Week Four lecture for KIEI 452 Social Entrepreneurship: Designing For Change. Fall 2014 taught by Gabrielle Lyon

1. Week 4: Nuts & Bolts-
Structures & Sectors
KIEI 452
Gabrielle Lyon, PhD
WEEK 3: What is Social?

2. How & When: Action Plan
WEEK: 1 2 3 4 5 6 7 8 9 10
Meet with Client (1) (2) (2) (3) (4)
Conduct background
research
Conduct interviews
Agree on recommendations
Fill in research holes
Build client implementation
plan
Finalize presentation and
present
(1) Understand business (2) Update on progress (3) Review findings (4) Final presentation

3. Change.org
Gabrielle Lyon-KIEI452-Week 4

4. K/W/L
• What makes a non profit a nonprofit?
• What do we WANT to know about the distinctions of for-profit/non-profit?
• Why do these things matter to understanding Social
Entrepreneurship?
Gabrielle Lyon-KIEI452-Week 4

5. Structure Spectrum
Philanthropy
Gabrielle Lyon-KIEI452-Week 4
Profits
100%
Donations
30%
Returns
Non-profit
Profit

6. Commercial vs. Social?
History Runs Deep
• 17th Century & Puritan Ethic:
– business and commercial activity is a sin.
– To atone do charitable work & keep it clean of any “taint” of
commerciality.
• Charitable and business sectors are fundamentally distinct in terms
of legal and regulation oversight.
– Charity is supposed to be about mission and not about money
• no profit-sharing, limits on compensation
– For-profit businesses, all about money and not about mission
• maximizing profit, no social responsibility obligations,
shareholder primacy)
Gabrielle Lyon-KIEI452-Week 4

7. Commercial Vs. Social
For profits
– Focus on stakeholders and distribute returns to investors
– Customers
NPOs
– Pursue charitable purposes and get tax benefits (ie don’t pay
taxes).
– Benefit from social legitimacy, good will, probono services,
donations
– Service beneficiaries
Gabrielle Lyon-KIEI452-Week 4

8. PURPOSE: Form Follows Function
NPOs
• Mission = public benefit activities ≠ primarily profit
– Organized for a non-pecuniary purpose.
• No person owns shares; property/profit are not distributed to
owners; recycled back into the public benefit mission
– Non-profits are tax-exempt entity:
• Formed under state law
• Tax exemption is a federal law
For Profit
Set up for the sole purpose of making a profit
Gabrielle Lyon-KIEI452-Week 4

9. What is a “charitable purpose?”
Exempt Purposes - Internal Revenue Code Section 501(c)(3)
• “exempt purposes set forth in section 501(c)(3) are charitable,
religious, educational, scientific, literary, testing for public safety,
fostering national or international amateur sports competition, and
preventing cruelty to children or animals. The term charitable is
used in its generally accepted legal sense and includes relief of the
poor, the distressed, or the underprivileged; advancement of
religion; advancement of education or science; erecting or
maintaining public buildings, monuments, or works; lessening the
burdens of government; lessening neighborhood tensions;
eliminating prejudice and discrimination; defending human and civil
rights secured by law; and combating community deterioration and
juvenile delinquency.” IRS.gov
Gabrielle Lyon-KIEI452-Week 4

10. GOVERNANCE & CONTROL
Non Profit Organizations - No one person, not even the founder, controls the
destiny of a nonprofit organization. NPO control is exercised by a governing board
of directors or trustees.
Board of Directors Responsibilities:
• Ensure resources are used to fulfill the mission
• Hire and fire the executive
• Fiduciary duties – sign 990s, oversee audit, review financial statements
• (D&O insurance)
• Ensure adequate resources
Other characteristics:
• Boards have to act as a group, not as individuals. No permanent tenure.
• Members are not usually compensated
• Bylaws outline the unique governance rules/responsibilities
• Traditionally play critical roles in the success of the organization
– Sctive role in fundraising
– Technical expertise (legal services, hr, financial management-related
expertise)
Gabrielle Lyon-KIEI452-Week 4

