8. Should New Zealand create a new business form for social enterprises?

Frykberg[1] defines the social enterprise as an organisation with a social mission that allocates majority of its income from trading activities to the fulfilment of its mission. Fundamentally, what leads organisational development for a social enterprise are social and ethical morals.[2] In comparison to public sector organisations and non-for-profits, social enterprises have been apotheosized as more market-oriented, efficient and entrepreneurial. In comparison to the commercial sector, social enterprises have been idealised as being more collaborative and ethically enlightened. The value of the social enterprise is that it is not reliant on government funding nor donations to survive. Rather, it operates as a business capable of employing people. It is being increasingly recognised that the legal context for social enterprises is now outdated as law and regulation have failed to keep pace with business developments. In particular, there currently exists insufficient recognition in the legal system of the specific needs of social enterprises.

This article presents the argument that New Zealand could benefit from creating a new business form for social enterprises. We will begin by exploring the status and forms of social enterprises in other jurisdictions. New Zealand’s three most common corporate structures for social enterprises will then be explored, followed by an exploration of the difficulties with the currently available forms for social enterprises. I will then critically evaluate whether companies are precluded from undertaking activities aimed at social impact. Next, we will explore whether the constitution can be used to indicate social aims. Finally, the benefits of creating a new business form for social enterprises will be critically discussed.

It is useful to examine other jurisdictions where conversation about the social enterprise has spanned longer. Over the past decade, Canada, the United Kingdom and the United States have developed novel forms of corporate social entities. In comparison, New Zealand worked within the existing frameworks, showing no inclination to adopt the ‘number eight wire’ mentality toward creating new business for social enterprises. The UK has a variety of legal structures that may be applicable to social enterprises, including industrial and provident societies, companies limited by guarantee, companies limited by shares and limited liability partnerships. In 2004, the UK, excluding Northern Ireland established a legal entity especially for social enterprises, deemed the community interest company (CIC).[3] The introduction of the CIC was the UK’s response in recognition that the existing forms were insufficient to meet the modern needs of social enterprises. To be recognised as a CIC, a company is required to pass a community interest test. Unlike registered charities, CICs are permitted to compensate their directors.

Like the UK, The United States has designed legal structures to cater specifically for the needs of social enterprises.In the US, the most widely enacted legal structures for social enterprises include low-profit limited liability companies (L3C) and benefit corporations.[4] Neither forms are exempt from federal nor state taxes. Unlike L3C, benefit corporations are required to have their social and environmental performance evaluated by independent third-parties and must publish annual benefit reports. Additionally, L3Cs and benefit corporations may offer investors unlimited returns, contrary to CICs whose returns payable to shareholders are limited to 20 percent of the value paid for the share.

The three most common social enterprise structures in New Zealand include incorporated charitable trusts, incorporated societies and limited liability companies (LLC).[5] Although there exist other structures such as co-operatives, Maori land trusts and limited partnerships, these forms are rare. Incorporated charitable trusts must satisfy charitable purposes and profits cannot be distributed to private individuals. By registering its donee status with Charities Services, donations made by a charitable trust are not taxed. However, this approach essentially limits what an entity can do due to activities being constrained within charitable purposes. Under the Incorporated Societies Act,[6] incorporated societies must be formed with a minimum of 15 members. Furthermore, the constitutions or rules must clarify its objectives. Finally, LLCs will distribute profits to shareholders but may restrict its own activities by writing in some social enterprise purposes which make it eligible to register as a charity. Unlike the US and UK, New Zealand has not yet established a bespoke business form for social enterprises.

Difficulties with the available forms for social enterprises have relatively recently come to light. One main issue with the charitable trust structure is the difficulty in securing capital. In particular, it is particularly difficult to attract private investors to share the risk as these entities do not return profits to shareholders.[7] Limited liability companies may similarly struggle with securing capital due to the assumption that they are profit-oriented due to the form of entity being utilised, whereas it may actually have objectives beyond generating profits. These objectives will need to be clarified against the default assumptions of potential investors. Policymakers, scholars and businessowners are beginning to recognise that some changes should be made so that social enterprises are not required to twist around themselves in order to conform with the existing legal structures.

There exists a longstanding debate amongst legal and business scholars regarding the goals, purposes and responsibilities of corporations. While one category of experts believes that the sole purpose and focus of companies should be profit maximisation, the other category of experts believe that companies have a moral and ethical responsibility to the environment and stakeholder groups that are affected by their business activities.[8] The neo-classical economists’ view of companies is that managerial decision-making should aim solely to maximise the company’s long-term value and shareholder wealth.[9] This perspective is otherwise termed as the ‘shareholder theory’, a traditional approach to the purpose of a corporation. At the root of this theory is the fact that shareholders invest solely for the purpose of maximising returns on their funds.[10] From the neo-classical economists’ perspective, it may be argued that the company as a business form precludes activities that are solely aimed at social impact and have no effect on the company’s long-term value nor shareholder wealth. The sole purpose of management is representing the financial interest of shareholders to deliver maximum returns, either in the form of dividends or increased share value. Hence, managers owe an ethical duty to the owners in generating significant value.[11] A common misconception of shareholder theory is that business managers must do anything that is possible and necessary to maximise profits. While profit maximisation is the primary goal, managers are to achieve this goal through legal and responsible means and practices.[12]

