A social enterprise may be structured as a department, program or profit center within a nonprofit and lack legal definition from its parent organization. It may also be a subsidiary of its nonprofit parent, registered either as a for-profit or nonprofit. Many organizations use a mix of different structures simultaneously.

The following diagrams illustrate the social enterprise structure vis-à-vis its relationship to the parent organization.

Structured Internally

Social enterprise is structured as a department or profit center within the parent organization. The social enterprise may (or may not) physically share space with the parent. From a legal, financial, management, and governance perspective the enterprise is internal to its nonprofit parent. Systems, back office, staff, and leadership are integrated.

Any of the operational models can be structured internally within the parent organization; however, embedded and integrated social enterprises are the most common forms using this structure.

Structured as a Separate Entity

Social enterprise is structured as a separate legal entity, either a for-profit or a nonprofit. In this case, the social enterprise may or may not physically share space with the parent. From a legal, financial, management, and governance perspective the enterprise is external to its nonprofit parent. If staff, overhead, or back office is shared, this is done so on a formal (contractual) basis as a business relationship. .

Any of the operational models can be structured as a separate entity from the parent organization; however, integrated and external social enterprises are the most common forms using this structure.

Structured as the Same Entity

Social enterprise is the same entity as the parent organization, meaning functionally that there is NO parent or host organization, rather the social enterprise is the only activity of the organization. There is no delineation between program, administrative and infrastructure aspects indicating the existence of two or more types of activities. This type of social enterprise may evolve into one of the other structures by adding new enterprises or social programs.

Embedded social enterprises are the most common form using this structure.

A social enterprise may be incorporated either as a for-profit or a nonprofit.1 It is however important to recognize that social enterprises are not defined by their legal status: legal status may be arbitrary. A social enterprise’s structure or model is not a definitive determinate of its legal status.

The decision to incorporate the social enterprise separately from the parent, and then to do so as a for-profit or nonprofit is driven by one or more of the following factors:

Legal Environment

The law in many countries does not make provisions or recognize the social enterprise (income-generating nonprofit) as legitimate or legal. Therefore, nonprofit organizations risk losing their nonprofit status and associated privileges by launching a social enterprise or income-generating activity. Some countries have made special provisions in the law and tax codes for social enterprises.

Legal issues are complex and vary widely. The environment is more enabling in some countries than in others; however, there is still work to be done around the world on this issue.

Generally speaking governments regulate social enterprise according to:

• nature of business activities--related or unrelated to organization's mission;
• use or destination of earned income--to mission activities or other purposes;
• source of income--general public, clients, 3rd party payers (insurance, donors), government;
• the amount of income earned through social enterprise--limits placed on either monetary amount of percentage of budget; or
• a combination of these.

In any case, the legal situation must be analyzed on a country-by-country and case-by-case basis.

Regulatory Environment in Emerging Market Countries2

While the legal environment varies from country to country, a general lack of clarity in the law about the legality and tax treatment of NGOs engaged in economic and commercial activities in emerging market countries results in a variety of practical and ethical challenges for many NGOs.3

Many social enterprises operate in "legal grey areas," fearing that their commercial activities will jeopardize their NGO status. Attempts to remain "off the radar screen" of local authorities forces social enterprises to remain small and thus unable to maximize their profit potential or achieve scale. In some instances, local authorities or "tax police" take advantage of the ambiguous laws and extort social enterprises, requiring them to pay bribes or exorbitant taxes that can threaten the survival of both the enterprise and the NGO. In other cases, governments have eagerly looked to social enterprises as a new mechanism for building the tax base, and charged high taxes on earned income, crippling social enterprise performance and preventing them from achieving their purpose of funding social activities. Where the laws are clearer, reporting requirements can be burdensome, penalties harsh, or tax incentives nonexistent. Furthermore, the lack of clarity in the law presents an ethical dilemma for NGOs as they struggle to promote and preserve a reputation of transparency and accountability to their constituents, donors, and public-at-large, while also trying to identify the most favorable tax treatment for their social enterprise.

Although the microfinance field has made inroads into creating an enabling environment for NGO financial service businesses and raising awareness about NGO income generated as a means to achieve sustainability, the legal environment for social enterprise development can still be strengthened. Advocacy efforts have the opportunity to dovetail with the work of microfinance, broadening governments' understanding of social enterprises not as a mechanism to build the tax base, but rather as an instrument to replace government funds that draw from taxes. An unambiguous and favorable legal environment, such as tax incentives to social enterprises, would not only foster growth in this field, but would also serve to increase integrity and clarify ethical questions and public misperceptions regarding NGO commercial activities.

Access to Capital

Social enterprises are capitalized through a variety of different instruments: grants, loans, charitable contributions, program-related investments (soft loans, etc.), or a combination thereof. The type of funding a social enterprise is able to obtain depends on its maturity, reputation, availability of funding (nonprofit capital market), and legal structure. On the latter point, an organization may choose a legal structure that is consistent with the funding it seeks. For-profits are often barred from receiving philanthropic funds and soft loans, whereas nonprofits have difficulty obtaining commercial funds--borrowed capital. In this case, legal status may be guided by the requirements for the most suitable type of funding.

Capitalization

Undercapitalization is a problem as common in private business as it is for social enterprises, particularly for capital intensive enterprises such as manufacturing. For-profits have the ability to raise equity investments that, depending on the local laws, are not an option for nonprofits, whose assets are considered publicly owned. Some social enterprises opt to incorporate as a for-profit and many mature nonprofits convert their legal status in order to capitalize the business with private funds in exchange for equity. In the early stage, social enterprise incubation usually occurs within a nonprofit parent, which also serves to capitalize the nascent enterprise.

