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This guide provides a broad overview of the legal issues that social entrepreneurs, both nonprofit and for-profit, may encounter in establishing a new venture. It includes a description of available corporate structures and the benefits and drawbacks of each, an introduction to trademark law, and an overview of various contracts and agreements that are commonly encountered during an enterprise’s startup phase. There is also a list of resources for social entrepreneurs interested in learning more about these issues.

While this guide covers a number of complicated issues, it is not a substitute for the advice of a qualified business or nonprofit lawyer who can provide advice tailored to your particular situation. However, our hope is that this guide will serve as a road map and help you to make the most of your time when you do sit down with an attorney. We also strongly recommend that every entrepreneur work closely with an accountant, in order to understand the financial and tax implications of decisions made in setting up a venture.

When you are done reading this guide, we suggest you look at Accounting & Taxes for Social Enterprises: Your Journey Starts Here by Aaron Fox, CPA.

This guide is divided into five sections: corporate structures, trademarks, contracts, agreements and other legal issues, Q + A, and resources.

The definition of a “social venture” or a “social enterprise” is consistent throughout these guides. The excerpt below is taken from the Idea To Launch guide authored by Andrew Greenblatt, co-founder of BeneStream.

This is a young field and there will be competing definitions. For the sake of this guide series, we will describe social enterprises as for-profit and nonprofit ventures that aim to sustain themselves financially without relying on donations while still making the world a better place. While traditional nonprofits plan to achieve their mission by relying on grants from foundations, contributions from donors, or running fundraisers like bake sales or galas, for-profit and nonprofit ventures bring in enough revenue every month from their products and services to pay their bills – and maybe even grow.

See the resource section for links to other definitions from leading social impact organizations.

These materials were prepared for informational purposes only. The links to third-party resources are also included for informational purposes only, and their inclusion does not constitute endorsement or approval. The information contained herein is general in nature and may not have application to particular factual or legal circumstances. These materials do not constitute legal advice or opinions and should not be relied upon as such. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship. Readers of this publication should not act, or refrain from acting, based upon any information contained in this publication without seeking the advice of professional counsel licensed in your jurisdiction.

One of the most important aspects of starting a social enterprise is selecting the appropriate corporate structure and tax treatment. Initial decisions will have a lasting impact on the entity’s operations, including permitted activities, purposes, and revenue streams. A corporate structure should be selected only after you have answered the following questions:

1. Who are the founders?
2. What is your social mission?
3. What problem are you trying to solve?
4. What impact do you want to have?
5. What is your business plan?
6. Is your organization likely to qualify for tax-exempt status. If not, should it be a pass-through entity or should it be taxed at the entity level?
7. Where will you get your initial and ongoing funding?
8. Who are your funders, investors, shareholders, or donors?
9. Who are your customers or clients?
10. Who will benefit from your organization’s activities?
11. Who has a stake in your organization’s success?
12. Who will control and manage the organization?
13. What are your personal and financial goals in starting the organization?
14. How long do you intend the organization to exist and what are your goals for the end of its existence?

The following list of corporate structures includes many of the frameworks best suited to a social enterprise. The structure that is most appropriate will depend, in part, on your answers to the questions above.

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DEFINITION

A nonprofit organization that is exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code must be organized and operated exclusively for one or more of the following purposes: religious, charitable, scientific, testing for public safety, literary or educational purposes, or to foster national or international amateur sports competition, to promote the arts, or to prevent cruelty to children or animals.

Generally, when people refer to “nonprofit organizations,” they are referring to nonprofits exempt under Section 501(c)(3). Commonly referred to as “charities,” these organizations must serve public, rather than private interests, and are able to accept tax-deductible donations. However, there are a number of other types of nonprofits that are tax-exempt, such as social welfare organizations (which will be also be covered by this guide), and trade associations that cannot accept tax-deductible donations, and are not as heavily regulated as charities.

For clarity’s sake, this guide will use the term “nonprofit” to refer to an organization exempt under Section 501(c)(3), and “social welfare organization” to refer to an organization exempt under Section 501(c)(4).

A nonprofit must not be organized or operated for the benefit of private interests, and no part of its net earnings may inure to (or be used for) the benefit of any private shareholder or individual. A nonprofit may only engage in limited lobbying activities, and is absolutely prohibited from intervening in political campaigns.

ESTABLISHMENT

Step 1: Incorporate a nonprofit corporation under state law. Include language in the Certificate of Incorporation required to qualify for tax-exemption under Section 501(c)(3) of the Internal Revenue Code, including a provision that restricts the purposes of the organization to one or more enumerated charitable purposes, and requires that assets of the organization be distributed for such purposes upon dissolution.

Step 2: Appoint initial directors and officers, hold a board meeting, and adopt bylaws, initial resolutions, and policies.

Step 3: Apply for a Federal Tax Identification Number/Employer Identification Number (EIN). An EIN is also known as a Federal Tax Identification Number, and is used to identify a business entity.

