Funding the Future: Does Social Enterprise Match Your Mission?
As nonprofit leaders look to emerging and innovative ways to fund operations, they may consider developing a social enterprise to generate revenue. In this emerging practice, it is important to understand the advantages and risks of establishing and operating for-profit businesses as a way to raise funds. There is a lot of interest in social enterprises recently that is, in part, due to Benefit Corporations becoming a new type of corporate entity in Pennsylvania and Delaware. Many nonprofit organizations are exploring whether it makes sense to go into for-profit business ventures and how to best form and manage these types of business operations.
Obtaining funding for a non-profit entity can sometimes be a challenge. Fluctuations in the stock market may make private foundations more or less likely to donate money to the non-profit and market uncertainty is making multi-year commitments scarce. Non-profits, however, are limited in the ways that they obtain capital to further their charitable purpose. Generally speaking, engaging in commercial activity can jeopardize the non-profit’s 501(c)(3) status if the non-profit generates taxable income unrelated to its charitable purpose. For example, many volunteer fire companies that are public charities operate private bars as a means of generating revenue. Often, the only employees of the nonprofit are bartenders and the largest budget item is alcohol. The financials of the nonprofit make it appear that it is a bar that occasionally buys some firefighting equipment rather than an organization that fights fires that generates a little extra revenue by operating a bar. The unrelated business income skews the financial statements of the nonprofit organization because it can make it appear that the purpose and activity of the organization is more directed to the commercial activity. This occurs because most commercial activity requires some sort of cost of good sold and money must be spent to make money. In contrast, most charitable funds go directly to the provision of charitable services and do not involve any sort of margin of profit.
Case Study: Benefit Corporations
One option for a nonprofit to consider it to establish a social enterprise in the form of a Benefit Corporation. This form of entity is a hybrid between a for-profit entity and a non-profit. It alleviates the tax implications of receiving taxable income for the non-profit as well as provides an additional source of sustainable funding in times of stock market decline.
Benefit Corporations differ from other types of for-profit entities in that they have a stated social purpose and are evaluated based on that purpose rather than purely on profit or shareholder return. The purpose of a Benefit Corporation includes creating general public benefit, which is defined as a material positive impact on society. A Benefit Corporation’s leaders operate the business with the same authority as in a traditional corporation but – whereas in a traditional corporation, shareholders with proper standing judge the company’s financial performance – here they judge qualitative performance based on the Benefit Corporation’s stated goals.
Some Benefit Corporations such as Tom’s Shoes, Seventh Generation and Ben & Jerry’s Ice Cream have become household names. The for-profit entities were established to both address a social or environmental issue and generate profit. They use their “do gooder” reputation to gain advantage from a marketing perspective or differentiate themselves from competitors. The recent trend of hybrid organizations provides a viable option for non-profit entities that are looking to generate income. This structure avoids mixing taxable and non-taxable income and supplements donations when the market and other factors preclude sufficient private donations. Benefit Corporations also further the non-profit’s charitable purpose while generating revenue.
Balancing More than the Books
Benefit Corporations, used properly, offer several advantages and opportunities. First and foremost, they allow the funding of the enterprise to be funded by sales of their product or service, rather than relying upon charitable giving. Simple on its face, this change has a profound effect at many levels of the enterprise’s operation, presenting both new opportunities and challenges for the enterprise. Market forces and competition will typically force the social enterprise to be more responsive and adaptable than a typical charitable organization due to the need to “sell” a product or service to customers rather than report outcomes or results back after charitable activity has taken place.
Charitable organizations often risk becoming “siloed,” providing the service they believed was necessary at their formation, and may have been, but never adapting to better serve the people or purpose they were formed to assist. Additionally, within the charitable structure, the organization must serve not only their intended beneficiaries, but often their donors as well, a situation often creating conflict and compromise avoided by the more direct market connection available through a commercial social enterprise.
At its core, the key challenge in the operation of the social enterprise is one of balance. While a traditional for-profit makes decisions based on maximizing profit, and the non-profit reinvests towards its charitable purpose, the social enterprise must always keep the two in balance. This must be done both on a balance sheet and in the perception of the enterprise’s investors, supporters and customers. In the right circumstances, this challenge pales in comparison to the benefits available to the social enterprise, and the ability to allow a successful business model generate profits for its operators, while also furthering its charitable purpose. Ultimately, the goal of any social enterprise should be to use the power of business and enterprise to advance charitable objectives.