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Competition Arrives to Social Enterprise

February 7, 2011

 

The conversation about legal issues faced by social enterprises has largely centered around legal structure: what corporate clothing a venture should don at the outset of its existence.  But there are many other legal issues SEs will face, and these will become more sophisticated as the field of social enterprise expands and matures.  This occurred to me recently when I stepped into a Skechers store at the mall.

I came across what appeared to be nothing short of a intentionally obvious copycat line of shoes created to mimic Tom’s Shoes.  The not-so-subtle name: Bob’s.  I asked the sales representative and she explained that these were just like Tom’s shoes, except that Skechers donates two pairs of shoes to children in need for each pair purchased by a customer.  What’s more, Bob’s shoes were less expensive than Tom’s by two dollars.  What surprised me most about Skechers’ one-upsmanship of Tom’s was not the stark similarity between Tom’s shoes and Bob’s shoes, but the fact that Skechers is now competing with Tom’s Shoes on charitability.  The reason to buy Bob’s rather than Tom’s, evidently, is that Bob’s have a greater positive social impact.

Consumers may have mixed feelings about the knockoffs, as one loyal Tom’s Shoes customer expressed in this blog post.  In the for-profit world of footwear, such an obvious imitation by a competing company might spur an intellectual property lawsuit (meritorious or not) alleging patent or trademark infringement.  But what happens when social enterprises encounter similar imitations of their products?  While it does not appear that Bob’s Shoes is at any imminent risk of being sued, this is unlikely to be the last time social enterprise encounters competition.

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Resources for Students

January 21, 2011

Recently I gave a talk at my alma mater, Washington University School of Law, and was pleasantly surprised by how many 1Ls (that’s first-year law students) both (1) were not aware of the concept of social enterprise, and (2) were very excited about learning more once they were introduced to the idea. I was approached by a number of students afterward who wanted to know where they should go to get up to speed on social enterprise and what could be done with it, particularly for law students. Unfortunately there is not much out there geared toward lawyers or budding lawyers – at least not yet. But here is my initial attempt, an annotated bibliography of sorts, to identify some of the resources that I think may be useful for law students, or really anyone looking to learn more about social enterprise.

Social Enterprise: A Lawyer’s Perspective. A helpful article by Allen Bromberger, discussing the legal structure options for social enterprises in the U.S.

www.LawForChange.org. An impressive and user-friendly collection of jurisdiction-specific legal resources for social entrepreneurs in the United States.

www.americansforcommunitydevelopment.org. The website of the organization that created the L3C, a hybrid legal structure designed with social enterprise in mind that has been adopted in some states. The site contains useful information about the design of L3Cs and how they legally work.

www.socialedge.org. A meeting place for the minds of some prominent social entrepreneurs, with periodic blog entries and substantive articles on issues arising in the field.

http://www.se-alliance.org. The Social Enterprise Alliance is a good organization to join if you want to stay involved in what is happening in social enterprise in the U.S. There are some local chapters, and more are being established every year.

Finally, I’d like to suggest that if you do nothing else, you read an article about an inspiring social enterprise. This is, I think, the best way to see what is possible with social enterprise, and it lays the groundwork for understanding the more technical finance and legal aspects that arise at the convergence of financial and social profit. A suggested article is one recently published in the New York Times, focusing on Husk Power Systems in India.

Obviously there is a lot more out there, so I would love to hear from anyone with suggested additions.

Legal Resources for Social Entrepreneurs Begin to Grow

October 11, 2010

Several months ago, without much fanfare, the Lex Mundi Pro Bono Foundation launched LawForChange.org.  The first comprehensive online resource specifically devoted to the legal questions of social entrepreneurs, LawForChange contains a remarkable collection of jurisdiction-specific articles organized by state.

Practitioners familiar with social enterprise are aware of the frustration that prospective social entrepreneurs feel when trying to identify the correct legal structure for their ventures.  Informal polls have suggested that the legal structure question is the single greatest challenge that social entrepreneurs face when starting a venture.   The frequency of this problem is one of the reasons why comprehensive legal resources for aspiring social entrepreneurs are so crucial.

In the future, I hope to see more resources like the one that LexMundi has created.  I would be interested to hear from anyone who has found with other publicly-available legal resources for social entrepreneurs.

“In truth, there is no such thing as a nonprofit organization.”

June 22, 2009

So declared L3C creator Robert Lang, Jr. in the April 1, 2006 issue of Worth. And really, wouldn’t most people agreedesired desiredthat all organizations — regardless of tax status — can and should create more value than they consume?

But there is a misconception, perhaps born of the dichotomous thinking about for- and non-profit organizations, that nonprofits are supposed to generate social profit, not financial profit.  In my experience, many older nonprofits tend to shy away from starting new earned income funding streams.  There may be many reasons for this, but one is certainly fear of jeopardizing their tax-exempt status.

Not only is this untrue, it perpetuates a limiting dependency on foundation grants and individual donations.  So, let’s break it down.  If you’re a tax-exempt organization, what can you (and what can’t you) do?  (But first, the obligatory legal disclaimer: this is not intended to constitute legal advice and any nonprofit seeking to make significant changes in its program should seek the advice of its own attorney before doing so.)