Step 4: Apply for tax-exempt status by filing Form 1023 or Form 1023-EZ (if the organization qualifies to use the simplified form) with the IRS. Once tax-exempt status is granted, it is retroactive to the date of incorporation, provided that the Form 1023 (or Form 1023-EZ) was submitted within 27 months of incorporation.

CONTROL

Members elect the board of directors and approve significant transactions. The board of directors manages the organization. If a nonprofit does not have members, which is common, the board will be self-perpetuating.

A note on fiduciary duties:

Nonprofit and for-profit directors, (and managers of LLCs) owe fiduciary duties of loyalty and care to the company they manage. The duty of care requires the directors to exercise good business judgment and to use ordinary care and prudence in making decisions regarding the operation and management of the company. They must take corporate actions in good faith and in the best interest of the company, exercising the level of care an ordinary person would exercise under similar circumstances.

The duty of loyalty requires that directors put the interests of the company ahead of their own. Directors may not divert corporate assets, opportunities, or information for personal gain at the expense of the company.

In the nonprofit context, directors have an obligation to manage the organization in a manner that advances the charitable purposes of the organization, and to ensure that the organization is not operated to enrich private interests. In the for-profit context, directors have a duty to manage the company in a manner that generates profits for the shareholders, which, for social enterprises, may at times conflict with the company’s social mission. This issue will be explored in greater detail below.

FUNDING AND TAX TREATMENT

Funding:

• Tax deductible donations from individual donors
• Fundraising events
• Foundation or government grants
• Program revenues/mission-related commercial activity (such as museum admission fees)
• Limited unrelated commercial activity

Tax Treatment: Tax-exempt

Nonprofits cannot issue equity, and therefore have no “owners.” The assets of nonprofits may not be distributed for the benefit of private individuals, except as reasonable compensation for services rendered. Nonprofits may only engage in a limited amount of commercial activity that is unrelated to the charitable mission, such as sales of products or advertising. Revenue generated through these activities may be subject to unrelated business income tax, or UBIT. A nonprofit that generates more than an insubstantial amount of income subject to UBIT may jeopardize its tax-exempt status.

Most states require nonprofits that solicit contributions in the state to register and to file annual reports, which include financial disclosures and other information with the state attorney general or secretary of state.

A note about forming a nonprofit:

The nonprofit sector is a highly regulated and competitive field. It can be difficult for new organizations to meet their compliance obligations while also raising the necessary funds to build their programs. It may be advisable to partner with an existing organization or test your ideas through a fiscal sponsor before undertaking the process to build a new organization and obtain tax-exempt status.

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A fiscal sponsorship is an arrangement whereby an existing charitable organization acts as a “sponsor” for a new organization or project, allowing the new organization to receive tax-deductible donations under the umbrella of the sponsoring organization. A fiscal sponsorship arrangement enables a new organization to raise funds and test the viability of a project before going through the process of establishing a new charitable organization or obtaining its own tax-exempt status.

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DEFINITION

An organization that is exempt from federal taxation under Section 501(c)(4) of the Internal Revenue must be operated for the promotion of social welfare. Such organizations are permitted to engage in unlimited lobbying activities, as long as those activities further the organization’s social welfare mission, and may intervene in political campaigns to a limited extent, including endorsing political candidates.


Nonprofits exempt from taxation under Section 501(c)(3) are absolutely prohibited from supporting or opposing candidates for political office.

While social welfare organizations are exempt from paying federal income tax, donations to these organizations are not tax-deductible.

Seeking tax-exemption under Section 501(c)(4) may be a good option for an organization that is primarily focused on social mission, rather than profit-making, but would not qualify as a charitable organization, whether due to excessive lobbying or because the social mission of the entity does not fit within the charitable purposes defined in Section 501(c)(3).

ESTABLISHMENT

Step 1: Incorporate a nonprofit corporation under state law. Include language in the Certificate of Incorporation required to qualify for tax-exemption under Section 501(c)(4) of the Internal Revenue Code.

Step 2: Appoint initial directors and officers, hold a board meeting, and adopt bylaws, initial resolutions, and policies.

Step 3: Apply for an EIN.

Step 4: Apply for tax-exempt status by filing Form 1024 with the IRS.


A social welfare organization is not required to apply to the IRS for a determination of its tax-exempt status – it may “self-declare.” However, most social welfare organizations do apply to ensure that the IRS does not challenge the organization’s status at a later point in time.

CONTROL

A social welfare organization is controlled by its members, if any, who elect the board of directors to manage the organization. If there are no members, the board will be self-perpetuating.

FUNDING AND TAX TREATMENT

Funding:

• Donations from individual donors
• Fundraising events
• Foundation or government grants
• Program revenues/mission-related commercial activity (such as museum admission fees).
• Limited unrelated commercial activity (subject to UBIT)
• Cannot issue equity

Tax Treatment: Tax-exempt (but cannot accept tax-deductible contributions)

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DEFINITION

A limited liability company (“LLC”) is a corporate structure that insulates its members from personal liability while providing flexibility in tax treatment. It combines the limited liability of a corporation and the tax treatment of a partnership. Owners (called “members”) of an LLC are insulated from liability for the acts of the LLC. Members may be individuals, corporations (including nonprofit corporations), or other LLCs. Unless the members elect for the LLC to be treated as a corporation for tax purposes, the LLC does not pay federal income taxes at the entity level – rather the profits and losses of the LLC “pass through” to the individual members who report this information on their tax returns. LLCs are characterized by flexibility, informality, and internal organization by contract.

