Social Firms Scotland

Legal structures for social enterprises

Presentation by

Stephen Phillips29 October 2004

Choosing the optimum legal structure

• Types of organisation

• Types of legal structure

• Matching the organisation to the legal structure

• Using two or more entities

Types of organisation

• Some key questions:

Profit-distributing or non-profit distributing?

If non-profit distributing, charitable or non-charitable?

Where should ultimate control lie?

Key Question 1 – Profit -distributing?

• Distinction between e.g. employee remuneration (inc bonuses & other forms of incentivisation) and equity returns [can readily be done within an NPDO]

• Also bear in mind possibility of contractual linkages between financial performance and returns to a given party (eg royalties on IPR) [can readily be done within an NPDO]

• Key issue – is there a party or parties whose financial returns should be directly linked to overall performance of the business/operations? ie risk capital (equity stake) on which a financial return is expected?

Key Question 1 – Profit-distributing? (cont)

• Also, look at project as a whole; who will be drawing funds out, and on what basis? With what degree of security/certainty? How does that tie in with allocation of risk? Is risk capital an essential part of funding package? And what mechanisms for recycling of surpluses would fit?

• Community interest companies (when available) will represent a halfway house; also possible to structure equity returns for one or more participants but not others within an existing company limited by shares or general partnership, LP or LLP model

• But where one party is to derive a return and the other(s) not (eg. to allow remaining surpluses to be recycled), checks and balances within a single entity may be difficult to engineer; often useful in that context to adopt a two-tier model, with a separate non-profit distributing body/charity being used to draw off surpluses

Key Question 2 – Charitable or non-charitable?

• Objects of the organisation must fit within traditional charitable heads (or –once the new Act is in force - the new 12/13 charitable heads)

• Must be non-profit distributing (but bear in mind contractual mechanisms for linking returns to performance)

• Majority on the board must be non-employees

• Trading – only if: (a) trade is carried on in the carrying out of a

primary charitable purpose; or

(b) work done mainly by beneficiaries [very important in a social firm context]; or

(c) below statutory threshold

Key Question 3 – Where should control lie?

Leaving aside complications where there are two or more entities in the framework (and the possibility of hybrids), there are four broad models:

• Membership-led organisation

• Partnership organisation

• Trust (or quasi-trust) organisation

• Equity vehicle

Membership-led organisation

Members

Management Committee/Board

ELECT

Decisions on:-• changes to

constitution (or name, objects, articles)

• winding-up• AGM matters

Decisions on:-• management policy• overall supervision

& control

Partnership organisation

Members

Management Committee/ Board

Decisions on:-

• changes to the constitution

• winding up

• AGM matters

Decisions on:-

• management policy

• overall supervision & control

APPOINT

Members

Trust (or quasi-trust) organisation

Directors

Shareholders

Equity vehicle

Directors

Decisions on:• change of name• change to objects clause• alterations to articles• winding up• authority to issue shares, approval

of share buy-back• approval of final dividend• approval of certain transactions

involving directors, financial assistance, etc; often major borrowings, asset disposals etc

Decisions on:• management issues; overall supervision

& control (esp. financial management)• issue of shares & loan stock • (normally) approval of share transfers• payment of interim dividend• recommendation on final dividend• appointment/removal of co. secretary

Types of Legal Structure

• Voluntary association

• Trust

• Industrial & provident society

• Company limited by guarantee

• Company limited by shares

• Scottish charitable incorporated organisation (SCIO)

• Limited liability partnership (LLP)

Choice of legal vehicle

• Voluntary association: No formal registration requirements (other than

charity recognition process Less ongoing admin. (eg no need to notify changes in

those serving on management committee) Very limited legal overlay (eg no stat. rules for AGMs) Much less intimidating for people wanting to get

involvedBut Not treated as a legal entity for most purposes Risk of personal liability for those serving on the

management committee [a serious disadvantage]