Leadership Decision

Frequently the board or executive director will opt to incorporate the social enterprise as a separate legal entity simply out of preference. Integrating business practices and income-generation into a nonprofit organization rocks institutional culture and tests capacity, potentially threatening core social service programs of the parent organization and causing internal strife or mission drift. Also, when the business is unrelated to the organization's mission, it can be difficult to gain stakeholder and staff support. In these instances, leadership may prefer to separate the entities both physically and legally.

• 1In the US this is a 501(c)(3) and in most developing countries a nongovernmental organization (NGO)
• 2For more information pertaining to social enterprise legal issues in emerging markets see: Etchart, Nicole and Lee Davis, Legal Series: Chile and Columbia, 2002; and Profits For Nonprofits, NESsT, 1999, chapter 3 Legal Issues as well as: International Center for Not-For-Profit Law (ICNL)
• 3Etchart, Nicole and Lee Davis, Unique and Universal: Lessons from the Emerging Field of Social Enterprise in the Emerging Market Countries, NESsT, 2003.

Three different types of social enterprise ownership structures exist: private, public and collective. Ownership can be either a driver for a social enterprise's legal structure or a determinate of it. In most counties nonprofits are considered "public good" or property of the public, thus calling into question the legal ownership of their assets, goodwill, brand, etc.

Public ownership may be practiced in the form of decision-making and participation as long as the organization is a going concern. Similar to traditional nonprofits, a public ownership structure indicates that governing board of directors directs strategy and financial oversight. Legally, nonprofit ownership becomes an issue if the owner(s) wants to sell the social enterprise, or close it and liquidates the assets.

Private ownershipof a social enterprise offers benefits of equity financing, unambiguous asset ownership and valuation, and the freedom to sell the enterprise. Conflict can arise between fundamental motives of profit-making and mission. For-profits must minimally breakeven and often have tax liabilities, limiting the type and purpose of the enterprise to more productive and financially driven models than those that may serve a social need, yet run at a deficit.

Public

Nonprofit Organizations -- the classic nonprofit organization is considered "public good," or property of the public. Nonprofits may own a for-profit or nonprofit social enterprise subsidiary. In the case of the for-profit, the nonprofit may sell the subsidiary or its assets, or raise equity for new investments; whereas the nonprofit subsidiary may raise charitable funds, but not equity and is subject to donor requirements and nonprofit law regarding ownership of assets and use of revenue. The nonprofit parent of the nonprofit subsidiary may acquire the assets of the social enterprise if the business fails or is closed.

Public Shareholders -- a consortium of nonprofit stakeholders that "hold shares" in a social enterprise (nonprofit or for-profit). Often the shareholders are comprised of parent organizations, partners and donors that have an existing program or financial stake in the social enterprise. Legal issues are similar for other public entities under this ownership structure. The public shareholder model is frequently used as an exit strategy when a parent organization seeks to spin off a social enterprise into an autonomous legal entity, yet wants to maintain some decision making power and preserve the mission during the transitional period to independence.

Cooperative

Nonprofit cooperatives are a common form of social enterprise particularly in developing countries. Driven by their social mission, most nonprofit cooperatives have a legal incorporation similar to other types of nonprofits, and are thus entitled to similar benefits as well as limited by similar restrictions as nonprofits. In practice, owners are "members" of the nonprofit cooperative and though they may have programmatic and business decision-making authority and realize certain advantages, they do not actually own the brand, infrastructure, assets, methodology, programs, revenue, etc. and do not enjoy private property ownership rights. The nonprofit cooperative requires oversight by a board of directors. The target population is the nonprofit cooperative’s membership; members realize social benefits, but do not receive income distributed from business activities.

For-profit cooperatives -- "cooperatively" or group owned social enterprise registered as a for-profit is age-old structure in both developing and industrialized countries. These cooperatives are profit-driven structures whose social contribution is aimed at improving economic conditions of a particular group, such as farmer or artisan cooperative. Often for-profit cooperatives (such as Equal Exchange, our example of Embedded Social Enterprise) are worker owned. Owners may also be called members and exercise legal rights and decision-making authority tied to property ownership: to sell, dissolve, liquidate the business and its assets, or expand the business and use revenue as they see fit. Owners may elect distribute profits to themselves or retain earning to reinvest in their business.

Private

Sole proprietorship -- in several emerging-market countries social enterprises are owned by a single individual to bypass laws restricting nonprofit commercial activity. In this situation the social enterprise owner is often the parent organization's executive director or a member of its board of directors. This structure introduces a risk of the business being cannibalized by an unscrupulous owner. Unfortunately in many countries, until the legal environment becomes more enabling, this is the only ownership option available. These entities though created to support a nonprofit are subject to local taxes and laws governing private businesses.

Private Shareholders -- in developing countries, the financial service industry is the leading example of shareholders and investor ownership of social enterprises (microfinance institutions, community or rural banks, credit unions, etc). Microfinance organizations that successfully commercialize their services and transform into for-profit financial institutions may sell shares to individuals, the government, other nonprofit organizations and donors to raise equity. Public sector owners are not required to be stakeholders in the parent organization or social enterprise other than as a social investor. Ownership shares may also be distributed to the target population as part of the social model. For example, when the Grameen Bank project transformed into an independent bank, it distributed 90% of its ownership to the poor rural borrowers its serves, while the remaining 10% was purchased by the government.

Benevolent Owners -- private ownership of social enterprises generally falls under the rubric of socially responsible business. In industrialized countries there are a growing number of small businesses created for the purpose of contributing to a social cause and generating revenue for their owners. In the United States, practitioners have formed their own industry organization: Social Venture Network. These businesses operate in accordance to standard laws for small business. For more information, see also the Business for Social Responsibility web site.