ESTABLISHMENT

Step 1: File articles of organization with the state.

Step 2: Apply for an EIN.

Step 3: Publish notice of the LLC’s formation, if required by state law (such as in New York).

Step 4: Negotiate and execute an operating agreement, which is essentially a contract between the members of the LLC. The operating agreement spells out the terms of the LLC’s operations – provisions may include the purpose for which the LLC was formed, how the LLC will be managed, and the process for admitting new members. A social enterprise established as an LLC may specify its social mission in the operating agreement, and may include provisions that make this mission difficult to change, such as by requiring an affirmative vote of all members of the LLC.

CONTROL

An LLC is controlled by its members, who may also act as the LLC’s managers, or may appoint managers to oversee the LLC’s operations. Managers of an LLC owe fiduciary duties to the LLC.

FUNDING AND TAX TREATMENT

Funding:

• Capital contributions from members
• Revenues from sales of goods or services
• Debt-financing

Tax Treatment: Pass-through

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DEFINITION

A low-profit limited liability company (“L3C”) is similar in structure to an LLC, with one significant difference. An L3C is a for-profit entity that must be organized to accomplish one or more charitable or educational purposes listed in Section 170(c)(2)(B) of the Internal Revenue Code. In other words, an L3C must have a charitable mission similar to a nonprofit qualifying as tax-exempt under Section 501(c)(3). The production of income or the appreciation of property may not be a significant purpose of an L3C, though it is permitted to make a profit incidental to carrying out its charitable mission.

ESTABLISHMENT

As of December 2013, L3Cs are recognized in Illinois, Louisiana, Maine, Michigan, North Carolina, Rhode Island, Utah, Vermont, and Wyoming. The process to establish an L3C is analogous to the process to establish an LLC, except that the L3C’s articles of organization must state that the L3C will significantly further the accomplishment of one or more charitable purposes, that the production of income and appreciation of property cannot be a significant purpose of the L3C, and that the L3C will not seek to accomplish any political or legislative purposes.

CONTROL

Like an LLC, an L3C is controlled by its members who may manage the L3C, or may appoint managers to oversee the L3C’s operations.

FUNDING AND TAX TREATMENT

Funding:

• Capital contributions from members
• Revenues from sales of goods or services
• Debt-financing

Tax Treatment: Pass-through


An L3C cannot accept tax-deductible donations, despite the primacy of its charitable mission.

A Note About Program-Related Investments:

One of the original purposes in developing the L3C was to develop a for-profit entity that could more easily attract program-related investments (“PRIs”). PRIs are investments made by private foundations for the purpose of supporting charitable activities. The foundation may also be looking for a financial return on its investment, but this profit motive must be secondary to the goal of supporting charitable activities. For example, a foundation may invest in a for-profit business operating in a low-income neighborhood, in order to create employment opportunities and revitalize the community. PRIs count toward the 5% distribution requirement, which requires that foundations annually distribute an amount equal to 5% of their net investment assets in furtherance of their charitable missions.

Foundations must exercise “expenditure responsibility” with respect to PRIs in order to oversee the use of the investment funds by the for-profit business and ensure that the funds are used for proper charitable purposes. The foundation must conduct a preliminary inquiry into how the funds will be used, and establish procedures to 1) ensure that the funds are only used for the purposes designated by the foundation; 2) obtain a full report as to how the funds are spent; and 3) disclose how the funds were spent to the IRS. These steps are not necessary if the foundation is making a loan or a grant to a nonprofit. Because of the time and expense involved in exercising expenditure responsibility, many foundations chose to avoid investing in for-profits, even if doing so would advance their charitable missions.

Because L3Cs are required to operate in furtherance of one or more charitable purposes, the hope was that private foundations would be allowed to make PRIs in L3Cs without having to exercise expenditure responsibility, because the L3C form would act as a guarantee that any funds invested would be applied toward charitable purposes. However, the IRS has never published guidance on this issue, and private foundations are still required to exercise expenditure responsibility, just as would be required in the case of a PRI in a regular for-profit corporation or LLC.

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A C corporation is a corporation formed under state law, and taxed separately from its owners.

DEFINITION

Characteristics of a C corporation include: (1) limited liability for directors, officers, shareholders, and employees; (2) perpetual existence; (3) unlimited growth potential through the sale of stock; (4) no limit on the number of shareholders (although the corporation will be required to register with the Securities and Exchange Commission [SEC] once it has reached certain thresholds in assets and/or number of shareholders); and (5) taxation of corporate profits at the corporate level, resulting in what is known as “double-taxation.” The C corporation itself pays tax on its profits, and shareholders that receive dividends from the corporation must also pay tax on those dividends.

ESTABLISHMENT

Step 1: File a certificate of incorporation with the state, which will include the number of shares that the corporation is authorized to issue.

