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www.inc.com/magazine/20110501/the-social-entrepreneurship-spectrum-for-profit-with-a-socialmission.html

The Social Entrepreneurship Spectrum: For-Profit With a Social Mission For some businesses, social impact can be measured by the size of the checks they write. For others, the mission is woven directly into the business. The Model Works Best When 1. The product is the social vehicle. In other words, the product or service being sold triggers the social or environmental change. 2. The user has the ability to pay most, if not all, of the purchase price. In the best cases, the product or service is a response to market demand. In others, a third party—for example, a school district or hospital—helps make up for the user's lack of funds. 3. The business cannot be separated from the social mission. Toms Shoes, for example, donates a pair of shoes for every pair sold. The social impact is intrinsically tied to the business proposition; without it, Toms is just another shoe company. The Advantages As with any business venture, the sky is the limit. A social mission can be a potent marketing and recruiting tool and an effective differentiator from the competition. A new generation of so-called impact investors is targeting for-profits with social missions, broadening the base of potential backers. The government is also getting involved: The Obama administration's Startup America initiative has allocated $1 billion for an impact investment fund. The Challenges To prove their value to investors, social entrepreneurs running for-profit companies must quantify not only their financial results but also their social impact, which is no easy task. Also, there's no guarantee that the social mission will be preserved as the company grows. Should a business take on traditional equity partners, merge, or go public, it can become difficult to protect the mission. Founders may start with good intentions, but once the business expands, they (or their boards) often must put fiduciary duty to shareholders ahead of the social mission. The Tax Implications Despite the good intentions of mission-based for-profits, they pay the same corporate income tax as other businesses. Like all for-profits, they are permitted to deduct up to 10 percent of their income in charitable contributions. They cannot receive tax-deductible donations.


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The Social Entrepreneurship Spectrum: B Corporations "Rather than just being a business that talks about 'people, planet, and profit,' we have put it into our corporate structure," The Model Works Best When 1. A business has more than one social impact. B Lab, which created the B Corp standard, assesses businesses according to their impact on their communities, employees, and consumers and the environment. The more a business does to benefit each category, the more points it receives. 2. You want access to impact investors. B Lab's rating system quantifies social impact—something impact investors typically require. The Advantages Members of the B Corp network are good to one another. Many offer discounted services, including Web design and headhunting. Mainstream businesses are following suit: Intuit offers QuickBooks for free to B Corps; Salesforce.com gives them a nonprofit discount. The B Corp label is also an effective marketing tool; B Lab runs its own ad campaign on behalf of B Corps aimed at 17 million consumers. The Challenges The B Impact Rating System exam requires answers to up to 220 questions; since 2007, about 900 companies have failed to make the cut. Those that do must amend their corporate governing documents and file them with state authorities and pay a yearly fee of $500 to $25,000, depending on company size. Every two years, businesses need to recertify. Despite the strict regulations, the certification has no legal significance. The Tax Implications B Corps pay standard corporate income tax. So far, the only city that gives tax breaks to B Corps is Philadelphia, where up to 25 B Corps a year will be eligible for a $4,000 tax break starting in 2012. ‌


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The Social Entrepreneurship Spectrum: Nonprofits Nonprofits are fueled by tax-deductible donations—cash from individuals, public grant funding, or money from foundations. The Model Works Best When 1. The user cannot pay. 2. The organization requires the perception of impartiality. When people donate to support a cause, they want the money to go to that cause, not to shareholders or the CEO's bank account. The Advantages Freedom from federal, state, and local taxes is a big plus. Launching a nonprofit also is generally less expensive than starting a for-profit. You don't have to give up equity for money; a nonprofit has no shares to give. Major foundations direct nearly all their funding toward 501(c)(3)s. The Challenges If your funders back away, you are in big trouble. (Charitable donations fell 3.6 percent in 2009.) In many cases, donations are restricted to specific projects; that can make it difficult for nonprofits to innovate and expand. And nonprofits don't offer much operating freedom; boards of directors typically control the purse strings and major hiring and firing decisions. Finally, 501(c)(3) groups must report assets, income, expenses, and executive salaries to the IRS; compensation is subject to review by the agency, which has increased the number of nonprofit audits it conducts more than 40 percent over the past two years. The Tax Implications Nonprofits are exempt from federal income tax. They can also receive tax-deductible donations of up to 50 percent of an individual's income and up to 10 percent of a corporation's income. Most states honor the IRS's exemption criteria. ‌.


