Adopting a mission to create and sustain social value (not just private value),In charity there is no excess.
—Francis Bacon, Of Goodness and Goodness of Nature (1625)
If your idea is a for-profit opportunity, you can skip this chapter. If you think your idea probably should be launched as a nonprofit, you can skip Chapter 22. The rest of the book applies to launching a nonprofit as well as a for-profit, but this chapter looks at some factors unique to social entrepreneurship and starting nonprofits.
There is no clean divide between entrepreneurship that seeks profits and entrepreneurship focused on the nonprofit world. In fact, there is an almost seamless continuum between enterprises whose goal is strictly commerce and profit and enterprises that engage only in charity. In between is everything from doing well by doing good to social enterprise.
There are those who say that the ideal business is a “post office box people send money to.” Most entrepreneurs like to think that they are doing more than creating ways to transfer wealth, that they are doing something meaningful for others, not just taking their money. Many—if not most—profit-making businesses sell products and services that make life better in some way for their customers. Anyone who has taken a lifesaving medication or been the beneficiary of a medical device, for example, has left behind a profit for the maker and is thankful for his or her cure. It’s not true of all businesses, of course, but most that make a profit also create at least some social value.
At the other extreme from the post office box, there are any number of nonprofit service organizations that help those with no means to pay for products and services—often essential products and services that the prosperous majority takes for granted. These organizations do their work by using contributed funds to help the less advantaged who live at the mercy of the next contribution cycle.
Over the last 20 to 30 years there has evolved a vibrant middle ground, blending the for-profit sector’s focus on business execution and revenue generation with the nonprofit world’s altruistic focus on making the world a better place. Defined and manifested in a bewildering diversity of ways, this is social entrepreneurship, or social enterprise.
Social enterprise uses market-driven business models to create social value and address critical social and environmental issues.1 Barely a concept even 20 years ago, this is becoming an increasingly active space. A Lexis-Nexis search for social entrepreneur turned up 6 stories for 1991, 573 for 2001, and 1,682 for 2006.2 There is no common definition, and there are many alternative terms, including social venture, nonprofit enterprise, social purpose business, and venture development. Organizations span the range from for-profit to a new legal form—limited-profit organizations formed to simultaneously advance community benefit and earn a return for investors—to nonprofits that derive money from activities that look like those of a for-profit (think Girl Scout cookies). Even many traditional nonprofits living on grants, government contracts, and donations are pushing to improve the effectiveness of their operations by adopting the execution and strategy practices of for-profit businesses.
In the world of social enterprise people clearly distinguish between advocacy organizations and service/product organizations. The former focus on research, opinion leading, driving change, legislation, and policy. The latter get things done, delivering services and benefits directly.
Conceptually, the question of what enforces discipline and effectiveness is a complicated issue in social entrepreneurship. In the commercial, for-profit world, winners are rewarded and the inefficient and ineffective are culled by market forces that judge on the basis of wealth creation (aka, financial profitability). These criteria provide a clear and useful means to assess not only success retrospectively but also opportunity prospectively. Jim Collins wrote a nonprofit monograph to his mega-bestseller Good to Great in which he noted that in contrast to the for-profit world, “the social sectors do not have rational capital markets that channel resources to those who deliver the best results…. The whole purpose of the social sectors is to meet social objectives, human needs and national priorities that cannot be priced at a profit.”3
Gregory J. Dees teaches social entrepreneurship and nonprofit management at the Fuqua School of Business at Duke. He has this take on the effectiveness of the social entrepreneur:4
Any definition of social entrepreneurship should reflect the need for a substitute for the market discipline that works for business entrepreneurs…. Social entrepreneurs play the role of change agents in the social sector, by:
Adopting a mission to create and sustain social value (not just private value),
Recognizing and relentlessly pursuing new opportunities to serve that mission,
Engaging in a process of continuous innovation, adaptation, and learning,
Acting boldly without being limited by resources currently in hand, and,
Exhibiting a heightened sense of accountability to the constituencies served and for the outcomes created.
