Determining the right legal structure for your social enterprise

This guide explores the typical legal structures that are used in the social enterprise sector, the core advantages and disadvantages of the respective structures, and the key issues for consideration when deciding on the right legal structure for your organisation

As there is no legal definition for what constitutes a social venture, there is considerable scope for choosing from a variety of different legal forms (although there are numerous viewpoints of what constitutes the 'best' social venture legal structure, often driven by vested interests). Before getting into the detail, it's worth bearing in mind two fundamental principles:

  • It is not the legal structure that makes an organisation a social venture - it is its activities.
  • Your immediate, and future, funding and income generating opportunities will have a major impact on the structure you choose.

An individual operating a social venture without a legal structure is usually regarded as a sole trader or self employed. Organisations that are operating as a membership body without a legal structure are typically regarded as an unincorporated association (also known as voluntary association and community groups). There are a number of reasons why you might consider adopting a legal structure for you organisation:

  • A requirement by stakeholders that you are planning to engage with
  • A requirement based on the type of activities you plan to undertake
  • To enhance your credibility with customers, funders, suppliers and employees
  • To protect individuals involved from personal liability.

As a sole trader, self employed individual or unincorporated association (i.e. not recognised as a separate legal entity), the individual or management committee of the association is directly liable for any debts or legal actions affecting your organisation- a risky position. For example, if the organisation generates a financial deficit, it will be the responsibility of the individuals involved to find the money to pay any creditors. Adopting a formal legal structure can protect individuals (e.g. members/ trustees/ directors) from personal liability, therefore limiting this type of risk.

The variety and diversity of the possible legal structures for social enterprise complicates matters. However, there are a number of over-riding principles that should be considered; thinking through these should help you decide the best legal form to adopt for your project. After looking at the different possible legal structures, we'll address some of these considerations.

Common legal structures

The most common legal structures used in the social entrepreneurship sector are:

  • Unincorporated association (which may also be a registered charity)
  • Company limited by guarantee (which may also be a registered charity)
  • Company limited by shares
  • Industrial & provident society
  • Community interest company- CIC (shares or guarantee)

The following tables examine these legal structures in more detail, along with a summary of the key advantages and disadvantages associated with the respective structures:

Unincorporated Association (Voluntary/Community Organisations)

Key Features

  • Most voluntary and community are unincorporated associations.
  • The governing method for unincorporated associations in usually the constitution or association rules.
  • The term 'unincorporated' means that, in law, the association has no existence apart from its members as individuals.

Pros

  • Governed by a simple constitution.
  • No regulation (e.g. through Companies House)
  • Easy to set-up and administer
  • Can hold property

Cons

  • No legal identity seperate from the individual members can only enter into contracts through its members.
  • Management committee and/or members are responsible for any debts the association incurs
  • Despite lack of legal personality may still have to pay corporation tax and file a tax return

Registered Charity (incorporated association)

Key Features

  • To become a registered charity, an organisation needs to register with the Charity Commission.
  • The activities of a registered charity must fall into one or more of 12 pre-defined charitable objects which are of benefits to the community.
  • A central feature of a registered charity is a board of trustees, i.e a group of people who volunteer to run the charity
  • Charities may qualify for a number of tax exemptions and tax reliefs on income and capital gains sometimes on profits

Pros

  • Can make it easier to raise funds from trust funds and companies
  • Directors cannot be paid
  • Tax execemptions and reliefs

Cons

  • More active regulation in return for the tax benefits
  • More responsibility for people involved - become charity trustess. Charitable law does not allow trustees to be paid for being trustees although they may be reimbursed for out of pocket expenses.
  • Charitable rules as enforced by the trustees may impact on entrepreneural aims.
  • Significant restrictions on trading.

Company Limited by Guarantee

Key Features

  • Company Limited by Guarantee is the most popular form of incorporation for organisations is the social sector. The governing body is this model is called a 'Board of Directors'.
  • 'Limited by Guarantee' means that each member's liability for the company's debts is limited to an amount written into the governing instrument often as little as £1 each.
  • The organisation has seperate legal identity and can be liable seperately from its members and directors, reducing the risk for members and directors. However, directors can still be liable for negligence and / or fraud.
  • In return for limited liability the company must register its inforporation with Companies Hous and regularly provide them with certain information:
    • Annual accounts; annual return
    • Notice of change of directors or secretaries and their particulars
    • Notice of change of registered office
  • Companies can be incorporated with a single member

Pros

  • Possesses legal personally seperate from members
  • Can own property and hold contracts
  • Directors can be paid

Cons

  • Regulation (from the Companies Act)
  • More responsibility for people involved - become company directors
  • May be difficult to raise philanthropic donations / grant aid.
  • Unlike with a CIC, assets are not protected with an asset lock

Registered Charity (company limited by guarantee)

Key Features

  • To become a registered charity, an organisation needs to register with the Charity Commission.
  • The activities of a registered cahrity must fall into one or more of 12 pre-defined charitable objects which are of benefits to the community.
  • A central feature of a registered cahrity is a board of trustees, i.e. a group of people who volunteer to run the charity.
  • Charities may qualilfy for a number of tax execemptions and tax reliefs on income and capital gains and sometimes on profits.