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The Social Entrepreneurship Spectrum: Nonprofits With Earned Income A 501(c)(3) nonprofit can still generate earned income. And plenty do. The National Center for Charitable Statistics estimates that nearly 70 percent of the $1.4 trillion generated by nonprofits in 2008 came from the sale of goods and services. The Model Works Best When 1. The nonprofit has a valuable product or expertise. An education nonprofit, for instance, could sell tutoring services. As long as the product or service is directly related to the mission, the income remains tax exempt. 2. The user has some ability to pay. 3. The nonprofit's mission is job training or skill building. According to IRS regulations, organizations that help certain classes of individuals—refugees or homeless people, for example—find jobs are permitted to become employers themselves. The Advantages Generating income frees an organization from total dependence on philanthropic dollars. At the very least, the income is a safety net; it also means more money to invest in the mission. Unlike many grants, earned income is unrestricted and can be used however the organization chooses. Finally, nonprofits with earned income retain all the advantages of pure nonprofits—including tax exemptions, ability to receive tax-deductible donations, and eligibility for nonprofit-exclusive grants from major foundations. The Challenges Nonprofits with substantial earned income usually have two staffs: one to work on philanthropic goals; the other to handle tasks like sales, marketing, and customer service for the business side. This makes them more costly to run and poses the risk of conflict of interest. All 501(c)(3) organizations must give priority to the nonprofit's stated mission. That can often make it difficult for income-generating arms to pursue opportunities. The Tax Implications If the IRS decides that a nonprofit's business efforts are not "substantially related" to its mission, the earnedincome is subject to taxes. The nonprofit's 501(c)(3) status is jeopardized, too. To qualify as substantially related, the business has to specifically accomplish the nonprofit's goals. Say a women's shelter opened a bakery to supplement grants and donations. That would likely be considered unrelated to the organization's mission—unless it was staffed by women from the shelter. The question is so subjective, though, that nonprofits have found themselves tied up in legal squabbles with the Feds for years.


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The Social Entrepreneurship Spectrum: Hybrids In the hybrid model, a nonprofit and a for-profit are linked. In some cases, one is a subsidiary of the other; in others, the two entities are bound by long-term contracts in which one entity fulfills a basic need for the other and vice versa. The Classic Example In 2005, the nonprofit Mozilla Foundation formed a for-profit subsidiary, Mozilla Corporation, to handle the explosive growth of the Firefox Web browser. Now, the for-profit makes about $104 million a year from revenuesharing agreements with its search partners, including companies such as Google and Yahoo. Meanwhile, the Mozilla Foundation, which is the corporation's sole shareholder, handles the development of the open-source software and brings in just over $222,000 in charitable donations. The Model Works Best When 1. The nonprofit's unrelated business income threatens its nonprofit status. 2. The for-profit needs help managing its philanthropy. As corporate responsibility programs have grown, some forprofit companies are starting their own nonprofits and foundations to manage charitable activities. 3. Each entity needs something offered by the other. The Advantages You get to have your cake and save the whales, too. The nonprofit remains tax exempt and eligible for foundation grants. The for-profit can raise unrestricted funds from angels and VCs and make tax-deductible donations to its nonprofit partner. Because they are legally separate entities, for-profit subsidiaries often have more flexibility than the income-generating arms of nonprofits. They can also pay talent whatever they see fit, without being charged with excessive compensation. The Challenges Hybrid arrangements can get complicated fast. They require separate boards and management staffs, given that significant crossover in leadership might signal a conflict of interest to the IRS. Any time there is a service transaction between a nonprofit parent and a for-profit subsidiary, both boards have to approve it and be able to show that the for-profit paid actual market rates for the product or service (proving that the parent and subsidiary are conducting arm's-length transactions and not receiving special favors). What's more, because hybrids are fairly new, there are no IRS rules on the model. The Tax Implications Each entity is taxed as if it is independent of the other. Nonprofits are still exempt from federal income tax, as well as taxes in states and localities in which their tax-exempt status is approved. For-profits are taxed according to their corporate structures.


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The Social Entrepreneurship Spectrum: Impact Investors All investors obsess about returns. But for impact investors, ROI is an especially tricky matter, because in addition to financial success, they are seeking social and environmental results. The Classic Example Impact investors often speak in terms of patient capital—that is, investments that can take as long as a decade to turn a profit. The Acumen Fund is credited with coining the term. Founded in 2001 by Jacqueline Novogratz, a former Rockefeller Foundation executive, Acumen broke new ground with its decision to support businesses in emerging markets with investment capital rather than grants. Unlike other impact funds, which are set up to make money, Acumen, which is structured as a nonprofit, seeks to recoup its investments via payback or exit within five to seven years. The fund has invested $57 million in 55 businesses; some 30 million people have used those firms' goods and services. The Model Works Best When 1. The investor sees opportunity in a social or environmental flaw. Impact investors invest in things such as the redevelopment of distressed land and financial services for the unbanked—which have the potential to generate value. 2. The investor has experience as an activist and an investor. 3. The investor isn't looking for a quick exit. The Advantages A recent study by J.P. Morgan's Global Research division estimates that there is a $1 trillion investment opportunity over the next 10 years in businesses that serve people earning less than $3,000 a year. What's more, the researchers estimated that there is $667 billion in profits to be made from these investments. "A lot of these areas are overlooked by conventional investors," says Amit Bouri, director of strategy and development for the Global Impact Investing Network, an industry group. "They're largely untapped markets right now." The Challenges Deals tend to be small, generally less than $1 million. Impact investors seek to quantify social return, which is far less tangible than financial return. The Global Impact Investing Network has developed a set of reporting standards known as Iris. An acronym for impact reporting and investment standards, Iris helps impact investors speak the same language so they can compare social returns from one investment to the next. The Tax Implications Impact investors are taxed at the same rate as traditional investors—though some states offer their own incentives.

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