The first thing to keep in mind is that it is possible to implement a revenue-generating business activity without altering your legal structure or jeopardizing your 501(c)(3) status.  In fact, you may not even need to amend your articles of incorporation.

Second, keep in mind that any income you generate from your business activity must be used to support your organization’s mission.  It is subject to all of the other rules that apply to tax-exempt entities, including the prohibition against self-dealing and private inurement.

The key legal effect that the adoption of a business venture will have on your organization is the potential for taxation.  As a 501(c)(3) tax-exempt organization, you enjoy the benefit of avoiding most taxes: the federal income tax, state income taxes, and even some state ad valorem taxes.  When you implement an earned income strategy, you will retain your tax-exempt benefits, at least for federal tax purposes, so long as your business activity is substantially related to your charitable mission.

If, however, you regularly carry on a business activity that is not substantially related to achieving your mission, you may be subject to an unrelated business income tax, or UBIT, on your earnings.  There are three key components to the previous sentence: in order to be subject to UBIT, (1) you must engage in a business activity, (2) that business activity must not be substantially related to achieving your mission, and (3) you must be engaging in that activity on a regular basis.

Following the above rule, consider whether your earned income venture is truly a “business activity.”  According to the IRS, a business is “any activity that is carried on for the production of income from the sale of goods or the performance of services.”  Fairly broad, and it covers most things you might think about when considering how you might leverage your organization’s abilities to earn income.

Next, ask whether your business activity is substantially related to your charitable purpose.  Your charitable purpose is what you wrote as your statement of purpose in your articles of organization when you first formed, or your mission statement.  Your business activity cannot simply generate income for your charitable purpose, nor can the activity be merely related to your purpose.  It must be substantially related – and herein lies the difficulty of the IRS’s inexact test.  Your business activity is more likely to be substantially related to your purpose if your activity is proportionate to the needs of your organization’s purpose, if you sell an item in substantially the same condition as you obtain it, and if the earning of a profit is incidental to the accomplishment of your mission.  Think of it as an activity whose primary goal is achieving your mission, while simultaneously accomplishing your secondary goal of turning a profit.

Third, look at whether you are engaging in your activity on a regular basis.  The IRS does not offer a bright-line test for what is considered “regular,” which leaves nonprofits again in the throes of uncertainty.  The commonly-discussed guideline is 15 to 20 percent, meaning that you should limit your unrelated business activity to less than 15% or 20% of your operational time or your gross income.  Another guidepost is whether you conduct your business activity in much the same way as a for-profit entity might, such that you are essentially competing with your for-profit counterparts.

The above three-part test is simplified; there are intricacies involved, as a more accurate determination of whether your organization’s activities subject it to UBIT requires analysis of IRS Private Letter Rulings and the Internal Revenue Code.  There are also a number of exceptions that may alter the analysis somewhat.  Complicated as it may seem, the take-home is hopefully clear: you can start an earned income venture without necessarily subjecting yourself to UBIT.

Entrepreneur’s Startups: Mixing Business With Passion

June 10, 2009

Check out my article on the 7 key steps to consider when starting social enterprise, recently published in the summer 2009 issue of Entrepreneur’s Startups!startups-summer-2009

Ruesga Detects a Sneer as the Council on Foundations Kicks Off its Annual Conference

May 4, 2009

Kicking off its annual conference in Atlanta, the Council on Foundations has launched a new blog, RE: Philanthropy where “leading voices talk about big moments and ideas from Atlanta and beyond.”  If the posts so far are any indication, there is some lively discussion going on at the Marriot Marquis.

Albert Ruesga, president of the Greater New Orleans Foundation, has kicked off a discussion about sector agnosticism that both acknowledges the concept and questions its wisdom.  Are sector agnostics simply misguided young people who assume that there is a market for everything?  Will capitalism solve the world’s social problems?  Join the discussion (and check out my comment) at http://www.cofinteract.org/rephilanthropy/?p=146#comments

Stimulus Dollars Available for Community Development

April 27, 2009

I was recently fortunate enough to attend a legal seminar at which Washington, D.C. tax attorney Michael Sanders discussed new market tax credits and the availability of stimulus funds for community development efforts.  Although this program has been available since 2000, it was news to me, and I’m thinking perhaps there are organizations and businesses out there who might be a good fit for the program but aren’t aware of it.  A run-down of the basics:

On March 23, 2009, the Treasury Department announced that due to an earmark in the American Recovery and Reinvestment Act of 2009 (the federal stimulus bill), an additional $5 billion will be available for the new markets tax credit.  This is great news for both investors and community development organizations/businesses because it means access to capital in economically depressed areas.

The new market tax credit stemmed from federal legislation passed in 2000 that allowed a 39% tax credit for investors in certified Community Development entities, or CDEs.  Here’s how it works: an entity applies for CDE certification through the Department of the Treasury.    Upon receiving this certification, the CDE can then seek funding and investment from banks, private individuals and foundations.  Investors in a CDE can claim a tax credit equal to 39% of whatever they have invested.  The goal is to attract investment and promote growth in economically distressed communities.

The CDE can then use the money it raises to provide loans to “qualified active low-income community businesses,” charter schools or other entities that qualify.  I’m still researching the details, but you can check out the Treasury Department’s site on the New Markets Tax Credit here.