Step 2: Hold an organizational meeting to adopt bylaws, elect directors and officers, and authorize the issuance of shares (pursuant to the certificate of incorporation).

Step 3: Upon receipt of payment, issue shares to the respective shareholders.

Step 4: Negotiate and execute a shareholders’ agreement.

Step 5: Keep records of all resolutions of the shareholders and directors, and keep a stock ledger, which should note the shares issued, the names and addresses of all shareholders, and the dates when they became shareholders.

CONTROL

A C corporation is controlled by its shareholders who elect directors and approve significant transactions. The board of directors manages the operations of the corporation.

Directors owe fiduciary duties of loyalty and care to the corporation.

FUNDING AND TAX TREATMENT

Funding:

• Equity financing (sales of stock)
• Revenues from sales of goods or services
• Debt-financing

Tax Treatment: Entity level

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DEFINITION

The benefit corporation is a new corporate entity, which is similar in most respects to a traditional corporation. However, there are three key differences that may make the benefit corporation attractive to social entrepreneurs. In addition to generating profit for its shareholders, a benefit corporation must also create positive social impact. Directors have additional fiduciary obligations, above and beyond the standard corporate fiduciary duties, to consider the impact of the benefit corporation’s work on various stakeholders. And, the benefit corporation must publish an annual report describing the benefit corporation’s progress in accomplishing its social and environmental objectives when measured against an objective third-party standard. A list of third-party standards is available here. Note that benefit corporations incorporated in Delaware (where they are called “Public Benefit Corporations” or “PBCs”) are not required to use an outside third party standard to evaluate their work, and need only publish their benefit report on a biennial basis.

ESTABLISHMENT

The process to establish a benefit corporation is analogous to the process for establishing a traditional corporation under state law, except that the benefit corporation’s certificate of incorporation must designate it as a benefit corporation and comply with the laws of the state of incorporation. For a list of states that have passed benefit corporation legislation click here.

CONTROL

The benefit corporation is controlled by its board of directors. Directors owe fiduciary duties of loyalty and care and have additional fiduciary obligations to consider various stakeholders such as the benefit corporation’s employees, community, suppliers, beneficiaries, and the environment before taking corporate actions.

FUNDING

Funding:

• Equity financing (sales of stock)
• Revenues from sales of goods or services
• Debt-financing

Tax Treatment: Entity level


It may be more difficult to attract investors because the benefit corporation, as a corporate form, is untested. Investors may be wary of the fact that directors have an obligation to create positive social outcomes, and cannot focus solely on maximizing investor returns. To date, there have been no court cases to offer guidance as to what would happen if these various obligations conflict. On the other hand, incorporating your social enterprise as a benefit corporation may help attract a growing community of like-minded impact investors, and will signal to your customers and to the public that you are committed to your social mission.

A Note About “B Corporations”:

B Lab is a nonprofit that serves a global movement of entrepreneurs using the power of business to solve social and environmental problems. B Lab is responsible for the “B Corporation” certification, which is to sustainable business what fair trade certification is to coffee or USDA organic certification is to organic vegetables. Various types of corporate entities are eligible to be certified as B Corporations, including C corporations, LLCs, L3Cs, and benefit corporations. A company qualifies for B Corporation status by meeting rigorous standards of social and environmental performance, accountability, and transparency with respect to its social mission and the organization’s stakeholders. Certified B Corporations include Ben & Jerry’s, Etsy, Method, Patagonia, Seventh Generation, and many others, including Perlman & Perlman. In order to obtain this certification, an organization must use the B Impact Assessment, available at B Lab’s website, to measure its overall social and environmental performance. A benefit corporation may use this assessment tool as the objective third-party standard against which it measures its social and environmental progress, in order to publish its annual benefit report.

Organizations scoring eighty out of 200 points for their accountability, employee, consumer, community, and environment standards are eligible to be certified as B corporations. An organization must also meet B Lab’s legal requirement. If an organization is a benefit corporation, the legal requirement is met. If it is an LLC, LLP, LP, or a C corporation, language that expands board member obligations to include consideration of stakeholder interests and the organization’s commitment to social mission must be included in the organizing documents. The process to accomplish this varies by state of incorporation and type of entity.

For more information, visit B Lab’s website. You might also want to read the guide, Evaluation and Impact Assessment by Andy Fyfe, who works for B Lab.

A trademark can be a name, logo, tagline, or other device used to identify goods or services from a particular source. Trademarks help consumers distinguish between different producers of goods and services, and allow companies to develop an identifiable brand.

A trademark is a form of intellectual property. The owner of a trademark has the exclusive right to use the trademark in connection with a particular class of goods or services, and may exclude others from using the trademark in a way that might be misleading.

In the United States, trademark ownership is established by using the mark first in commerce. If the trademark is or will be used in interstate commerce, it can be registered with the U.S. Patent and Trademark Office (USPTO). While registration is not absolutely necessary, it does give the trademark owner several advantages. This first is that it puts others on notice of the owner’s claim to the trademark. It is presumed that the trademark is in use nationally – without registration, it is only possible to exclude others from using the mark within the geographic region in which the trademark is actually used. Lastly, registration gives the trademark owner the right to seek monetary damages in court for infringement.

