Hey Engagespark, I am doing a research on foreign social enterprises since we are having new regulation on the area here in Denmark. This blog has being very interesting as a starting point.

I understand your argument about taxes, but I have being involved with NGO’s focusing on corporations lacking tax payment – especially in the poor countries and the argument that the “company” use of money is better spend then government spending, well, fact is that money often is going out of the country.
At least if you start income-earning operations in the poor countries, be sure to pay your share of the taxes, there is a battle going on to make corporations pay, and its better to be on the right side.. especially when you are in the doing-good business.

I will take a further look at your site, and thank you so far 🙂

“or you’ll just lose a lot of money to taxes that could have gone to social programs.” http://www.thebeaveronline.com/tax-evasion/

This is the exact thing we are going through right now. There was so much detail on what you researched that wasn’t going to work, and then very little details about how the Hong Kong company will help with these issues and how to set it up correctly.

Why did you choose HK over other no/low tax countries? Just because it was in Asia? Did you look at other countries like Panama, Belize, Singapore, etc.?

What implications will this choice have for you in the U.S.? What will you have to do to stay compliant, and what risks are there? (How do you stay out of trouble)?

Will you have issues accessing your cash internationally? Will there be any tax issues with using your profits towards a social cause? Now that a few months have gone by, have you found out any more pros and/or cons to your new HK company?

Hello Christina – Thank you for your post. I am currently working on local sourcing focused social enterprise in Guatemala. Any chance we can talk for a few minutes to get your insight on legal structure as well as challenges that you faced? I can be reached at samrat.karnik@gmail.com

Thanks so much for the comment, Christina. We definitely agree that there should be legal guides for incorporating non-US based social enterprises. After we launch engageSPARK and get working on our next social business, we likely will spend a fair amount of time looking into social enterprise structures in some foreign locations; once we do, we’ll definitely publish our findings.

Regarding Hong Kong, we haven’t seen any legal framework that allows us to protect our social mission within our articles of incorporation (called Memorandum and Articles of Association in Hong Kong), but we decided to nonetheless incorporate there for the reasons we spelled out in our blog post. What we’re doing to ensure that we remain a not-for-profit social enterprise is creating a strict contract between our shareholders that severely punishes any shareholder who tries to sell or transfer their shares, so that there is a huge disincentive for the shareholders to disregard our social mission. We’re also forbidding dividends in our bylaws. We believe that these two restrictions will safeguard our mission to a great extent.

Thanks for the kind words. We’d agree that pure for-profits (as opposed to social enterprises that have both social and for-profit missions) have access to larger pools of capital because investors don’t need to worry about their
investee companies pursuing anything other than profits – if the company seeks profits only, the investor has a higher likelihood of seeing a higher return. But, that doesn’t mean social enterprises can’t attract seed capital.

The challenge, though, is balancing dual missions of profit and social good, especially if investors start putting pressure on the social enterprise to focus less on social impact and focus more on extracting value for themselves. While in that case, your social enterprise may have higher growth, it may in turn have lower impact – balancing all of that is a difficult task. And it’s also important to think about who is benefiting from the value creation of building the enterprise – how much of it benefits the target community, the executive team, and the investors. Also, please check out our response to Nan above, where we delve a bit more into this question.

Hi Tul – great points! Regarding your first point, you’re absolutely right. And there is certainly something to say for being “owned” by the public – it adds a level of oversight to ensure a social mission that a for-profit can’t truly have. We in fact very much wanted to be a 501(c)(3). But we couldn’t be one given our goals. We spoke to many experts on non-profit law (and did a bunch of separate legal research) and concluded that our business model wouldn’t jive with being a 501(c)(3). As we note in the blog post, we plan to also market the engageSPARK services to businesses (as a fundraising mechanism – so that we have more funds to improve engageSPARK, subsidize rates to NGOs, and develop new pro-poor products and services). But by doing that we run the risk of losing our tax-exempt status if too many of our sales end up being to businesses. While we’d still be a non-profit answerable to the public, losing our tax-exempt status would be too huge of a financial hit, which leads us to your next point.

Regarding taxes, you’re correct that governments do a whole lot to help the poor and society in general – and we’re in no way suggesting that they don’t. We believe, though, that engageSPARK will be a revolutionary product in this space and that we have great ideas for new social enterprises that will be equally revolutionary in impacting poor people’s lives. We’d like to implement our new ideas and continue to improve and grow engageSPARK as quickly and with as much impact as possible. Losing 40% of our profits to taxes essentially slows down our growth and impact. Of course, taxes impact the poor in other ways, but we (naturally) need to focus on our own impact and growth and we’d argue that taxes take away from that.