Sound familiar? This is essentially the same definition as that of a for-profit entrepreneur. This shouldn’t be surprising. Execution in pursuit of value creation should look the same no matter what the form. So what’s different? For social enterprises that have the twin goals of social outcomes and earning free cash flow from revenue, mission-related impact is the central criterion, but wealth creation isn’t ignored. “On the surface, many social enterprises look, feel, and even operate like traditional businesses. But looking more deeply, one discovers the defining characteristics of the social enterprise: mission is at the center of business, with income generation playing an important supporting role.”5
The concept of social entrepreneurship is centered not just on mission but on entrepreneurship, making a social benefit–focused organization become more like a business. The idea is that nonprofits can benefit from the focus of for-profit businesses: customer focus, sound strategy, effective planning, efficient operations, and financial discipline. A social entrepreneur should focus as intently on excellence in all of these as does any back-to-the-wall for-profit entrepreneur.
The first impulse of most social enterprise entrepreneurs is to organize as a nonprofit corporation. Odds are good that this is an appropriate choice, but there is an increasingly diverse array of alternatives.
There are over a million nonprofit corporations in the United States.6 Since the 1960s, the number of nonprofits has been growing at a higher rate than that of for-profits.7 A nonprofit (or not-for-profit) corporation is chartered under state laws to operate for educational, charitable, social, religious, civic, or humanitarian purposes. Nonprofits have no owners. In essence, the law considers them to be created on behalf of the public. Nonprofit corporations are formed by individual incorporators who can be almost anyone. They are governed and operated by boards of directors or trustees for the benefit of the public. Nonprofits may own for-profit or nonprofit subsidiaries.
Because they are granted special tax status by the state for the benefit of the public, nonprofit corporations may not distribute surplus funds to parties with a controlling interest. Surpluses must be used to further the approved mission of the organization, and on dissolution any proceeds must be distributed to another nonprofit. Tax returns must be filed annually with the Internal Revenue Service (IRS) and certain state bodies to report financial activity and certify compliance with a number of restrictions on self-dealing and conflict of interest. In recent years many states have increased their vigilance on compliance and issued additional regulations preventing self-dealing and abuse of tax-exempt status.
Incorporation as a nonprofit can confer exemption from many state and local taxes, including sales, property, and income tax at the state level. Under the Internal Revenue Code’s Section 501(c), in certain conditions nonprofits can be exempt from U.S. income taxes. This exemption is not conferred automatically by incorporation at the state level, but it can be granted by application to the IRS. In addition, organizations approved by the IRS under Section 501(c)(3) are eligible to receive contributions that can be deducted from the donor’s income taxes if the central mission of the organization is in one of the following categories:
Educational organizations and private schools
Organizations providing insurance
Charitable organizations
Religious organizations
Scientific organizations
Literary organizations
Amateur athletic organizations
Organizations for the prevention of cruelty to children or animals
Private foundations and public charities
Lobbying expenditures
Sections 501(c)(4)–(27) provide for a wide variety of additional nonprofit classifications that are tax-exempt but, with a few exceptions, cannot accept tax-deductible contributions.8 IRS Publication 526 (2009), Charitable Contributions, provides information on the treatment of tax-deductible contributions.9
Tax-exempt does not mean that nonprofits never pay taxes. Nonprofits are obligated for all payroll taxes on employees, the same as for-profits. Under certain circumstances unrelated business income over $1,000 will be taxed if the profits are generated by activities that are unrelated to the exempt purpose of the organization, that are considered a trade or business, and that are regularly carried on by the organization. If unrelated business activity accounts for a significant enough portion of a nonprofit’s activity, its nonprofit status may be jeopardized entirely.
The low-profit limited liability company (L3C) has been created in some states as a new, hybrid form of pass-through entity with characteristics of both a nonprofit and a for-profit corporation. Like LLCs, L3Cs have the liability protection of a corporation, the flexibility of a partnership, and the ability to be sold in pieces. An L3C operates as a for-profit business but is designed for enterprises with social missions. Their charters explicitly provide that the corporation is formed to further a socially beneficial mission.
Seed investment is hard enough for any start-up to get, but it is especially difficult for enterprises that focus primarily on a social mission. Foundations like to support the launch of new social mission enterprises, but frequently they want other sources, such as private investors or revenue-generating activities, to fund sustainability. Since sustainability often implies the need to engage in the kinds of revenue-generating activities that for-profit businesses pursue, foundations can get into tax trouble if they are deemed to be investing in certain kinds of for-profit activities. The L3C provides a structure that facilitates remaining in compliance with certain IRS rules governing program-related investments.