While trademark ownership is based on actual use of the mark, it possible to register a trademark with the USPTO based on a good faith intent to begin using the mark. The applicant must later confirm to the USPTO that they are actually using the mark in commerce, by filing a timely Statement of Use, or the trademark registration will be considered abandoned.

In order to avoid waiving your rights to enforce your trademark, you should monitor and object to use by a third-party of any mark that may be confusingly similar to your mark.

Before using or attempting to register a new mark, a search should be performed to ensure that the new mark will not infringe upon a mark already in use by another entity. Searches for registered marks may be performed online via the USPTO website. However, a lawyer can perform a comprehensive trademark search that goes beyond the USPTO database, which is the best way to determine whether there are existing marks already in use that are confusingly similar to your mark.

Below is a list of agreements you may need as you build your venture followed by an explanation of some of the keys terms that may be included in each agreement. While not all of these agreements will be applicable to your particular situation, this section is intended to provide an overview of the legal issues you may confront as you build your enterprise, and the contracts and documents you may want to have in place to ensure that you and your enterprise are well protected.

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FOUNDERS AGREEMENTS

Before taking in outside investment, founders of for-profit startups should execute a founders’ agreement, addressing such issues as the goals and visions for the company, the social mission, the ownership structure, whether ownership vests based on continued participation in the business and what happens to a founder’s ownership interest if she leaves, roles and responsibilities, salaries, how key decisions are made, and how disputes among the founders will be resolved. Such an agreement will protect you and your new social enterprise in case of a dispute between the founding members, including in the event that one founder does not live up to the expectations of the other founders.

MEMORANDUM OF UNDERSTANDING (MOU)

An MOU is a flexible agreement that can be used in a number of different situations and customized to meet the needs of the parties. Often, before entering into a complex transaction, the parties will execute a non-binding MOU that outlines the terms of the transaction, and the parties’ obligations during the negotiation process (such as maintaining confidentiality until the tranaction is finalized). While the MOU may or may not be binding on the parties, certain provisions, such as a confidentiality provision, or a provision requiring the parties to negotiate in good faith and exclusively with each other for a set period of time, may be binding.

CONFIDENTIALITY/NON-DISCLOSURE AGREEMENTS

A non-disclosure agreement (NDA) is used to protect confidential or sensitive information shared between business partners, with employees, or in negotiations or transactions with third parties. Terms may include a definition of the confidential information, an agreement not to disclose the information, and the circumstances under which otherwise confidential information may be disclosed, such as when the information becomes publicly available through no fault of the parties, is independently developed, or is required to be disclosed by law.

TERM SHEET

A term sheet is generally used as a tool in negotiation to outline the proposed terms of a transaction, so that the parties can agree on the general terms before drafting the specific agreements needed to finalize the transaction. Term sheets are commonly used in financing transactions, and might include such terms as the details of the offering, the amount to be raised, the pre-money valuation, liquidation preferences, voting rights, anti-dilution provisions, and provisions required to comply with securities law. There may also be binding no-shop/confidentiality provisions. The terms of the transaction as set out in the term sheet are not binding until the final agreements are executed.

IP_Agreements

Intellectual property refers to certain kinds of property rights (i.e., patents, trademarks, copyrights, and trade secrets) that allow creators to exercise a set of exclusive rights with respect to their works. As an entrepreneur, your intellectual property may be among your organization’s most valuable assets, so it is important that you have a clear understanding of who owns the rights in that property, and in other important intangible assets, such as your website and social media accounts. The following agreements can be used to transfer ownership of intellectual property rights, in whole or in part.

WORK-FOR-HIRE AGREEMENT

With some exceptions, the individual who creates a work, such as a painting, a photograph, or a novel, owns the copyright in that work. The “work-for-hire” doctrine is an exception to this rule. A work is made for hire when it is created by an employee in the course of his or her employment, or it is specifically commissioned for use as (1) a contribution to a collective work, (2) a part of a motion picture or other audiovisual work, (3) a translation, (4) a supplementary work, (5) a compilation, (6) an instructional text, (7) a test, (8) answer material for a test, or (9) an atlas, if the parties expressly agree in a written instrument that the work shall be considered a work made for hire. For example, if you hire a designer as an employee, anything that she creates in the course of her employment would belong to your company under the work-for-hire doctrine. However, it would not be uncommon to have an agreement with your designer stating that, to the extent anything created during the course of her employment does not fall under the work-for-hire doctrine, she assigns ownership in the copyrights to the company.

If you hire an independent contractor to create work for you, the work-for-hire doctrine would only apply if you have a signed agreement in which both parties agree that the work is a work-for-hire, and if the work is commissioned for use as one of the nine items listed above. For any other type of work (such as a logo), you would need to use an assignment agreement to allow the creator to transfer her ownership rights to you.