On the other hand, stakeholder theory posits that a corporation’s activities should extend to meet the needs and expectations of a wider spectrum of stakeholders such as employees, consumers, suppliers and the general public.[13] These needs and expectations are to be fulfilled by managers, who on one hand must manage the company for the benefit of stakeholders to protect their rights and participation in decision-making whilst on the other hand, must act as the agent for shareholders in ensuring the financial feasibility and survival of the corporation to protect their long-term financial stakes.[14] In the modern day business environment, it may be argued that it is not enough for organisations to merely exist for the purpose of making a profit. Instead, enterprises must recognise the enhanced social and environmental awareness of the public by meeting profit expectations while also promoting social goals and rewarding stakeholders.[15] Through a comparison of the neo-classical shareholder theory and stakeholder theory, it is evident that corporate management is torn between focusing solely on shareholders’ interests or taking into account a wider spectrum of shareholders.

An increasing number of social enterprises in New Zealand are adopting the LLC structure and making clear in their constitutions that profit maximisation is to be balanced by social aims.[16] Although it is not mandatory for a company to have a constitution,[17] a constitutional document can be useful in setting out the rules of governance for a company. A constitution clearly defines the relationships between the company, shareholders, directors and other stakeholders, which acts as a binding agreement between the specified parties.[18] Being a public document, the constitution can somewhat inform potential investors as well as the general public of the company’s vision and aims. In particular, the Department of Internal Affairs recognises that the constitution of a social enterprise can detail its dual aims by clarifying that profit maximisation must be balanced with socially advantageous objectives.[19] Additionally, the constitution can somewhat raise awareness of the different purposes between social enterprises and traditional corporations.

Arguably, the establishment of a new corporate form for social enterprises may be an effective means of addressing the pressing issues pertaining to sourcing investors and funding. Moreover, the new corporate form could address the conflict between the neo-classical view and stakeholder theory of corporate management. As Moe[20] states, the new generation of entrepreneurs focus on more than securing profit and will prefer to operate as social enterprises. Some legal scholars argue that if new legal structures were made available for social enterprises, this may be an effective way of addressing the concerns of potential investors by explaining and raising awareness of the vision and purpose of a social enterprise.[21]

This article has argued that New Zealand could benefit from creating a new business form for social enterprises. Discussion surrounding social enterprises has spanned longer in other jurisdictions such as the UK and US. As a result, these jurisdictions have designed business forms or legal structures specifically for social enterprises. New Zealand has not yet followed this lead and instead, expects social enterprises to conform to already existing business forms, such as incorporated charitable trusts, incorporated societies and LLCs. The primary limitation of the existing business forms is the difficulty in securing capital. In particular, potential investors may not be aware that social enterprises balance social goals with profit maximisation which could cause confusion. By creating a new business form for social enterprises, conflicts between the neo-classical view and stakeholder theory of corporate management could be addressed. Additionally, the new corporate form would effectively draw a distinction between the social enterprise and traditional corporation, clearing up the confusion about the two entities’ differing goals, objectives and visions.

Sources:

[1] Kate Frykberg A short summary and case studies of social enterprise and social finance in Aotearoa New Zealand (Todd Foundation, 2012) at 3.

[2] Steven Moe Social enterprises in New Zealand (1st ed, Parry Field Lawyers, Christchurch, New Zealand) at 18.

[3] Department of Internal Affairs Legal structures for social enterprise (Department of Internal Affairs, 2013) at 11-12.

[4] above n 3 at 12.

[5] Moe, above n 2 at 23-24.

[6] Incorporated Societies Act 1908, s 7.

[7] Charities Act 2005, s 13.

[8] Edward Freeman, Andrew Wicks and Bidhan Parmar “Stakeholder theory and ‘the corporate objective revisited’” (2004) 15 Organ Sci 259.

[9] Ron Bird, Anthony Hall, Francesco Momente, & Francesco Reggiani “What corporate social responsibility activities are valued by the market?” (2007) 76 JBE 189.

[10] Robert Rhee “A legal theory of shareholder primacy” (2018) 102 Minn L Rev 1951.

[11] Steven Bragg “Shareholder theory” (25 January 2019) <www.accountingtools.com>.

[12] Above n 9.

[13] Nada Kakabadse, Cecile Rozuel and Linda Lee-Davies “Corporate social responsibility and stakeholder approach: A conceptual review” (2005) 1 IJBGE 277.

[14] Charles Fontaine, Antoine Haarman and Stefan Schmid The stakeholder theory (Oxford Business Press, 2006).

[15] Ruben Burga and Davar Rezania “Stakeholder theory in social entrepreneurship: a descriptive case study” (2016) 6 JGER 4.

[16] above n 3 at 4.

[17] Companies Act 1993 Part 5 s 26.

[18] Stephen Bottomley The constitutional corporation (1st ed, Routledge, London, UK, 2007).

[19] above n 3.

[20] Steven Moe “Social enterprises and legal structure options in NZ” (1 September 2017) Law Talk <www.lawsociety.org.nz>.

[21] Moe, above n 13.