Pros

  • Can make it easier to raise funds from trust funds and companies
  • Possesses legal personality from members and directors
  • Can own property and hold contracts
  • Combines advantages of registered charity and Company Limited by Guarantee
  • Tax exemptions and reliefs

Cons

  • More active regulation in return for the tax benefits
  • Must also continue to comply with company regulations (e.g. Companies House filings)
  • More responsibility for people involved - become charity trustees. Charitable law does not allow trustees to be paid for being trustees although they may be reimburse for out of pocket expenses.
  • Charitable rules as enforced by the trustees may impact on entrpreneurial aims
  • Signigicant restrictions on trading

Company Limited by Shares

Key Features

  • Most frequently adopted corporate legal structure.
  • The governing body in the model is called a 'Board of Directors'
  • There is no limit on dividends that can be paid to shareholders.
  • Member/shareholders' liability for the company's debts is limited to the amount of their contributions this can be as little as £1 each.
  • Organisation has seperate legal personality and liability from the of its members and directors, reducing the risk for members and directions. However, directors can still be liable for negligence and/or fraud.
  • In return for limited liability the company must register its incorporation with Companies House and regularly provide them with certain information:
    • Annual accounts, annual return
    • Notice of change of directors or secretaries and their particulars
    • Notice of change registered office
  • Companies can be incorporated with a single member

Pros

  • Not subject to the additional regulatory requirementss of a CIC.
  • Good investment nodel - ability to pay dividends may make it easier to attract private investors
  • Embeds entrepreneural drive; shareholdres benefit from Company's success.
  • Directors can be paid.
  • Has a seperate legal identity from its members.
  • Can own property or enter into contracts in its own right

Cons

  • Regulation (from the Companies Act)
  • Potential conflicts of interest between individual social entrepreneur and broader shareholder constituency.
  • More responsibility for people involved - become company directors.
  • Cannot generally raise philanthropic donations/grant aid, therefore need to be entirely self-financing or financed through private investment.
  • Unlike with a CIC, assets are not protected by an asset lock.

Industrial & Provident Society

Key Features

  • Essentially these are co-operative, run and owned by their members, but which may operate for the benefit of the community in addition to benefiting the members.
  • An IPS can own property, enter into contracts, issues shares and take out loans.
  • It can be registered with and regulated by the Financial Services Authority ("FSA"). The aims of the society and the way it is run must comply with certain conditions in order for the FSA to accept and maintain the registration.
  • An IPS must have at least three members.

Pros

  • Good for promoting democratic ownership and control through co-operative structures
  • Have a seperate legal identity from its members
  • Can own property of enter into contracts in its own right

Cons

  • Less fit for purpose for organisations with hierachical structures.
  • Not as well recognised as some of the other legal structures such as Company Limited by Guarantee or Registered Charity.
  • FSA registration entails formalities (e.g. keeping filing of accounts)

Company Interest Company (CIC)

Key Features

  • CICs can be private companies limited by guarantee or by shares, or a public limited company.
  • They can adapt the co-operative, not for profit or general commercial company model.
  • There are number of obligations that COC has to meet and continue to meet in addition to those imposed on an ordinary company:
  • Must safisfy a community interest test (looks at the underlying motiviations of the company in terms of what it will do, who it will help and how, if it makes a profit, or surplus, what the company will do with it)
  • Must adapt certain stautory clauses it its constitution (asset lock and preventing the COC falling under control will do with it)
  • Must deliver an annual community interest company report with its members but dividends payable to private shareholders (non-asset locked bodies) will be subject to a dividend cap.

Pros

  • Distinct brand for social enterprises
  • Embraces democratic ownership, not for profit and commercial models
  • Combines freedom of entrepreneurial activity with protection of 'asset lock';
  • Directors can be paid
  • Light touch CIC regulator
  • Has a seperate legal identity from its members
  • Can own property or enter into contracts in its own right

Cons

  • Dual regulation from Companies Act and the CIC Regulator, but work seamlessly together
  • More responsibility for people involved - become company directors.
  • Not relevant for non social enterprise
  • May be difficult to raise philanthropie donations/grant aid
  • Cap on dividends ("asset lock") could dsepress demand from investors