In this series, I dive into the challenges that social entrepreneurs face in solving the issues they can no longer leave unsolved. In this article, we take a closer look at one of the foundational questions when launching a social enterprise: what type of entity do I register my organisation as?

Almost all aspiring social entrepreneurs have heard some version of the same advice: register as a company if you want to make money, register as a charity if you want to take donations. People assume that picking the legal entity is one decision. Most people treat it that way anyway.

However, choosing the legal entity of your organisation is not one decision. It is at least three decisions, disguised as one. And being able to receive donations is not necessarily part of it.

The first decision: who gets the surplus?

Start with one of the assumptions that people have, namely, that charities are not allowed to make money. Charities can trade, sell, and turn a profit exactly like any business. What they cannot do is hand that profit to shareholders or members. The profit has to stay in service of the charitable purpose.

A company with shareholders, being an organisation that can issue shares and pay profit out to its owners, is usually excluded in Australia by law from charity registration. Charity status requires giving up the right to distribute what the organisation earns to the private benefit of its shareholders. Nevertheless, a company without shareholders faces no such exclusion. An example of this is a company limited by guarantee, with no one entitled to a payout. This type of entity is actually one of the most frequently used legal forms for charities.

Thus, for social entrepreneurs, this question is not about being in business, but who can legally claim money from it. Surplus is only the first of at least three decisions hiding inside the decision “company or charity”. The next two are just as vital but easy to miss.

The second decision: who's exposed if it goes wrong?

Besides questioning where a surplus of revenue can or should go, a very important question is what type of personal liability someone wants to have. Liability risk or protection is not answered through the same line as for-profit or not-for-profit. There are various organisational entities within the line where surplus can flow to the owners, where the owner is personally liable or only the legal entity itself, as well as within the line where surplus is locked to the purpose of the organisation. It is the question of whether the structure is incorporated.

For example, a sole trader, as a for-profit organisation, has full personal liability. An unincorporated association is a not-for-profit, but the members carry exactly the same exposure as they are personally liable for the debts of the organisation. But an incorporated association, a company limited by guarantee, and a standard company all offer limited liability. For these examples, it does not matter that they are on either side of the profit line.

So, when a founder decides the legal entity solely on the question of funding, they can be caught in a difficult liability question when things go wrong.

The third decision: who's actually in control?

As the word is in the name, social enterprise, most people think of control in the situation of a standard company, where control follows shares. Then, it is easy to assume that when you put in the capital and the unpaid work at the start, you control the organisation.

However, this is not the case in every form. There are various forms of legal entities that are run by the members, such as co-operatives and incorporated associations, with a one-member, one-vote governance. However, a company limited by guarantee places control with its members and directors, not with whoever funded the organisation first.

A founder who only decides its structure by answering the funding or liability question may give up more control than they would care for.

The advice wasn't wrong. It was incomplete.

Picking a legal entity based on these three questions (who gets the surplus, who's exposed, who's in control) is no easy task and has inherent trade-offs, as we have seen. That is why, at some point, many social enterprises choose to run two entities alongside each other: one to run the trade and provide the funding, and one charitable to receive donations.

Which brings us back to the much-heard advice at the top: register as a company if you want to make money, register as a charity if you want to take donations. Social enterprises don't make the decision necessarily because of the possibility to receive donations, as both companies and charities can receive them. It is just that, with charities, donations can be tax-deductible, as that requires deductible gift recipient (DGR) status provided by the Australian Taxation Office (ATO).

Social enterprises choose to do so because along the way they figured out that they could not accept the trade-offs paired with their initial choice anymore — the surplus, the liability or the control. But all were focused on providing as much social impact as they could to help the cause they care about.

Which of these trade-offs are you willing to accept, and which do you want to keep deciding for yourself?

Social Enterprise Series

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