Written by Megan Cornell
If you have a business which has a social, environmental or other cause as its primary purpose, you are likely considering whether you should incorporate as a for-profit business or a not-for-profit business. For some enterprises, the answer is obvious. For others, it is much less clear. Here are some of the issues that you should consider.
In many jurisdictions, there are for-profit corporations, not-for-profit corporations and hybrid corporations, which combine aspects of both traditional structures. However, in Canada (and within Ontario), there are only two ways to structure your corporation: it can be for-profit or not-for-profit. Co-operatives are another form of business organization that can be a fit for certain purpose driven enterprises, but we won’t touch on co-ops in this discussion.
First, Some Terminology
“Not-For-Profit Corporation” or “NFP”: A non-profit corporation is a corporation essentially operating at-or-near the cost of operation and which does not disburse excess income to its members (in a non-profit corporation, the “shareholders” are called “members”). While non-profits can retain income year-to-year, they can only do so for certain limited purposes. In this discussion, we will reference Canadian NFPs, but there is a very similar (soon to be reformed) regime in Ontario. NFPs can be taxable or not, charitable or not. Both tax-free status and charitable status require additional qualifications.
“Purpose-Driven Business”: A business where having large profits is not the only goal or aim of the corporation. There is usually a stated social or environmental goal.
“Social Enterprise”: A business which operates on certain principles of social responsibility, usually creating a positive environment for workers, as well as contributing to the community it operates in.
“Impact Business”: A business that measures its impact on the world around it (social, community and environment), which seeks to reduce any negative impact and increase positive impact.
“Triple Bottom Line Business”: A business which measures its success on 3 criteria: economic value (i.e. profit), social responsibility (the people associated with the business) and environmental responsibility.
“B-Corps”: In the words of B-Labs: “B Corps are for-profit companies certified by the nonprofit B Lab to meet rigorous standards of social and environmental performance, accountability, and transparency.”
There is a lot of terminology overlap here, as is expected when a movement like corporate social and environmental responsibility is growing. The terms aren’t interchangeable, but we will use “purpose-driven” for this discussion as a catch-all for entities that consider metrics other than profit as the driver for their entity.
This discussion will center on five main topics to consider when deciding how to organize your purpose-driven entity: ownership, governance, financing, growth in value and finally, purpose.
Ownership
One of the fundamental differences between a For-Profit Corporation and a NFP is ownership of the entity. A NFP in Canada has “members”. The terms of their membership are set out by the NFP and there is no inherent value in that membership – there are no underlying rights to the assets of the NFP and no right to assets on wind-up of the NFP. When a person ceases to be a member by virtue of the membership rules, there is usually no transfer of value back to the member and membership can usually not be “sold”, and almost always cannot be “sold” for a profit. A NFP does not have owners to answer to regarding value of the organization – the Board of Directors must simply govern the NFP in accordance with its established purpose.
For-Profit Corporations, on the other hand, have shareholders who own the corporation and have the underlying right to the assets of the corporation. For a purpose-driven corporation, this means that there are underlying responsibilities and a duty to act in the shareholders’ best interests, interests which might not always align with the purpose of the corporation. However, value can be grown in the corporation to serve the purpose of the corporation, and that value is not subject to the same financial considerations which govern NFPs (discussed below).
Governance
Contrary to popular belief, NFPs often have more rigorous financial and reporting requirements than their for-profit counterparts. Charities, of course, have even more requirements.
NFPs which accept more than $10,000 in either gifts or donations from people or entities that are not members, directors or officers of the NFP OR which receive more than $10,000 in public grants and funding are considered “soliciting corporations”. Soliciting Corporations have greater reporting obligations and rules around Board membership as follows:
Soliciting Corporations must have a minimum of 3 directors, two of whom are not officers or employees of the NFP or its affiliates;
Financial Reviews: gross annual revenue of less than $50,000 requires “review engagement” financials; an audit is the default for revenue between $50,000 and $250,000 (review engagement is possible); and an audit is required for revenue over $250,000;
Financial Statements must be filed with the Federal government;
There are restrictions on what happens to the corporation’s property upon liquidation – it must be given to a “qualified donee” under the Income Tax Act.
Unanimous members’ agreements are not allowed.
So, while NFPs taking in less than $10,000 in public funds or grants can operate fairly nimbly under the legislation, once they have any sort of significant income outside of their members and officers, the reporting and governance rules become fairly cumbersome.
A For-Profit Corporation, on the other hand, can be fairly nimble, depending upon how it is set up and operated by its shareholders. Generally, shareholders of a corporation cede the governance of the corporation to the Board of Directors, who must govern the business in the best interests of the corporation (which are generally the best interest of the shareholders). The powers of the Board are often restricted, however, through a Shareholders’ Agreement. Although legislation places numerous requirements on corporate governance (such as certain matters requiring shareholder votes), and the law places many requirements on the nature of how the Board may govern the corporation, For-Profit Corporation governance tends to be more agile and flexible than Soliciting Corporations.
A For-Profit Corporation can strive to implement any number of goals to meet purpose-driven objectives. Triple Bottom Line Businesses do exactly this, and B-Corps have now introduced a third party verification for such businesses. For-Profit Corporations can do this through mission statements, expectations in Shareholders’ Agreements, or even in the incorporation documents. B-Corp status requires that the Articles of Incorporation of a business be amended to include language such as:
“The directors shall, acting fairly and responsibly, consider the short-term and the long-term interests of the Company, including, but not limited to, the Company’s shareholders, employees, suppliers, creditors and consumers, as well as the government and the environment (the “Stakeholders”), and the community and society in which the Company operates, to inform their decisions.”
In these variety of ways, a purpose-driven corporation can seek to formalize its purpose and objectives, as well as its commitment to being an impact business. There is a developing interest around shareholder activism and whether considering stakeholders other than shareholders (i.e. making decisions which put other interests above pure shareholder value) can lead to legal action. Momentum Law is watching this issue in Canada carefully and seeking best practices to avoid such legal action.
Financing
A key choice in determining corporate structure is understanding how the entity will be financed.
If an entity is likely to be largely financed through grants and donations, then a NFP structure is usually required, since many grants will require that structure. Membership fees can also be used to finance a NFP entity. In contrast to selling shares in the corporation, issuing more memberships does not, generally, dilute any one member’s interest in the entity. This can make memberships a powerful way to grow engagement with the entity and can also be a good source of recurring revenue.
On the other hand, if the main source of financing for an entity is projected to be private enterprise investment which would seek, at least in part, to grow the value of that investment, then a for-profit structure is necessary. B-labs has published a paper regarding how being a purpose-driven enterprise can help raise funds:
http://www.bcorporation.net/sites/default/files/documents/raising-money.pdf
Growth in Value
One of the primary differences between a NFP and a For-Profit Corporation is the growth in value in a for-profit company. A for-profit company can grow in value and provide an asset from which those who put their time and energy into building the company can extract a return. In other words, you can grow value in a private company and a shareholder can sell their interest. In a NFP, members do not have any value to transfer to another interested party once that member is no longer engaged in the entity.
Purpose
Both non-profit and purpose-driven for-profit entities can exist to fulfill a given purpose. Both types of entities have a space in the Canadian landscape, and which type of entity is the best choice for a given purpose depends on a wide range of factors.
How Momentum Can Help
If you would like to learn more about any of the above, please do not hesitate to contact us.