Program-related investments are defined by the IRS as investments in which the primary purpose is to accomplish one or more of the foundation’s exempt purposes. Production of income or appreciation of property is not a significant purpose, and influencing legislation and taking part in political campaigns on behalf of candidates are not purposes. In determining whether an investment is primarily program-related or primarily for the production of income or the appreciation of property, the IRS looks to whether other investors who engage in investments only for profit would be likely to make an investment on the same terms as a private foundation.10 Failure to meet the standards of a program-related investment exposes foundations to certain penalty taxes, including excise taxes under Section 4944 of the Internal Revenue Code. In theory, the L3C structure enables attractive investment opportunities for foundations as seed investors by qualifying their investments as program-related and at the same time qualifying them for profitable, revenue-generating activities and follow-on private sector investment, generating returns to all investors while fulfilling the social mission.
The IRS cannot provide a blanket determination of qualification of the L3C structure. It has publicly stated that foundations may not rely solely on L3C status in determining whether an investment qualifies as a program-related investment, but it will issue private letter rulings on a case by case basis.11
As of 2010, Vermont, Illinois, Maine, Michigan, North Carolina, Utah, and Wyoming had created L3C options.
A B corporation is a type of corporation that writes into its corporate governing documents mandates to serve the interests of employees, the community, and the environment in addition to the standard focus on return to shareholders. The intent is to harness the power of business to solve social and environmental problems. To become a B corporation, businesses are certified under a rating system by B Lab, an independent 501(c)(3). “B Corporations’ transparent and comprehensive performance standards enable consumers to support businesses that align with their values, investors to drive capital to higher impact investments, and governments and multinational corporations to implement sustainable procurement policies.”12 State laws are evolving with respect to B corporations. There may be certain tax benefits. Procedures on sales and mergers have not been defined, particularly concerning who has standing to approve or object.
Cooperatives are legal entities owned and democratically controlled by their members. Often they are organized as corporations without capital stock under state cooperative laws. They can be for-profits or nonprofits. For-profits can distribute profits, subject in some cases to threshold limitations. Sectors in which cooperatives operate include consumer cooperatives, producer cooperatives, agriculture, housing, utilities, health insurance, and jobs/employment. They generally have open membership, economic participation, and a social or community focus.13
A mission is what an organization does. It describes the organization’s purpose. In his book How to Change the World—Social Entrepreneurs and the Power of New Ideas, David Bornstein writes:
An important social change frequently begins with a single entrepreneurial author: one obsessive individual who sees a problem and envisions a new solution, and builds organizations to protect and market that vision, who provides the energy and sustained focus to overcome the inevitable resistance, and who—decade after decade—keeps improving, strengthening, and broadening that vision until what was once a marginal idea has become a new norm.14
Everything that can be said about the imperative of for-profit entrepreneurs to find a need and identify customers with that need fully applies to the social entrepreneur, maybe more so. Recall that the beneficiary and the customer need not be the same person. The customer is the one who pays you money for your product or service. Every time someone uses Google, that person is a beneficiary, but Google’s customer is the advertiser who pays Google for access to users. The beneficiary-customer map for nonprofits is important and often is overlooked.
Revenue-generating products and services of social enterprises have customers just as for-profits do, but often the beneficiaries of products or services may not be the ones paying money for them, or at least not paying their full cost. These beneficiaries of social enterprises should be treated like customers, because that is good manners and effective operations, but frequently they are not really customers because someone else is paying the cost. That someone is the customer: a foundation, an individual donor, a government agency. The one who makes the funding decision is a customer, and that customer has its own needs, as well as a basis for making funding decisions. In conceiving and launching an enterprise, it is imperative that a social entrepreneur go through the same thought process as any for-profit entrepreneur in defining the needs of those customers. Their needs are often very different from the needs of the beneficiaries, and if social entrepreneurs want their money, they must figure out how to meet their needs, recognizing fundraising is a terribly competitive environment.
