Potential reputation impact on parent nonprofit from stakeholders and community if they are
seen as too “business-like” or “profit motivated”
• New hybrid entities have not been tested
• Additional reporting requirements
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Reasons to consider a social enterprise that is a partially owned
for-profit subsidiary/ benefit or social purpose corporation
If the majority of the following is true:
Social enterprise activities could pose liability issues for parent nonprofit
Social enterprise activities are not tax-exempt
Social enterprise operates in an industry that is difficult for a nonprofit to operate in
Social enterprise can benefit from licenses, certifications and tax credits that are only
applicable to for-profit structure
 Social enterprise can benefit from contracting preferences only available to for-profits
 Social enterprise wants to bring in additional sources of funding, especially in the form of
equity




Potential downsides
• Partially owned subsidiaries can be complicated and expensive to set up, especially when
bringing in equity investors
• Having multiple stakeholders/ shareholders making decisions for the organization may
potentially lead to straying from organization’s initial mission or purpose of the social
enterprise
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APPENDIX
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Tradeoffs between different ownership structures
Relative importance of criteria – can vary by organization
Wholly owned
Partially owned
Worker owned
Cost and timelines to
set up
• Varies based on legal
form
• Can be expensive and
complicated to set up
depending on ownership
structure
• Can be expensive to set
up effectively
Organizational
dynamics
• Parent nonprofit selects
board and has control
via this process
• Decision making can be
complex
• Worker-owned aspect
key to mission
• Decision making
structure varies
Access to capital
• Capitalized by parent
nonprofit
• Attract equity
• Potential for innovation
• Depends on legal
structure of the
cooperative
Other considerations
• Make decisions on how
to represent
relationship (i.e.,
consolidated financial
statements)
• Generally, cheaper and
faster
• Ongoing investment and
training to maintain
culture
• Might be suitable only
for certain target
populations
Tax implications
• Depends on the legal
form of the subsidiary
• Depends on the legal
form of the subsidiary
• Worker owned
cooperatives are not tax
exempt
• Supporting mission can
get complicated if
multiple parties are
involved
• Worker ownership
critical to mission
and/or theory of change
Supports
accomplishment of
social mission
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L3C: Low-Profit Limited Liability Company
What is an L3C?
➨ An L3C is a hybrid legal entity that blends elements of non-profit and for-profit entities. It is essentially an
LLC that must be organized and operated for a social purpose and profit must not be a significant
purpose
What makes an • Unlike an LLC, the L3C has an explicit primary charitable mission and only a secondary profit concern
L3C different than • Unlike a charity, the L3C is free to distribute the profits, after taxes, to owners or investors
standard LLC?
• Makes it simpler to qualify for PRIs
Level of support
Other
considerations
• Relatively new legal form, only allowed in certain states
• Many practitioners and experts in the field are not a fan of this structure for the following reasons:
• In general, the L3C has more restrictions without clear benefits (for example, no tax breaks -> structure
might make more sense if there are tax breaks)
• Untested new form with not much information currently available
Sources: Interviews
1http://www.sec.state.vt.us/corps/dobiz/llc/llc_l3c.htm
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Benefit Corporation
What is a Benefit Corporation?
➨ A Benefit Corporation is a hybrid legal entity that blends elements of non-profit and for-profit corporations. It is
essentially a corporation that must be organized and operated for the purpose of “creating a general public benefit.” It
is taxed like a corporation. It protects directors from liability for pursuing a social objective instead of simply profit.
Benefit Corporations are also subject to additional reporting requirements relating to its performance in creating a
general public benefit and its performance against a third-party standard.
Characteristics of
a Benefit Corp/
Social Mission
What is a
Benefit Report?
Level of support
What are the
advantages of
this structure?
•
Mandates that, in addition to shareholders, the board of directors take the environment, community, employees and suppliers into account
when they make decisions; Requires environmental and social benefit (i.e. triple bottom line)
•
Mandates a high level of transparency and accountability - within 120 days after the end of each fiscal year, a Benefit Corporation is
required to publish a Benefit Report, which states how the Benefit Corporation performed that year on a social and environmental axis
•
Mandates that directors assess the performance of the corporation in achieving its general public benefit purpose against a third-party
standard (such as B Corp)“
•
Third party independent assessment that measures social and environmental impact; most prominent is currently B Labs’ Assessment.
The Benefit Corporation has to then share this assessment of its performance publicly
•
Both GRI and B Lab offer companies the use of their reporting (GRI) and assessment (B Lab) tools for free
•
•
Environmental benefit can be minor (i.e. recycled paper, no water bottles, etc.) but social benefits are not enough
Relatively new legal form, only allowed in certain states
•
Provides clarity to directors and officers that duty includes pursuing the creation of material positive impact on society and the
environment, even in liquidity scenarios
•
Offers liability protection to its directors and officers to consider interests of its workforce, community, and the environment when making
decisions
•
Offers a distinct point of differentiation in environmental where many organizations may claim to be socially minded
•
Some municipalities (e.g. San Francisco BoS 120082) offer adjustments or preference for “competitively-solicited City contract(s)” to stateincorporated Benefit Corporations”1
Sources: Interviews
1http://www.sfbos.org/ftp/uploadedfiles/bdsupvrs/committees/materials/bfs040412_120082.pdf
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Social Purpose Organization
What is a Social Purpose Organization1?
➨ A Social Purpose Corporation is a hybrid legal entity that blends elements of non-profit and for-profit
corporations. It is a corporation that must state a specific social purpose for which it is formed. It is
taxed like a corporation. It protects directors from liability for any decisions that involve balancing the
corporation’s special purpose against its financial condition. Social Purpose Corporations are also
subject to additional reporting requirements assessing its performance in achieving its special purpose.
Characteristics of
a Social Purpose
Organization
•
Unlike a Benefit Corporation, a Social Purpose Corporation is not required to pursue a generalized public benefit or measure
its performance against a third-party standard. Social Purpose Corporation directors may give weight to a variety of factors,
including the prospects of the corporation, the interests of the corporation and its shareholders, and its “special purpose”, as
they see fit in their decision-making.
•
Social Purpose Corporations are allowed to choose their own “special purpose,” as long as it fits the general description set
forth below. The SPC must clearly state its specific purpose, outline goals to achieve that purpose, and publish an annual
report disclosing how well it has achieved that purpose (no third-party standard required for this report yet)
•
The special purpose chosen by a SPC can be anything that generally benefits society, but can include the following:
What is
Considered a
“special
purpose”?
What are the
advantages of
this structure?
•
•
One or more charitable or public purpose activities that could be carried out by a nonprofit public benefit corporation
•
The purpose of promoting positive short-term or long-term effects of the Social Purpose Corporation’s activities upon
stakeholders, the community and society, or the environment
•
The purpose of minimizing adverse short-term or long-term effects of the corporation’s activities upon stakeholders,
the community and society, or the environment
Similar to Benefit Corporation (previous slide) but with even less liabilities for directors, as well as less accountability from
third-party standards
Sources: Interviews
1Update 4/2015 to reflect CA change from “Flexible Purpose Corporation to “Social Purpose Corporation”
http://www.nonprofitlawmatters.com/2014/10/06/goodbye-flexible-purpose-corporation-hello-social-purpose-corporation-governor-brown-signs-s-b-1301/
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