ASSIGNMENT AGREEMENT

An assignment agreement permits a creator to assign, or sell, her intellectual property rights in a work to another party. An assignment agreement would generally include terms such as the definition of the work to be assigned, the consideration or purchase price, a statement assigning the work, representations and warranties that the assignor owns the intellectual property rights in the work to be assigned, and indemnification provisions. An indemnification provision protects the indemnified party from legal liability that may result from the other party’s wrongdoing related to the contract. For example, an indemnification provision would protect you if it later becomes clear that the assignor knew that she did not actually own the intellectual property rights in the assigned work and the true owner brought suit against you to stop you from using the assigned work.

LICENSING AGREEMENT

A licensing agreement allows a holder of intellectual property rights to grant limited permission to another party to use the licensed work while still retaining ownership of the intellectual property rights at issue. A licensing agreement may grant the licensee some or all of the exclusive rights held by the rights owner – for example, a licensee may have the right to use the work for a limited time period, in a limited geographic area, or only for a specific purpose. Generally, the agreement contains terms such as a definition of the work to be licensed, the consideration or purchase price, representations and warranties that the licensor owns the intellectual property rights in the work to be licensed, a statement licensing the work, and any limitations on the license.

PHOTO/VIDEO MODEL RELEASES AND WAIVERS OF LIABILITY

Model releases generally should be secured from any persons appearing in published images (or from their parent or legal guardian if the model is under eighteen years old). Model releases may include terms such as an irrevocable license to use the model’s likeness, any limitations on the right to use the likeness (i.e., time, purpose, or geography), and a release from any claims arising out of use of the model’s likeness, such as invasion of privacy, right of publicity, or defamation.

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INDEMNIFICATION

A social enterprise may wish to indemnify its directors, officers, and employees, meaning that the enterprise will agree to cover the costs of any claims brought individually against its directors, officers, or employees resulting from their work. Generally this is accomplished by including an indemnification provision in the certificate of incorporation, bylaws or operating agreement. Such provisions usually only provide for indemnification where the indemnified individuals were acting in good faith and within the scope of their duties, and not in cases where they were grossly negligent or engaged in willful misconduct.

INSURANCE

Many enterprises purchase Directors and Officers Liability Insurance (commonly known as D&O Insurance). D&O insurance is liability insurance that protects an entity’s directors and officers, and the entity itself in the event that a legal action is brought against one or more directors or officers and in the event that the entity is required to indemnify its directors or officers.

Depending on the structure of your enterprise and risks you are likely to face, you may also want to consider additional insurance, such as general commercial liability insurance, special event insurance, and auto insurance, as well as any insurance, such as health, workers compensation, and disability, that is required for your employees.

WORKER CLASSIFICATION

As your enterprise grows, and you begin to hire staff, it is important that you properly classify your workers, and that you not treat workers who should be employees as independent contractors for payroll and tax purposes. Independent contractors differ from employees in that, in an independent contractor relationship, the employer has the right to control only the result of the work. The independent contractor controls what will be done and how it will be done, and generally sets her own schedule and uses her own equipment in performing her work. The IRS and state labor and employment agencies closely monitor whether workers are correctly classified as independent contractors, so it is important to consult with an employment expert if you have any question about how your workers should be classified.

Care should also be taken with respect to the classification of employees as either exempt or nonexempt from the overtime pay requirements. For-profit organizations generally may not have unpaid interns and are required to compensate interns for their work, unless the internship program qualifies as an educational or training program meeting very specific criteria.

Social Good Guides (SGG): What are the biggest misconceptions startup changemakers have coming into your office for the first time?

Carly Leinheiser (CL): There are a number of misconceptions and misunderstandings that surround the nonprofit and social enterprise sector.

For example, many people interested in starting a nonprofit do not realize that the nonprofit sector is heavily regulated, and subject to oversight by both the IRS and state attorneys general. Unless your entity will be funded primarily by tax-deductible contributions, it may be easier to accomplish your social mission with an entity such as an LLC or Benefit Corporation, that is not subject to such strict regulation.

Another common misunderstanding is around the fact that there is no single entity that is both a nonprofit and a for-profit at the same time – meaning, there is no single entity that can accept tax-deductible contributions, engage in commercial activity, and take equity investments. Some of the hybrid entities and arrangements discussed in this guide come close, but ultimately, the founders of a new venture still must decide whether they belong on the nonprofit or for-profit side of the dichotomy.

SGG: What kind of lawyer should a startup changemaker seek out?

CL: It is best to find a lawyer with general business expertise who also has experience working with startups and organizations with a social mission. Depending on your needs, you may also want to consult with an attorney with experience in nonprofit law, startup funding, intellectual property, or another specific field.

If you are starting a nonprofit and applying for tax-exempt status, look for a lawyer who has specific experience working with nonprofit organizations as your legal needs may be very different from those of a traditional for-profit company. Applications for tax-exempt status that are not drafted by lawyers well-versed in nonprofit law and IRS requirements may be significantly delayed or ultimately denied, so be sure that your application makes the strongest possible case for tax-exemption.

SGG: What should I learn or know about before I sit down with a lawyer for the first time?

CL: Anyone looking to set up a new entity should have a solid business plan and know at least some of the details of the entity they want to create, including who the initial directors or managers will be, the entity’s social mission and desired impact, sources of initial and ongoing funding, and initial beneficiaries, customers, or stakeholders. Anyone seeking assistance with a contract or transaction should know the parties to the agreement and the structure and basic terms of the transaction.

