Monday, May 03, 2010

Notes on Structure Lab: Legal and Financial Models for Social Entrepeneurship

Last week, I attended Structure Lab, a half-day workshop on legal and financial structures for ventures for social good. Like many people in the arts, I'm interested in new models that help people combine mission-driven work with an entrepreneurial spirit. And as someone in the planning stages of a new venue (a cafe that offers craft beer, Belgian frites, and intriguing encounters with strangers), I was looking for information and tools that can help me make the best decisions for the financial and mission-related viability and health of the new company.

The Structure Lab is set up as a "game" in which you explore cards in various categories (values, assets, financing, etc.) to better articulate what you are really trying to do with your project concept. The idea is that you specify your values, relationships, and assets, and then match those up with potentially fruitful legal structures, financing models, and growth potential. We each worked individually on our own sets of cards, coming back together for discussion as we progressed through the various stages. The cards were a brilliant touch--they helped structure the day, supported simple prioritizing and sorting activities, and gave participants with a tangible, reusable take-home. While I'm not sure I'd recommend the workshop (it was quite expensive for what I received), I definitely benefited from the format.

The good news? I collected some tools to use in planning and discussing a new business. The bad news? I didn't learn too much about hybrid legal structures that might apply to small-scale ventures like mine. For me, the first half of the workshop was great, but the second piece--the matching--was too brief. I didn't feel like I had the pre-knowledge needed to make useful decisions about how to line up various kinds of legal structures or financing strategies to my goals. I learned new vocabulary and questions to ask myself and others, but the exercise itself felt a bit frustrating and haphazard.

The rest of this post is separated into two sections--one about what I learned about how to think about business formation, and the other about hybrid structures for social entrepreneurship. If you've started a business or organization before, the first section is probably rudimentary, but for me, it was really helpful.

Tools for Planning & Forming a Social Venture

The first half of the workshop focused on three things: values, relationships, and assets. Each of these categories was crafted to help participants narrow down to particular legal structures of interest. For example, the values section was posed in terms of spectrums: from simplicity to complexity, security to risk, constancy to nimbleness, autonomy to engagement. If you see your venture as a simple, risky, nimble operation, a quick and flexible legal structure (like the LLC) may make sense. On the other hand, if you want to start a complex project that is highly engaged with partners and will have a long-term prospectus, more complicated legal structures (like nonprofits or corporations) might make more sense.

The relationships cards asked participants to list individuals and organizations with whom the company will have different kinds of relationships. Who are your investors, co-conspirators, and believers? Who can validate your idea? Who are your buyers, your recipients, and your regulators? For each relationship type, I wrote down who fell into the category, what kind of involvement I saw them having, and how that translated to a certain kind of role in the company (owner, manager, governor, contractor, transactor). The idea here is that your plans for different relationships dictate certain kinds of business directions. A company in which employees are co-owners might translate well to a coop model. A company in which program recipients are involved with governance suggests a community board model. And so on. This relationship bit helped me think about how different kinds of folks will be involved with a highly participatory, community-co-created project in the long-term. It also helped me identify people I should be spending more time with in the short term (and it made me think of you, Museum 2.0 readers, who I see as potential co-conspirators).

Finally, we looked at assets. While these included expected cards for cash, credit, equipment, property, and IP, they also included distribution systems (vehicles for delivering the program) and brand/relationships. Again, we listed out specific items in each category along with engagement strategies for each. But this time, instead of mapping those to roles and ownership stakes, we mapped the assets to three kinds of asset management--protection, leverage, and share. For me, this was pretty interesting, particularly when it comes to intellectual property. I see the cafe I'm building as an R&D space for the cultural sector, and I want to be able to share research and ideas that come out of it freely with cultural organizations, while protecting my ability to also leverage that research for sale to for-profit companies that are interested in research around customer loyalty and community engagement. I'm usually so sharing-oriented, but I appreciate the complexity of figuring out how to balance giving things away with selling them--it's what I do in my work all the time (and it was an important part of the distribution of The Participatory Museum).

As noted above, the workshop became more confusing and less useful when we moved into matching what we'd written to various legal structures, governance models, and financing models. Part of this had to do with the shift in interaction--we stopped writing and personalizing cards to our own projects and were instead expected to read the little cards and glean from them enough information to make informed decisions (something that others may have been more able to do given much greater levels of experience with financing and legal structures). The cards were helpful for expanding my vocabulary and thinking about the options, particularly when it came to the market interaction, governance, and growth cards. The cards were tagged with various legal structures, so that, for example, you knew that endowments only work for financing non-profits, stock options are only applicable to corporations, and so on.

One of the governance ideas I liked most (and thought could easily extend to non-profits) is a Stewards Council. This is a structure that is apparently gaining traction in the social entrepreneurship world in which a company has a group of advisors with limited economic interest/investment who have some powers to weigh in on and even veto board decisions that may impact the ability of the company to accomplish its mission. This is a kind of check against board interests that are purely focused on shareholder returns and might steer a company away from its mission. But I think this might also make sense in non-profits, where boards are often funders and may not be able to steward the mission as successfully as a more diverse group of community members.

