First a caveat: My goal is to provide an overview of a topic growing in significance, offer intellectual food for thought, stir up some debate, and encourage discussion – in 1200 words or less. Thankfully, individuals way smarter and knowledgeable than I have spent many months researching the legal complexities involved. So, with a huge sigh of relief I respectfully direct you to the links on the following site for a more thorough examination of this issue. www.centreforsocialenterprise.com
Understanding the current situation
Okay, first question: do we really need a separate legal structure? What challenges would it help social entrepreneurs overcome that they can’t accomplish otherwise? Legitimacy, for one thing, saysStacey Corriveau, director at BC Centre for Social Enterprise. The term “social enterprise” does not have a legal definition in Canada, neither in the Income Tax Act, nor any national or provincial act or regulation. And that leads to a branding challenge. Branding legitimizes the practice, builds awareness and establishes credibility.
A legal structure would also help clarify the limits on social enterprise activity, Corriveau adds. There are far too many charities, for example, who misunderstand the obligations of the CRA and its definition of “related business.” Many remain offside without even knowing it. Then there’s the need to attract investors. As charity lawyer Richard Bridge states, “In Canada and elsewhere, limited access to capital is arguably the greatest obstacle to social enterprise projects.” To wit: although corporations can be used as social enterprise vehicles, the intention of shareholders is to maximize profits, not promote community interests. Meanwhile, incentivizing investment into non-share corporations is difficult in its own right.
Fair enough, but can’t we work with what we have? “We currently have structures in Canada that are pretty flexible for any organization that wants to operate social enterprises; I don’t really see a huge amount of value in having a new structure,” posits Anne Jamieson, program manager of the Toronto Enterprise Fund at United Way of Greater Toronto. Canada also boasts a legal nonprofit structure, she adds, something lacking in the US and UK, making the process more amenable in this country.
In fact, social enterprises in Canada have at least five different ways of structuring themselves: incorporating a share capital corporation; incorporating a non-share capital corporation (nonprofits); a charity operating a related business; a charity or nonprofit running a for-profit business; and cooperatives. Are these not enough, Jamieson asks?
Not according to Bridge. “The CRA’s treatment of nonprofit organizations is increasingly restrictive, to the point now that the generation of profit is only accessible if it is “unanticipated.” This is a serious impediment to social enterprise,” he replies. “Canadian non-share capital corporations/societies cannot be established for the purpose of profit, and they have no shares to offer to potential investors,” adds Bridge, explaining that in some provinces, Nova Scotia for one, societies are prohibited from engaging in any business activities at all. What’s more, though nonprofit organizations play important roles in community, in their current form they are ineffective vehicles for commercial enterprise.
Finding the right vehicle for the venture
Next question: what would this legal structure look like? With inspiration hailing from the US and the UK, we take a glimpse at their arsenal. In 2007, L3Cs (low-profit limited liability companies) were introduced in the US. Most importantly for our purposes, L3Cs can accept program-related investments (PRIs) – loans, equity investments etc. from foundations with the expectation of below-market (or zero) returns. As opposed to grants, if PRIs return to the foundation, the grantor must reinvest the amount into another PRI or a grant within one year (Note: CRA recognizes PRIs and some Canadian foundations already use them, but they’re not as of yet systematized).
“L3Cs are really intended to make it possible for foundations to take the riskiest role when investing in social enterprise,” explains Jerr Boschee, founder and executive director of the Institute for Social Entrepreneurs in Dallas, Texas. “Their money would go in first and that would allow other investors to follow.”
Taxed according to the tax rates of partners at the table, L3Cs offer something else that makes Corriveau gush: tranched investments. “You can have different stakeholders investing in the social enterprise with different rates of return.” It essentially encourages mainstream investors to come to the table. The problem with an L3C is it’s not a new legal entity but a variation of something called a limited liability company (LLC). Without a similar foundation in Canada, L3Cs would be difficult to adapt.
Which brings us to the UK and their community interest companies (CICs). Introduced in 2005, CICs possess interesting features that make a related model desirable, say its proponents. For one thing they’re easy to set up. For another, they can issue shares to raise capital. But, unlike traditional corporations, dividends paid on these shares are controlled by a cap on returns, ensuring more money goes toward community good. To ensure assets are retained in the community, CICs are subject to an “asset lock.” If the organization winds down, assets and profits are transferred to another asset-locked CIC or a charity. Though less regulated than charities, CICs are taxed at corporate rates.
One of the biggest advantages of CICs, according to Bridge, is they’re able to do what Canadian charities and nonprofit organizations cannot directly accomplish themselves: raise equity capital. “That is, raise funds in exchange for shares, the way that traditional business corporations and some co-ops do. This enables and encourages the investment of private wealth in community projects – a combination with enormous potential.”
Figuring out what works
So what’s the verdict in the UK? “It’s quite useful because it has brand association and protection in place and it’s the one regulated form of social enterprise so there is some added value,” says Ceri Jones, head of policy at the Social Enterprise Coalition. But keep in mind it’s only been around for a few years. “We’re working within the framework of what we have already,” she adds, alluding to a rich legacy that inspired different legal forms. As to whether Canada should use CIC as a model, she replies, “it depends on what you have in place already.”
With more than 3,500 CICs established in four years, it’s clear to Stephen Lloyd they’re a useful innovation. But, cautions the senior partner and head of charity and social enterprise at Bates, Well & Braithwaite in London, the lack of tax relief and asset lock are problematic. “The asset lock can make it difficult to use CICs as a vehicle for raising risk capital where the investors want not only a rate of return but also participation in long term capital growth.” Still, legal forms are vital, he says. “Without an easy to use off-the-shelf legal form such as a CIC, social entrepreneurs are condemned – as with the case in the UK prior to the CIC legislation – to creating one-off legal structures which are necessarily expensive and time consuming.” Corriveau and Bridge support a modified version of the CIC in Canada, one that alters cap on investment returns and modifies the tax treatment. “I would want to see something between a corporation and a charity,” says Corriveau.
Questions and concerns still abound, however. Julie McDowell of ClearlySo Canada defers the decision to her members, but remains hesitant. “The social economy is already growing rapidly, driven by creative entrepreneurs who are breaking new ground daily,” she says. “We must be careful not to propose ideas that might unintentionally break their momentum just at a point when investors are warming to the idea of a blended return.”
For Jamieson it’s a question of priority. “It’s not about saying we should or shouldn’t do it, but there are things we could be spending our time and money on that would bring us more tangible results.” Things like promoting success stories, she adds. Others, like Heather O’Hara, wonder whether legal reform is the answer. “Legal reform is not the critical determinant of success,” says the executive director of Potluck Café & Catering. “From our personal experience, the lack of a specific legal structure for social enterprise in Canada has not prevented us from reaching success in terms of achieving both our community mission and a self-sufficient, sustainable enterprise.”
Perhaps so, but Corriveau is quick to point out that a new legal structure “is just another item on the menu, we’re not taking anything off of it; and if your structure works for you, party on.” Spoken like a true trailblazer.