11. Board Membership
Boards typically have a nominating committee
• More self-perpetuating than for-profit boards
• Stakeholders, governance watchdogs, media can create public
relations problems if there is a bad board
Term limits ensure some turnover
– Most boards recruit new members through their own networks
Roles for service recipients, institutional funders, or local affiliates (in a
networked organization) to select board members or have seats on the
board
Gabrielle Lyon-KIEI452-Week 4

12. Governance
For Profit Companies:
• Boards hire/fire/compensate CEO, oversee audit, approve major
decisions
• Fiduciary duty to corporation – generally this means shareholders,
except in financial distress where value of corporation and value of
equity can diverge significantly
Gabrielle Lyon-KIEI452-Week 4

13. Context for Decision Making
• For-profit: Get done what is needed in order to maintain the
financial bottom line
• NPOs: Balance between board of directors and executive director
– Board hires the ED; ED hires everyone else
– Board approves the budget; ED manages the budget
• Public Sector: Lots of constraints on decision-making
– Legislative & regulatory
– Political framework (managers vs. elected officials)
Gabrielle Lyon-KIEI452-Week 4

14. Actual Decision-Making
For Profit:
– Top down
NPOs:
– Might be top-down; sometimes bottom-up.
– Still need to interface with the board. (If nothing else they have
to approve the budget.)
Public Sector:
– Financial managers often have to navigate competing interest
groups.
– Important financial decisions require coalition building &
support.
– Decisions can’t usually be passed along without some sort of
public sanction or approval.
Gabrielle Lyon-KIEI452-Week 4

15. ACCOUNTABILITY
For Profit:
• Shareholders
NPOs
• File IRS form 990s; report finances, salaries of 5 most highly paid
employees
• 990s have to be made available to the public (see Guidestar)
• NPOs usually overseen by the state’s Attorney General’s office.
Gabrielle Lyon-KIEI452-Week 4

16. Ownership
NPOs
No one person ‘controls’ the organization. The assets are dedicated to
the mission. Assets are PERMANENTLY dedicated to exempt
purposes.
(DEFINITION: EXEMPT - Educational; Literary; Scientific; Religious)
NOTE:
If the organization dissolves or merges (after debts/liabilities) assets
have to go to another NPO.
Gabrielle Lyon-KIEI452-Week 4

17. Financial Management
Private & NPOs
• Bound by Generally Accepted Accounting Principals (GAAP)
Public Sector
GAAP might be used but might also deviate; public sector financial
managers are not necessarily bound by accrual accounting
Gabrielle Lyon-KIEI452-Week 4

18. Legal Structures & Issues That Follow…
Non-profit:
• Should not pursue profit (certainly not capital gains)
• Profit-seeking activities restricted
• Donations (individuals, grants)
• Sponsorships
• Earned Income
• Debt
• UBIT
 They can’t raise equity. Why?
For-profit:
• Primary duty is to maximize profits
• Pursuing a social mission could be a distraction or limit profits and
violate fiduciary duty
Gabrielle Lyon-KIEI452-Week 4

19. BLENDED VALUE
• Social mission ‘baked in’
• “Any commercial activity or venture that is operated to achieve
business and social goals simultaneously.”
Gabrielle Lyon-KIEI452-Week 4

20. How to ‘Embed’ Social Purpose
in a For-Profit??
• Can you make social impact an integral part of a company?
• Is there a legal formation that will bind social impact to a corporate entity?
• Ben & Jerry’s
• Newman’s Own
Gabrielle Lyon-KIEI452-Week 4

21. Create Multiple Entities
Example 1: Urban Education Institute (Uchicago)
• Start as non-profit: Use donations and grants for initial salaries,
R&D, and launch.
• Resulting product or service  for profit entity to raise expansion
funds from the capital markets & public sector funds (i.e. UChicago
Impact & 6-16)
Example 2: Bain
• For-profit
• Then set up non-profit, Bridgespan
Example 3: National Geographic Channel
• Joint venture controlled by a non-profit parent (National
Geographic & FOX)
Gabrielle Lyon-KIEI452-Week 4