Choice of legal vehicle

• Trust No formal registration requirements (other than

charity recognition process) Less ongoing admin. (eg no need to notify changes in

trustees) Limited legal overlay (as compared with eg a

company) Absence of member-level reduces admin.But Does not have full legal personality (so need to show

linkage in trustees) Possibility of personal liability for trustees (though

lower risk than in voluntary association) May be regarded by funders as more exposed to

abuse, since no accountability at AGMs

Choice of legal vehicle

• Industrial & provident society Full legal personality Limited liability Body of stat. requirements is less detailed than for

companies Use of standard models may make formation process

seem more simple [Useful vehicle for public share issue] (not relevant to

char.)But Registration procedures are needed to form an IPS Registration is more expensive than company

incorporation (esp. where there are major departures from model rules)

Ongoing requirement to notify changes to the FSA Statutory overlay – and less flexible than for companies IPS structure is unfamiliar to lawyers, many banks etc

Choice of legal vehicle

• Company limited by guarantee Full legal personality Limited liability Companies House provides much more up-to-

date framework than FSA Can be charitable or be a CIC or neitherBut Registration procedures are needed to form a co. There are ongoing requirements to notify

changes in directors, sec/y, reg. office etc Major body of statutory and case law as overlay Can be intimidating (as compared with vol. assoc.

or trust) for those wanting to get involved

Choice of legal vehicle

• Company limited by shares Full legal personality Limited liability Readily lends itself to detailed tailoring in relation to

decision-making and financial returns (eg through separate classes of shares)

Can be a CIC if appropriateBut Registration procedures are needed to form a co. There are ongoing requirements to notify changes in

directors, sec/y, reg. office etc Major body of statutory and case law as overlay Company will be liable to tax, so not optimum for a

joint venture where one or more shareholders are public sector bodies or charities

Choice of legal vehicle

• SCIO Full legal personality Limited liability Simple model rules (one-tier and two-tier) Limited legal overlay User-friendly registration process with OSCR; and

single-step (near as….) registration and charity recognition process

[probably] Limited ongoing requirements in relation to returns to OSCR

[over time] User-friendly guidance notes available from OSCR

But Only available if the objects are charitable Will take time to build up wider recognition of what an

SCIO is Not available for a while yet……!

Choice of legal vehicle

• LLP Full legal personality Limited liability Very flexible in relation to structuring of decision-

making and financial returns (but very few models available as yet)

But Registration procedures are needed to form an LLP. There are ongoing requirements to notify changes in

members etc The members of the LLP are taxed on their share of

profits (not the LLP itself), so much more tax-efficient than a company limited by shares in the context of a a joint venture where one or more shareholders are public sector bodies

Matching the organisation to the legal structure

If it is a membership-led organisation:

• Voluntary association

• IPS (though not recommended unless there is a set of model rules which fit)

• Company limited by guarantee (charitable or CIC; or neither)

• SCIO – two tier (if charitable)

Matching the organisation to the legal structure (cont)

If it is a partnership organisation:

• Voluntary association

• Company limited by guarantee (charitable or CIC; or neither)

• SCIO – two tier (if charitable)

Matching the organisation to the legal structure (cont.)

If it is a trust (or quasi-trust) organisation:

• Trust

• Company limited by guarantee (charitable or CIC; or neither)

• SCIO – one tier (if charitable)

Matching the organisation to the legal structure (cont)

If it is an equity vehicle:

• Company limited by shares (CIC if limited return is intended and community interest test satisfied)

• General partnership (though joint & several liability means that LLP more attractive)

• Limited partnership (though LLP easier to structure)

• Limited liability partnership (LLP)

Using two or more entities

• Charitable holding company (or SCIO), with wholly-owned subsidiary (possibly a CIC)

• Independent profit-distributing company, with siphon-off of profits to charitable company

Charitable holding company (or SCIO) with wholly-owned subsidiary (possibly a CIC)

Company limited by guarantee (charitable)

or could be SCIO

Company limited by shares(possibly CIC)

Profit-distributing company (possibly CIC), with siphon-off of profits to charitable company

Company limited by guarantee (charitable)

or could be SCIO

Company limited by sharespossibly a CIC