January 14 2016

AbilityMate is growing, and we now need to register a legal entity.

Usually this is pretty straight forward but in our case it turns out to be a bit more complicated. We have spent many weeks researching, getting advice from various legal and commercial advisors, and discussing this with anyone willing to listen.

We thought we'd put it all up in an article, firstly to get feedback from our community of world-changers, and secondly to help any future Social Enterprises with making the decision.

BACKGROUND

AbilityMate is a Social Enterprise, meaning that it operates "for purpose". We have a businessmodel that generates revenue, but profit is not our main objective. Our model is designed primarily to achieve our social purpose, so we make just enough money to grow the business and achieve our purpose. 

As you can see we are not "for profit", and we are not a charity either, we are somewhere inbetween. This makes things a bit harder as there are no legal structures in Australia specifically for Social Enterprises.

To scale AbilityMate we will need capital.  We can get capital either from Philanthropy/grants (if we register as a NFP), or from Equity Investment (if we register as a Pty Ltd). 

However as Prashan Paramanathan from Chuffed.org pointed out in a fantastic article on the subject of legal structures for Social Enterprises "Philanthropy is great at funding shiny things to get from $0 to $5m. It's not great in helping a successful venture get from $5m to $50m and pretty much non-existent in helping you get from $50m to $500m."

So a for-profit legal entity seems the logical choice for us as we will need significant capital. The flip side though is that although NFP structures cannot get you access to equity capital, they do get you some really good tax breaks. For this reason some social enterprises register two entities, a NFP and a for-profit, and operate the two together as a hybrid.

This is an option for us but we are a lean startup, we need to keep our costs down and focus on proving the business model, so we are very careful with getting additional admin costs early on in the business.

So where to from here? Let's start with being clear on our goals.

THE GOALS

(A big thanks again to Prashan who articulated the goals so well we couldn't do it any better, so we used his as a starting point)

We want our structure to allow us to raise equity while embedding our purpose into our DNA. Practically what 'embedding our purpose' means is:

  • That everyone (ie shareholders and directors) are clear on what the purpose of the organisation is, and
  • That they are required and permitted to act to further the purpose, and
  • That shareholders (in particular founders) have a way of ensuring that the purpose is followed even with ownership changes

We also added a fourth goal, which is:

  • That the organisation be as financially efficient as we can make it, and where possible designed to take advantage of the tax breaks and concessions usually offered to mission-driven or public benefit organisations. 

THE BASIC STRUCTURE

To achieve the goals our basic structure is a Pty Ltd, based on the "Social Benefit Company" defined by Prashan (which in turn is based on the US Public Benefit Corporation).

It has three key changes from a normal Pty Ltd:

  1. A clear statement of a specific public benefit that the organisation is set up to deliver (the "Purpose") which we put into our Constitution.
  2. Expanded and clarified Director's Duties that permit and require Directors to act to deliver the Purpose and to consider the wider impacts of their decisions ("Directors Duties") - again we put this into our Constitution.
  3. A requirement that changing the Purpose or Directors Duties requires a 100% shareholder vote ("Mission Lock"). This will be put into our Shareholders' Agreement.

This gets us locked into a clear purpose and satisfies the first 3 goals.

The only issue with this structure is that, in the eyes of the Australian Tax Office (ATO), this is just a normal for-profit business and it will be taxed as such. It also won't get any of the benefits (like Fringe Benefit Exemptions) that other charities get.

ADDING A CHARITABLE TRUST

To satisfy the fourth goal of getting tax concessions, the option we've been looking at (based on advice) is to have a Charitable Trust that owns the Pty Ltd.

The structure would be as shown below:

The Charitable Trust has some benefits but also some drawbacks, as summarised below:

 

PROS:

  • Any profits from the Pty Ltd are passed to the Charitable Trust which is fully tax exempt (you get franked credits to get all the tax back)

CONS:

  • The advice we've been given is that a Charitable Trust has a lot of required reporting, as the government looks at Tax Exempted organisations very closely.
  • Higher setup costs - a Pty Ltd by itself costs around $450, the Pty Ltd plus Charitable Trust costs around $4000

 

There is a detailed overview below of the duties and administrative requirements of a Charitable Trust:

Trustee Handbook - Roles and Duties of Trustees of Charitable Trusts in Australia

AN ALTERNATIVE TO THE CHARITABLE TRUST

Adding the Charitable Trust gives us tax exemption, but could we maybe achieve the same outcome in a more efficient way?

For example, let's say AbilityMate wants to distribute some funds to a Makers Place to help them get setup for manufacturing Assistive Devices.

With the Charitable Trust, the transaction would look something like this:

It seems to us that the same outcome can be achieved without the charitable trust, by simply having the Pty Ltd fund the Makers Place directly instead of declaring a profit.

The transaction would look like this:

This solution is not perfect, it allows us to distribute funds to support our cause without paying company tax, but we still do not get other tax advantages, like Fringe Benefit excemptions for our employees. On the flip side, however, we don't have to setup or administer a Charitable Fund, so it seems like a fair trade-off. 

This seems like such a simple alternative, so we are wondering - did we miss something? Is there a catch somewhere we're not aware of?

If this is the case then we don't need to register a Charitable Trust, we can achieve the same outcome with only a Pty Ltd.

Did we miss something? We would love to hear from any Accounting or Tax gurus out there!

CONCLUSION - FOCUS ON CREATING VALUE

As an early-stage startup we need to be very careful to focus on creating value for our customers now and de-risking the business model, and not get too caught up with very long-term questions. 

Our basic structure will be a Social Benefit company, that makes complete sense.

As for the Charitable Trust, at this stage we cannot see any real benefit in adding this additional setup cost and monthly overhead to our structure, but we are reaching out to get more expert opinions.

We will post an update here soon.....