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This article, written by Steven Moe from Parry Field, examines what the most commonly used legal structures are for social enterprises in New Zealand and examines the key benefits and challenges associated with each of them.
One of the most confusing aspects about setting up a social enterprise is getting the legal structure right. You might have thought the hard work was done when you had the great idea that you hope can become a self funding business that also achieves good in the community. In fact that is just the beginning of the journey because you also need to find the right type of entity (separate to you as an individual) which can move the idea forward.
In New Zealand there is currently no legal structure which is specifically aimed at being a vehicle that social enterprises can use with confidence. In another article this lack has been discussed in more detail and that issue can be further explored here. For now, we need to make do with the legal structures which are available and the two most common are setting up as a company, or setting up as a trust. This article looks at both of those options.
One of the key points to consider before we look at the detail of each option is to remember that you need to “tell your story” in a compelling way to future investors, funders and the community. Choosing the right structure is therefore really important because that becomes a fundamental part of that story. Will it be easy to explain to funders who offer grants that you have a company structure and are the sole shareholder? Probably not. If you want investors who are seeking returns on their investment then will they easily understand that you have set up as a trust? You get the idea. So thinking through who your story needs to be told to will be important when thinking through the structure that is most appropriate.
Why set up as a Company?
A company structure offers a model which is well known and is easily explained. We see this used quite a lot in New Zealand not just in “for profit” scenarios. The word “limited” at the end of all company names in New Zealand is there for a reason – it is an effective way of limiting and containing liability that the entity may incur. That provides comfort for shareholders who will not be personally liable if the venture does not succeed. The contrast with trying to run a social enterprise in your personal name should be obvious – in that situation you have 100% control but could also be personally liable for debts that are incurred.
One of the other main advantages of this structure relates to governance. The founders who had the great idea can also be the shareholders and therefore retain control over the direction of the company. The company will have a board made up of at least one director and they are usually appointed by the shareholders which again offers another level of control to those who founded the company.
One of the downsides of setting up as a company has been hinted at earlier: people assume that a company structure is being used because there is a desire to make a profit. If your strategy is to approach foundations or other groups who might provide large scale funding for your idea then that can make it tough to explain. One of the ways to deal with this is to try and hard wire your purpose into the company structure itself by stating clearly in the founding document (in the case of the company, the Constitution) what the purpose of the company will be. This will be essential if you decide to apply for registration of the company as a charity with Charities Services because they will look at the purposes which are set out there to decide if your entity meets the criteria to be registered as a charity. For more on these issues see this article here.
Why set up as a Trust?
Setting up a trust is probably the most common form that is used in New Zealand. It is a structure which is easily explained and because there are no “shareholders” as such it provides a clean story to explain to people. There is something of an inbuilt assumption that if you are a trust then it is automatically assumed that this is a “for good” type of entity. This is in contrast to the company structure where there can be an assumption that there is a “for profit” element as a main objective.
A trust does not have shareholders and is instead guided by trustees who form a Board. In some ways this might be seen as providing less control to the original founders. However, in practise the founders will choose trustees who share the vision for the trust so that they can ensure it follows in the direction intended. One of the key decisions at an early stage is how to make decisions about replacement trustees – will they be shoulder tapped by current trustees, elected or some combination of both those options? Governance issues will sooner or later become a key point for the trust so it is best to get this sorted early. This aspect and the issues involved is explored further in this article about governance here.
The purpose is also safeguarded by the founding document for a trust, the Trust Deed, which will have a “purposes” section that sets those out clearly. It is really important to make sure that the purposes decided on accurately reflect what the trust is intended for. As with a company structure if you go to Charities Services this will be really important when they decide to register you as a charity (or not). One of the weaknesses we see is that people do not define the purpose using terminology and ways of describing what they will do so that they fit within one of the four recognised charitable purposes. For more on this, see the article here.
What about two for one?
As can be seen each of the most commonly used structures has both pluses and minuses. One option we have seen people do is to set up using both structures in order to try and get the unique advantages that each provide. In that scenario there is usually a trust which has been registered as a charity and has donee tax status. When telling the story to funders and donors that is a structure that can be easily explained and they can get on board with.
At the same time the trust may have a trading arm which is set up as a company. Usually the shareholder will be the charitable trust. The income that is generated by the business of that company then usually will go back to the trust for it to continue carrying on its charitable purposes. But having the company may provide more flexibility such as a vehicle to enter into joint ventures with other entities or seek other investors into the company. Like most structuring it is important to get good accounting advice on some of the tax and accounting implications of setting up in this way as well.
We hope that this overview of the two main options for social enterprises in New Zealand has provided some clarity over why each structure might be used. Ultimately it would be great if there could be a new form of entity which took the best aspects of both the company and trust structures and that could be used going forward. For now though we need to make do with what is available and adapt the structures that we can use in order to further advance social enterprises in New Zealand.
If you still have some questions about the best legal structure, check out our webinar on legal structures here.