Think Creatively Before Settling on a Hybrid Entity
At Sustainable Law Group we are privileged to work with a number of social entrepreneurs who are redefining business as usual in for profit and nonprofit organizations alike. Since we opened our doors in April 2012 we have helped to structure and form all of the new types of hybrid entities, including Low Profit Limited Liability Companies (L3Cs), Benefit Corporations and Flexible Purpose Corporations.
Social entrepreneurs can be – and have been – particularly creative when structuring business enterprises. Although this penchant for thinking outside the box led to the creation of the new hybrid entities, these new forms are not necessarily a panacea that offers the greatest opportunities for success.
Each week we hear from people who are excited to accomplish meaningful work outside the bounds of traditional for profit and nonprofit structures. However, we often find ourselves counseling our clients that forming a hybrid entity may not be the right choice, as it may increase costs and reduce opportunities to receive traditional sources of capital.
For example, several of our clients that intended to form hybrid entities had business ideas that would qualify as charitable programs under Internal Revenue Code section 501(c)(3). Choosing a for profit structure (and all hybrid entities are taxed as for profits) over a nonprofit charity may mean that these clients would not be able to attract as much revenue and assets to their organizations, and would confront a much higher cost of doing business in the form of federal and state income taxes.
Many social entrepreneurs are attracted to hybrid entities because they can actually own all (or part of) their business. We agree that equity ownership is a great benefit, but if an organization would qualify as a charity, this benefit must be weighed against the cost of losing out on charitable gifts, grants and contributions. Also, it’s important to remember that nonprofits – and their founders – are free to form for profit subsidiaries and joint ventures using hybrid and more traditional for profit entities.
Although the field of impact investing is growing rapidly, many traditional investors are not ready to invest in hybrid businesses. Equity investors are often more comfortable with risk, but within certain bounds. Because the hybrid entities are so new, some traditional investors view them as riskier investments because the distinctive aspects of their corporate governance haven’t yet been tested in court. Therefore, choosing to form hybrid entities may cut out a large swath of capital.
We are always thrilled to form hybrid entities. But we really enjoy employing all available tools to maximize our clients’ potential to do well by doing good. These new structures offer social entrepreneurs greater flexibility to use business practices to make the world a better place. However, it’s important to remember that traditional entities have their benefits too, and may still be the best option.
If you are thinking about starting a new social enterprise please contact us to learn more about what’s right for you and your business.