Moreover, we’d add that it’s important to note that 501(c)(3)s don’t pay taxes because their work is charitable. So it’s already widely accepted that when an entity a) isn’t financially benefiting any individuals and b) has a charitable purpose, it shouldn’t be taxed on its income. But if the non-profit’s income comes from activities that aren’t charitable at their core even if that income is being used (and is required to be used) for charitable purposes, the non-profit will be taxed. We think that isn’t fair and we’d thus argue that there really is no legal form under U.S. law that fits the mission of a true not-for-profit social enterprise. In an upcoming post (where we’ll discuss the various social enterprise legal forms in detail), we’re going to propose a legal structure that we think will solve many of these problems in a fair way. Check for that blog post in a few days.

We’d love to hear your feedback!

Thanks, Nan. You and Impact Entrepreneurs raise a great point. Raising capital without being able to offer returns to investors is very tough and tends to limit you to grants from foundations/other non-profits. And relying on grants to run a business often results in sustainability problems. We’re bootstrapping our enterprise, using as few funds as possible to get to market as quickly as possible. Our view is that by getting to market as quickly as possible – even if our product isn’t perfect – we’ll be able to start bringing in revenue that will continue to fund our enterprise and allow us to update and improve our product in real time as we receive direct and specific feedback from our users. It’s not the perfect solution to the problem, and for social entrepreneurs who cannot bootstrap and need funding from outsiders to even start building their social enterprise, it won’t work (unless they’re able to get grants or zero-interest loans from foundations/public charities). But for us, remaining a not-for-profit social enterprise is key to our work and purpose.

We’d also add that another way for not-for-profit social enterprises to raise some seed capital is to find a customer that is willing to fund you. Some customers that need your solution might be willing to essentially pay for you to build what they need so that they can start using it to solve the problem they have – as soon as possible. This way, you don’t have a real investor that is looking for financial returns, but rather you have an “investor” that is looking for a “solution” return, typically without any onerous investor-type obligations. We’ve actually found an organization that has expressed interest in funding certain parts of our platform. One way to increase your odds of getting a customer to fund you is by implementing user-centered-design. While interviewing and learning from potential users, you may come across some that would be willing to pay you to build what they need, and you might be able to get the seed capital you need to start your social enterprise from those users. Again, this won’t work for everyone, but it might for some.

Thanks, Embark Energy. Sounds like a very reasonable conclusion. We don’t have any problems with the different social enterprise forms, including the Benefit Corporation, and see how it can work well for a lot of social enterprises. The beauty of the Benefit Corporation, as you point out, is that the Benefits Director can stand his/her ground in preventing mission drift. However, our research has indicated that in practice, it doesn’t work as smoothly as one would hope when investors put a lot of pressure on the enterprise to bring in returns. We would guess that the best way to avoid this is by having investors who are very focused on the social mission and not just on getting profits. But finding those investors may be tough. Plus, if the investors begin to feel that their “financial” returns are too low as compared to “social” returns, they may start changing their attitude. That said, it sounds like you organization is fairly new in the process just like we are. We’d love to hear back how things are going for you in 1 or 2 years’ time – whether you start seeing that sort of pressure from investors and whether in practice that pressure starts affecting your activities and focus.

Also, one of our main problems with the Benefit Corporation is taxes – it’s not
necessarily a problem for all social enterprises, but we see engageSPARK as the first in many social businesses that Opportunity Labs will build and grow, and losing a huge chunk of engageSPARK’s profits in taxes will hurt our ability to set up new social enterprises.

In a few days, we’ll publish another blog post discussing the social enterprise legal forms (L3Cs, Benefit Corporations, and the Flexible Purpose Corporation) in more detail. In that post, we plan to propose a new type of social enterprise form that we think will address some of the gaps we find in the existing ones. We’d love to hear your feedback on that post too. Thanks again for commenting!

Of course, if you offer up equity to tempt an investor, they will often demand a position on the board, voting shares, and some amount of control over the direction of the company. You can try to draft a strict shareholder agreement from the get-go, but when you are courting investors, amendments and changes to the shareholder agreement are also part of the negotiations. Eventually, you will encounter some fork in the road in which you have an interested investor who wants more control than you were originally intending to relinquish… a tough dilemma to be sure, but also part of the fun of entrepreneurship!