22. Use Existing Legal Structures
Limited Liability Corporation (LLC)
• More flexibility. Social purposes can be integrated throughout the
operating agreement
• If number of investors increases especially through an IPO – then need to
go to a C corp.
C Corporation
– Basic legal structure used by public companies and many privately
owned companies
• Organizational document – articles of incorporation
• Writing in a social mission would authorize the corporation to pursue a
social benefit but would not require it.
Gabrielle Lyon-KIEI452-Week 4

23. Where the conversation is headed…
Gabrielle Lyon-KIEI452-Week 4

24. Hybrid “Ideal”
• Everything produces BOTH social value and commercial value
• NOT commercial VS social; social value & commercial revenue are
indivisible.
Ex. Microfinance
• When the loan is managed well both parties benefit
Gabrielle Lyon-KIEI452-Week 4

25. Hybrid Organizations
• Nonprofit/For Profit are distinct operating models
(Social Sector vs. the Commercial Sector)
What happens IN PRACTICE when you put them together?
Gabrielle Lyon-KIEI452-Week 4

26. B Corp “Benefit Corporations”
B Lab is the certifying (nonprofit) agency
• Take the B Lab impact assessment test
• Adopt the B Corp legal framework
• Sign a term sheet that makes the certification
official
Laws passed in 26 states (was only 7 in 2012)
• 1,128 companies registered as B Corps
globally in 33 countries
• 20 B Corps in Illinois
Gabrielle Lyon-KIEI452-Week 4

27. B Corps…
• Must spell out their values in their charters
• Report annually on activities that benefit the public
• Submit to third-party auditing of their social impact.
• Approval of two-thirds of shareholders
Issues
• Accountable to shareholders?
• Some states don't even allow companies to add stakeholder
interests to their articles of incorporation;
• Are amendments legally binding? Need to be tested in court
• Is amendment even necessary?
Gabrielle Lyon-KIEI452-Week 4

28. Low-Profit Limited Liability Corp. (L3C)
“A LLC that is organized to further one or more charitable
or educational purposes within the meaning of the
Internal Revenue Code.”
1. To encourage investment into non-profit and for-profit social
ventures by simplifying compliance to the IRS rules for PRIs.
• Binds the three characteristics of Program Related
Investments (PRIs) from the tax code with a LLC legal
structure.
• Allows for-profit seeking investors to access investment from tax-exempt
sources (like private foundations)
Gabrielle Lyon-KIEI452-Week 4

29. Low-Profit Limited Liability Corp. (L3C)
Issues:
1. Tax consequences are not yet known
• At the federal level “no one has signed off”
• State-created mechanisms
2. Unnecessary
• LLCs offer flexibility already
• Does not remove the burden of higher levels of due diligence,
reporting and accountability required for investments in for-profit
social ventures.
Gabrielle Lyon-KIEI452-Week 4

30. Hybrids challenges (or ARE they?)
• Legal Structure
• Financing
• Customers? Beneficiaries?
• Culture and Talent Development
Gabrielle Lyon-KIEI452-Week 4

31. “Executives of NPOs should not be encouraged to search for a holy
grail of earned income…Sending social service agencies down that
path jeopardizes those who benefit from their programs-and it harms
society itself, which depends for its well-being on a vibrant and
mission-driven nonprofit sector.” (1)
“Hybrids face the special challenge of building an organizational
culture committed to both social mission and effective operations.” (2)
Based on your experiences with your clients what do you think
about these generalizations?
1) Foster, Bradach. Harvard Business Review, 2005
2) Battilana, Lee, Walker & Dorsey. SSRI, 2012)
Gabrielle Lyon-KIEI452-Week 4

32. Break-even
Philanthropy
Profits
100%
Donations
30%
Returns
Non-profit
Profit
Venture Philanthropy
Impact Investing
The Impact Financing Continuum
Philanthropy
VC Funding