Legal Structures for Social Good (in the US)

Before the workshop, I'd read a good deal about the L3C, B Corp, and other nascent legal structures for social entrepreneurship. I'd been particularly excited about the L3C, which is a mission-first, low-profit LLC that is eligible for program-related investments (PRIs) by charitable foundations. B Corp is newer--right now it's a national trustmark (a certification, like organic), though Maryland just passed a law making "benefit corporation" a legal designation.

I was disappointed, and a little surprised, that the workshop facilitator did not talk at length about these structures nor was able to answer most peoples' questions about them (including basic questions like what "low-profit" means in the L3C context). Yes, these structures are still emerging, but L3C has been on the books in a few states for awhile and many of the workshop participants, like me, seemed particularly interested in them.

What I did learn, however, was not that encouraging. It seems that most L3Cs are large organizations, and they are formed as L3Cs specifically to access program-related investments (PRIs). Here's a brief primer on PRIs. Foundations make charitable grants and donations to non-profit organizations. They also manage investment portfolios that allow them to keep building their endowments so they can continue making charitable grants into the future. The IRS requires foundations to distribute at least 5% of their assets each year to charitable/social organizations. This 5% can be used for grants to non-profits or program-related investments in for-profits. The challenge traditionally is that to use a PRI to invest in a for-profit, both the foundation and the for-profit company have to go through lots of work with the IRS to justify that yes, the company is doing social good and is eligible for some of the foundation's distribution of assets. The L3C structure was set up so that for-profits and foundations can more easily partner and make PRIs possible. This seems to be working, though the question of whether the L3C label is sufficient evidence on its own for a company to be eligible for PRIs has not yet been tested in court.

So the upside is that an L3C is eligible for a pool of investment from foundations that was previously difficult to get. There's a second upside that only really makes sense for very large organizations, and it has to do with tranching, or segmenting, of investment. Basically, the idea is that a foundation could invest in an L3C at a very low rate of return with high risk (because it's a good mission-fit investment to make), which would allow the L3C to offer other more traditional investors a higher rate of return at lower risk in a different tranche of investment. This can make a socially beneficial company more likely to attract investment. The foundation with the PRI effectively jumpstarts the viability of the L3C by taking on the most risk and lowest amount of return.

This is all great for big companies, but for small projects like mine, an L3C might not be that useful. I'm not planning on pursuing complicated tranched investment strategies, and I don't have pre-existing relationships with foundations that are making PRIs in the arts or in community development. While the idea of incorporating as a mission-first company really appeals to me and fits with my thinking, I was told that an L3C model can actually scare off potential investors who see the company as not serious about making money. And it apparently takes an incredible amount of time, relationships, and education to help foundations that don't currently make PRIs consider doing so.

And what about the B Corp? We spent even less time talking about this during the workshop. This one really is new, at least the Maryland legal version, and at least for me, a corporation of any kind (B, S, C, coop) is more complicated than how I want to get my business started. I do think the B Corp certification is interesting, and it might make sense for a non-profit to go through the assessment and check out the rating system to understand what the B Corp folks see as indicative of a socially responsible business (though you should note that B Corp certification is not available for non-profits).

Ultimately, the workshop facilitator noted that many people who start social ventures choose their legal structure based on discussions with funders. Funders who are interested in charitable donations are more likely to engage with a non-profit, whereas those who are interested in investments (even at low profit) are more likely to get involved with companies. So if you are interested in putting some money into a project that will promote civic engagement through substantive interactions among strangers and serve as an experimental R&D center for public-facing cultural institutions, give me a call and we can figure out the next step together.

5 comments, add yours!:

Jonathan Katz said...

Nina,
Take a look at Omidyar Network. They are capitalist philanthropists. One area of their interest is "marketplaces", seen as zones of information, access, and resources.
I call them capitalist in the sense that they want a ROI for their money, even if they have to go through some contortions to measure the return. there are a number of other similar groups building on their success(luck) in business to offer a supposedly better, market driven approach to philanthropy.

Jeremy said...

Hi Nina. A little off-topic but not too far: if you've not come across Jim Collins' "Good to Great and the Social Sector" (http://www.jimcollins.com/books/g2g-ss.html) it's worth a look. It won't help you with your own plans, though. Good luck with them!

Nina Simon said...

Thanks Jonathan and Jeremy for your comments. There are lots of social venture networks out there - I think Investor Circle is the biggest - that focus on investments that are mission-first. So far, I haven't found many that focus on missions that aren't related to direct service (food, water, healthcare) or technology (especially green tech). But I'll keep hunting...

Jeremy, I haven't read that one yet - I read the original book but kept meaning to read the nonprofit version. Thanks for putting it back on my radar and reading list!

claire antrobus said...

Hi Nina

I work with social enterprise (mainly on finance and funding issues) but in the UK we have different legal structures and issues. We often look with envy at these guys in the States http://www.nonprofitfinancefund.org/

You probably know of them already - but if not it might be useful - more on finance than governance/ legal.

Good luck!

Hanna Sathiapal said...

Hi Nina, thank you for sharing your experiences with Structure Lab. Looking for solutions for one of my ideas (resource center for micromuseums)I just came across The Open Source Science Project (http://www.theopensourcescienceproject.com) which includes a microfinance platform. I don't know anything about it but I was thinking that maybe part of your project could be run as a research project?