Do you have a clear idea of what the funder is looking for? Is there a match of mission? Is your articulation of mission clear, and is there a good connection between it and your plan? What research and validation have you done to support your idea? What operating and infrastructure criteria are they expecting you to have? Who will do the work? Is the team adequate and qualified? What is your funding plan for launch and later sustainability? What is the competition; is this need being filled elsewhere already? What metrics of effectiveness do they want to see? Often funders don’t want to assume a long-term obligation to sustain you. How will you cover longer-term costs? Resources are more than just money. Where will you get them?
Increasingly, social enterprises are being pressed to demonstrate efficacy quantitatively. Measuring the creation of social value is much more complicated than it is in the for-profit world, in which one looks to profitability and growth. Social enterprises don’t provide products and services out of nothing. They consume resources: dollars, people’s time, and possibly contributed goods. Do they create more social value than they consume? If you are a social entrepreneur, sooner or later you will need to make the case that you do, especially if you’re dependent on donations and volunteer labor for support. How will you do that?
Of course, the point of departure is an accounting of what you have done. The cost input side is easy to quantify. But what units of success will you use to show performance relative to the mission? Do you have consensus among the various stakeholders that these are the right measures? Have you agreed on realistic targets for achievement? What reporting systems will you use, and who will maintain them? Who will receive the data, and what will they receive? (This is an important one.) How will you solicit and receive feedback?
Total charitable giving in the United States exceeds $300 billion in a year, but few givers are excited about paying for overhead. People want to target the cause, not pay for bureaucracy. You want to be an effective social entrepreneur and everyone wants to be efficient, but there is a point at which you can’t be effective or even efficient if you don’t have enough funding to pay for basic infrastructure and resources that anyone needs to be effective and efficient. Alongside a clear mission and a commitment to it, having a plan for financial sustainability is paramount in social entrepreneurship. It forces the creation of an operating plan that ensures success and survival in the long term. A credible plan for sustainability is one of the most important things foundations, government agencies, and individual donors consider when deciding whether to seed the launch of a new social enterprise.
It’s a common misperception that nonprofits rely mainly on donations and grants. The variability of funding sources is enormous,15 but as in the for-profit world, no options are easy ones. Competition for funding is as intense in the nonprofit world as it is in the for-profit, probably more so. Grant makers and foundations are overwhelmed with proposals for “free money.” Most funding applicants successfully document a compelling need. They fail to get funding when they lack a credible operating plan and a path to sustainability. Remember, donors are your customers—treat them that way. That doesn’t mean giving them nice treatment; it means finding out what they really want and giving it to them. Almost always they want you to show how you will operate as effectively as any for-profit business and how you will quickly become sustainable. They want to take credit for catalyzing another successful enterprise and move on to help the next one launch.
Nonprofits have some options to cut costs that are not usually available to for-profits. Volunteers can substitute for the cost of hired help, but of course managing volunteers is a huge challenge that often limits effectiveness. A nonprofit can solicit contributions of in-kind materials and products, but often there are inherent inefficiencies in working with in-kind contributions. Generally, it’s about the same as comparing a primitive barter economy and a modern market economy.
One of the main reasons people start social enterprises is that the beneficiaries can’t pay the full cost of the services or products they receive. But before you reflexively go out looking for donations to cover their costs, it makes sense to convince yourself that this is true. Are there financing alternatives (e.g., student loans) or demand aggregation (health insurance) that would make the service or product affordable for the beneficiaries, in which case you could turn them into paying customers? Is there someone else who would pay on their behalf (employers, government)?
Some social enterprises try to generate profits from a side business to produce revenue for their mission. Making profits in social enterprises by selling things is no easier than it is in for-profits even when you don’t have to pay taxes, have lots of volunteer labor (with all the challenges that presents), and pay your people less than your for-profit competitors do (and those are significant advantages).
