Nonprofit or For-Profit? How to Choose the Right Legal Structure for Your Next Venture

Submitted by Guest Contributor

By Jim Fruchterman, CEO, Benetech

At the upcoming Social Enterprise Alliance Summit '14, I’ll be advising social entrepreneurs who want to start a new venture about what type of legal structure they should create—a nonprofit, for-profit or hybrid?

It’s not a simple question to answer, especially given the proliferation of legal forms, like the benefit corporation or low-profit limited liability company, that allow entrepreneurs to meet both financial and social bottom lines.

I founded Benetech as a nonprofit technology company that provides software tools and services to address pressing social needs in 1989. Each of its program areas—Global Literacy, Human Rights, the Environment and Benetech Labs—offers the greatest social impact on funds invested.

And as a veteran entrepreneur, I have often wrestled with this question. Three years ago, I even published an article titled, For Love or Lucre, to guide other social entrepreneurs through the issues they need to consider before they determine the legal form of their new venture.

But call me structure agnostic: I believe that for-profit and nonprofit structures can both be good vehicles for improving society. Which is why I argued that before deciding on the legal structure of a new venture, it is necessary to thoroughly explore the social enterprise idea. Once you understand your venture and your motivation, the question about structure should have a straightforward answer.

Not much has changed in the three years since the article's publication. In fact, today’s entrepreneurs and social innovators are grappling with this same question at a time like no other for the social entrepreneurial movement.

We are seeing tremendous innovations in social enterprise, but these are merely part of larger, global changes in the ways in which society organizes itself to create public goods. Digital and mobile communications are changing the rules about social networks, intellectual property and the availability of big data, with an overall blurring of the boundaries between states, for-profits and nonprofits.

As philanthropy wonk Lucy Bernholz writes, these changes add up to a new social economy, where diverse enterprises deploy private resources for the creation and sustenance of public goods.

Let me, then, restate my advice for aspiring social entrepreneurs today. Before looking at what type of legal structure to create, you need to explore four foundational issues:

1. Motivation

If you are going to take on the risks and responsibilities of a new venture, not only do you need to be motivated to succeed, but you must also understand your motivation for starting a new social venture. How fundamental is the social mission to the success of your venture? How will you prioritize the social bottom line if the venture is in peril? What are your personal financial objectives for this venture, and how do you define your organization’s success?

2. Market

Understanding your customers, their environment and their needs is crucial to any social venture. Who are you serving and how to best benefit them? Who or what is the competition, and what is your value proposition? What is the market size and how profitable could you be serving that market? The answers to these questions will shape your decision of how to structure your venture.

3. Capital

How much money do you need to launch your venture, and how much will you need to keep it growing? If you cannot raise or do not have the capital you need, consider the nonprofit structure, or rework your business plan to start more slowly with less money. You should also understand how tax structure affects your business. Being a nonprofit exempt from income and property taxes won’t make a big difference if your venture is unlikely to have much income or property. But if your main source of capital is philanthropy or government funding, then that’s a strong case to organize as a nonprofit.

4. Control

For-profit and nonprofit structures have very different control and governance regimes, so it is important to determine how much control you need to have over your venture. Nonprofit structures are generally less flexible than for-profits, because of the requirements to qualify for nonprofit status. How important is confidentiality to your venture? Will you need to share control with investors or with the public interest?

Once you have explored these four foundational issues, you are ready to think about the type of legal structure that best suits your organization. In my original article, I offered an overview of five basic organizational structures from the United States, but their analogues exist in many other countries. Canadian readers, for example, may be interested to know that my article has been adapted into a version that focuses on the structural options available for social enterprises in Canada.

The new generations of business and social leaders around the world are breaking the molds of traditional legal structures. As a pragmatic idealist I believe the changes they are creating will deliver more benefits for the betterment of society.