SGG: What pro bono services are available to social entrepreneurs?

CL: Pro bono resources include legal blogs, articles, and websites dedicated to social enterprise law. Many universities have programs that publish or provide resources for social change organizations, and some law schools have transactional or intellectual property clinics that will provide legal services to nonprofits and social enterprises. State and city bar associations may provide referrals for free or low-cost legal services, and there are many nonprofit organizations that provide free or low-cost legal services to certain nonprofit organizations. Workshops and presentations on legal issues of interest to changemakers may also be available. Low-cost boilerplate legal documents are available from websites such as Legal Zoom, Docracy, and similar companies, but you should exercise caution whenever using boilerplate documents as they may not be suited to your unique transaction or situation. Some law firms may be willing to provide pro bono assistance for specific projects, particularly for nonprofits.

SGG: When should I incorporate my nonprofit or social enterprise?

CL: Before incorporating, you must make several decisions about key areas of your business. You should have a detailed understanding of your business model and your social mission.

The founders of a nonprofit organization should have a clear understanding of the organization’s purposes, whether it will qualify for tax-exempt status and, if so, under what section of the Internal Revenue Code. You should also understand the regulations governing charitable organizations and whether the legal constraints will impair the successful growth and operation of the entity. If you cannot carry out your goals as a charitable organization, consider forming a social welfare organization under Section 501(c)(4), or a for-profit entity. In the case of a for-profit entity, the founders should know the entity’s initial ownership structure, as well as have a business plan. In either case, you should have already spoken with your initial funders and discussed whether they are able and willing to invest in, or donate to, the type of entity that you plan to incorporate.

Once you have answered these questions, you should incorporate your organization so that you have a legal entity established when you need to take corporate action, such as by entering into a contract, opening a bank account, receiving a grant or donation, accepting a loan, or applying for a permit.

SGG: Is it possible for a changemaker to change their legal status once they’re already incorporated? If so, at what point, and how difficult is the process?

CL: It is possible to change an entity’s corporate structure – the process may involve merging the old entity into a new entity, or transferring the assets to a new entity and dissolving the original entity. The process is particularly difficult if the original entity is a nonprofit organization that wishes to convert to a for-profit structure.

While the process can be both costly and time-consuming, there are situations where changing the corporate structure might be the best course of action, such as when an organization has the opportunity to accept a significant donation or investment only if it reorganizes.

SGG: Once I determine which legal structure is right for my company, how long will it take to complete and file the paperwork and for it to be approved?

CL: The answer varies based on the legal structure, the state of incorporation or formation, and the time it takes to draft the organizing documents and get approval from the organization’s founders. Once the initial organizing documents are filed with the state, it can take anywhere from a few days to a few weeks to receive state approval. It may take longer if there are errors in the filing, and some states are more particular than others about the format and language used in organizing documents. The more time-consuming piece is drafting the operating or shareholders agreement (for LLCs or corporations, respectively), or applying for tax-exempt status for nonprofit organizations. Once the application for tax-exempt status is submitted to the IRS, it can take anywhere from three to nine months, and possibly longer to receive a determination, unless the organization is eligible to use the simplified Form 1023-EZ.

SGG: What is the most important thing I need to know?

CL: Hire the right professionals early, including an attorney and an accountant, to assist you in creating a sound legal entity that will serve your purposes, and make sure you have the right contracts and agreements in place to protect your interests. Your advisors can work with you to develop a viable business model and address any potential legal or compliance issues while you’re still in the planning stages and can easily make adjustments.


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GENERAL

American Bar Association
Association of Fundraising Professionals
B Lab
Benefit Corp Information Center
Criterion Institute’s Structure Lab
Directory of Fiscal Sponsors
Federal Tax Identification Number/Employer Identification Number (EIN)
Form 1023
Legal Zoom
National Center for Charitable Statistics
U.S. Patent and Trademark Office (USPTO)
Securities and Exchange Commission (SEC)

PRO BONO HELP

American Bar Association Consumers’ Guide to Legal Help
International Senior Lawyers Project
Lawyers Alliance for New York
New York Lawyers for the Public Interest
Probono.net
Pro Bono Partnership
Trustlaw Connect by Thompson Reuters Foundation
Volunteer Lawyers for the Arts

BOOKS + ARTICLES

“Defining a Conscious Economy: A Glossary of Sustainability Acronyms and Terms” by Beth Busenhart and Charlie Kuhn – CSRwire
“Seven Legal Hiccups That Can Crush Your Startup” by J. J. Colao – Forbes
“A New Type of Hybrid” by Allen R. Bromberger, Perlman & Perlman, LLP
“How a Business Can Change the World: Social Entrepreneurship Business Models” by Inc. staff

BLOGS, WEBSITES, AND ONLINE PUBLICATIONS

Charity Lawyer Blog
Law for Charge: A Legal Forum For Social Innovators
Harvard Business Review
Perlman & Perlman’s Social Enterprise and Nonprofit Law Blog
Profit and Purpose Blog
Socent Law
Stanford Social Innovation Review Blog
The Chronicle of Philanthropy