Jerr Boschee, director of the for-profit Institute for Social Entrepreneurs, says, “Unless a nonprofit organization is generating earned revenue from its activities, it is not acting in an entrepreneurial manner … only earned income will ever allow a nonprofit to become sustainable or self sufficient.”16 This may be true, but acting in an entrepreneurial manner is not an end goal, only a means to an end goal. For a social entrepreneur, the end goal is the mission. Sustainability makes fulfilling the mission possible. Some organizations achieve sustainability through fund-raising, grants, and donations, hard as that is. Others make it through revenue-generating, for-profit activities. If you try for-profit activities, you’re into everything written in the rest of this book, and you will need to do all those things as well as any for-profit competitors—and there will almost always be competitors if there is a profit to be made. Many social enterprises have great success stories about doing just this, and of course many others struggle or fail, just like in the rest of the for-profit world. If you choose to pursue one of these “double bottom line” strategies for sustainability, just hope you don’t end up so consumed with the challenges of making a profit that you lose sight of your mission. Most people find one bottom line hard enough. But don’t lose hope. The amazing thing is how many social entrepreneurs are succeeding every day. It can be done.17
We started to title this section “Special People Challenges” but decided readers might misinterpret it. Thought about in the right way, it often takes special people to start and work in social enterprises. The tension between bottom line profit and creating social value for others is not just a burden on enterprises; it weighs on people too. A social enterprise has to recognize that there are special challenges in being effective and efficient with people who often are not choosing the work because of the financial rewards.
Nonprofits can pay market wages, but they tend to struggle to do so and most don’t or can’t: refer back to the previous sections on funders’ reluctance to pay overhead. Profit-based incentives and pay-for-performance are largely or completely excluded by both common practice and the law (the so-called bar on distribution). Thus, freedom to recruit and motivate with compensation is limited. The answer is generally to look for great people with a heart for the mission and the willingness to accept below-market compensation, but it’s a hard thing to do successfully and consistently. Many social enterprises compensate by using lots of volunteer time, but volunteers have to be recruited, trained, and managed and are often difficult to manage and hold accountable. You can “fire” volunteers if you have to, but you can’t do it too often, and the threat of firing doesn’t have the same motivating effect it has with employees taking home market-competitive salaries.
As a result, there is a career stigma, or stereotype, in regard to nonprofit people in the eyes of the for-profit world. It’s sort of a vicious circle: People assume the nonprofit world tends to attract less-qualified people, making career transitions from a nonprofit to a for-profit career difficult, which leads to self-selection against careers in the nonprofit sector.18
Perhaps even more significant to you as someone considering launching a social enterprise, what might launching a nonprofit mean to you personally in terms of compensation and career? A for-profit entrepreneur delays gratification with the expectation of a big payoff in the future. As a social entrepreneur, unless you come up with a fabulously successful dual bottom line for-profit company, you will be operating as a nonprofit. In nonprofits there is no liquidity event, no payoff for you at the end.
The same is true for the key team members you will recruit to help you build the organization. In nonprofits, often intangible job characteristics such as freedom to pursue professional interests (especially in fields such as health care, research, and education) and the personal satisfaction of association with the mission are the main incentives that interest many people. However, this often brings personnel management challenges significantly more complicated and demanding than those in the for-profit sector. Look at yourself and be sure you have the personality and management skills to take on this added challenge.19
All corporations are accountable to their boards of directors or trustees. There are some special factors involved in governing social enterprises, especially if they are nonprofits. For one thing, metrics and measuring performance are complicated. In addition to the accountabilities common to all corporations that we discussed in Chapter 9, you will have to combine accountability on efficient operations with performance relative to the mission. Boards are often tough on costs of overhead and support operations. They tend to press management to put all possible resources directly into the mission. Good communication with boards goes a long way toward smoothing governance and preserving consensus on operations and mission.
Generally, there is less autonomy for leadership in a nonprofit than in a for-profit. Traditional nonprofits usually use boards as fund-raising vehicles, which leads to large boards heavily weighted with people who give money.20 This can create unwieldy boards that don’t focus much on operations or your management challenges or, worse, have little operational or business experience and focus on them too much. Both are situations you don’t need, and they are avoidable in the beginning as you build the board if you balance the tension between fund-raising and board recruiting.
Your board has a statutory responsibility to look after the public interest. This means that the board members have to ensure that you are executing effectively in fulfilling your mission. They’re obligated to be vigilant against self-dealing, conflicts of interest, and abuse of tax-exempt status. Most states require extensive provisions in the corporate bylaws and policies on these points and look to the boards to enact and enforce them. Although more a matter of degree than of difference, this is an added responsibility for board members of nonprofits, though lately the burdens on public company for-profit boards have increased also.
Regardless of the form, launching an enterprise to drive change and create social value demands excellent execution in all the things covered in this book: understanding and serving customers, market validation, innovation, strategy, planning, funding and sustainability, operations, managing risk, financial management, metrics, accounting, finance, law and governance, and team building—all in a context of low financial rewards and no big payoff at the end. It sounds daunting. What’s amazing is how many social entrepreneurs and volunteers remain undaunted. Remember the main reason you’re thinking about social entrepreneurship: the mission. Social entrepreneurship is about some form of helping the disadvantaged, making life better for someone, creating social value. If it was easy, everybody would be doing it. Of course, in reality everybody ought to be doing it, so good for you if you are.
What form of business is best for your idea: for-profit or nonprofit? Why?
Can you make a clear connection between your idea and who you identify as the customers and the beneficiaries?
Do you have a credible plan for sustainability?
How will you measure your success? Who will care about your success? How will you communicate with them?
1. Dees, J. Gregory, Jed Emerson, and Peter Economy, Enterprising Nonprofits—A Toolkit for Social Entrepreneurs (New York: Wiley, 2001): 4–5.
2. Bornstein, David, How to Change the World—Social Entrepreneurs and the Power of New Ideas (New York: Oxford University Press, 2007): 307.
3. Collins, Jim, Good to Great and the Social Sectors, a monograph to accompany Good to Great (Boulder, CO: Jim Collins, 2005): 19.
4. Dees, Gregory J., “The Meaning of Social Entrepreneurship,” http://www.caseatduke.org/documents/dees_sedef.pdf, 2001 (accessed September 15, 2010).
5. Dees, 2001.
6. The National Center for Urban Statistics, http://nccsdataweb.urban.org/PubApps/profile1.php (accessed September 15, 2010).
7. Weisbrod, Burton A., The Nonprofit Economy (Cambridge, MA, Harvard University Press, 1988): 62.
8. IRS Publication 557, Tax-Exempt Status for Your Organization, June 2008, http://www.irs.gov/publications/p557/index.html (accessed September 15, 2010).
9. IRS Publication 526, Charitable Contributions, http://www.irs.gov/publications/p526/index.html (accessed September 15, 2010).
10. http://www.irs.gov/charities/foundations/article/0,,id=137793,00.html (accessed September 15, 2010).
11. Dinning, B. Ray, “Structuring Social Ventures: The L3C as a Non-Traditional Business Entity,” December 7, 2009, http://lawpartners.wordpress.com/2009/12/07/using-the–13c-to-structure-social-ventures-by-ray-dinning-jdllm/ (accessed September 15, 2010).
12. B Lab, http://www.bcorporation.net/about (accessed September 29, 2010).
13. Dawans, Vincent, Kim Alter, and Lindsay Miller, “Social Enterprise Topology,” http://www.41enses.org/setypology#_blank (accessed September 15, 2010).
14. Bornstein, 2007: 3.
15. Weisbrod, 1988: 3.
16. Boschee, Jerr, and Jim McClurg, “Toward a Better Understanding of Social Entrepreneurship: Some Important Distinctions,” http://www.se-alliance.org/better_understanding.pdf (accessed September 15, 2010).
17. Tishler, Carla, “Enterprising Nonprofits: A Toolkit for Social Entrepreneurs—Why Running a Nonprofit is the Hardest Job in Business,” May 29, 2001, http://hbswk.hbs.edu/archive/2265.html (accessed September 15, 2010).
18. Oberfield, Alice, and J. Gregory Dees, “Starting a Nonprofit Venture,” Harvard Business School Case 391–096 (1992).
19. Leete, Laura, “Executive Leadership in Nonprofit Organizations,” in The Nonprofit Sector: A Research Handbook, ed. Walter W. Powell (New Haven, CT, Yale University Press, 2006): 159–179.
20. Middleton, Melissa, “Nonprofit Boards of Directors: Beyond the Governance Function,” in The Nonprofit Sector: A Research Handbook, ed. Walter W. Powell (New Haven, CT, Yale University Press, 2006): 141–153.
21. See Chapter 20 for more on iInTIME.