TEMPLATE FORMS

Docracy
Get Free Legal Forms
Goodwin Procter’s Founder’s Workbench
Legal Zoom

SOCIAL ENTERPRISE DEFINITIONS

Ashoka
Echoing Green
NYU Wagner’s Reynolds Program for Social Entrepreneurship
Schwab Foundation
Skoll World Forum on Social Entrepreneurship
Social Enterprise Alliance
Stanford Social Innovation Review Article

RelatedSSG

Accounting and Taxes for Social Enterprises: Your Journey Starts Here
Business Plans and Planning for Social Enterprises and Nonprofits
Evaluation and Impact Assessment
Funding Your Startup Social Enterprise
Nonprofit Funding and Long-Term Sustainability

ANoteToOurInternationalReaders_new_blueThe guides are primarily intended for social entrepreneurs based on the United States, though some of the resources may be generally of interest to an international audience. Please remember that many of the topics covered by the guides, such as corporate structures, laws and legal customs, accounting, business planning, funding and fundraising, etc., vary widely from country to country, and that the information presented here may not be correct, applicable, or relevant to any other country or jurisdiction.

We strongly advise those of you building social impact ventures outside the United States to seek advice and support from reputable professionals who are licensed in your jurisdiction, and/or have area expertise in the country where you plan to build your businesses. For more information, please see our Terms of Use.

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CARLY LEINHEISER: GUIDE AUTHOR

Associate Attorney, Perlman & Perlman, LLP
Website | Blog | @taxexemptlawyer | @dotcarly

Carly Leinheiser is an Associate Attorney at Perlman & Perlman, LLP, where she advises public charities, private foundations and social enterprises, including benefit corporations, on a wide range of matters. Her practice includes corporate formation and governance, tax-exempt compliance, fundraising and cause marketing, intellectual property, open licensing, and technology and privacy issues. Ms. Leinheiser has counseled clients on the formation and dissolution of nonprofit organizations and the establishment of hybrid legal structures that incorporate aspects of traditional nonprofit and for-profit corporations.

Ms. Leinheiser previously served on the New York City Bar Association’s Nonprofit Organizations Committee, and is a volunteer for the Centre for Social Innovation, where she provides pro bono counsel to early stage nonprofits and social enterprises.

Prior to working at Perlman & Perlman, Ms. Leinheiser practiced commercial litigation and worked as a Law Fellow with the New Jersey Office of the Attorney General’s Charities Section. During law school, she served as a law intern with Brooklyn Defender Services, and interned with a Senegalese human rights organization in the prison reform program. Ms. Leinheiser previously worked as special event planner and fundraiser at two social service nonprofits, Cascade AIDS Project and The Dougy Center, in her hometown of Portland, Oregon.


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GEORGE AYE: COVER DESIGNER

Co-Founder, Greater Good Studio
Website | Email | @greatergood_ | @georgeaye

George Aye co-founded Greater Good Studio to increase the impact of his user-centered design practice. He is also a tenure-track professor at the School of the Art Institute of Chicago where he teaches with the architecture, interior architecture, and designed objects program. Prior to these current positions, he was the lead designer at the Chicago Transit Authority, designing a prototype bus for Chicago. He started his career as a designer at IDEO Chicago.

He remains wildly optimistic that we can solve the most entrenched problems of our time, together for the greater good.


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MARC O’BRIEN

Consultant and Strategist, Social Good Guides
Website | LinkedIn | @think5577

As a Design Strategist and Creative Facilitator, Marc focuses on human-centered design and social innovation. Marc organizes, plans, and leads creative workshops to create positive change and tackle some of today’s gnarly social challenges.

Through playful exercises, he helps people come up with fun, usable, and innovative solutions to challenges. With a graphic and web design background, Marc is able to put ideas generated from these workshops into action, which continues conversations and encourages further collaborations across multiple industries. He loves finding ways for organizations to make huge changes and impacts in unexpected places.

Since 2009, Marc been actively involved, as both an advisor and facilitator, in Project M, an immersive program designed to inspire and educate young creative individuals by proving that their work can have a tangible impact on the world.

A multitude of his collaborative workshops and projects have been featured in the New York Times, Fast Co, AIGA, GOOD, Print, ID, PSFK, and various other design and culture outlets. Marc has lectured and facilitated numerous workshops at a number of distinguished universities and conferences throughout the country. Among other things, Marc is building out Secret Project @ CCA along with teaching in the graphic design department, and leading GOOD SF. He also rides a bamboo bike, makes homemade hot sauce, and unplugs in the outdoors. You can follow him on Twitter, @think557


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SHANA DRESSLER

Founder, Social Innovators Collective
Series Producer, Art Director and Editor, Social Good Guides
Website | Email | LinkedIn | @shanadressler | @sic_org

In 2011, Shana Dressler founded the Social Innovators Collective with the mission to train and nurture the next wave of social change leaders to help them achieve measurable impact and financial sustainability. Since then she has been creating and leading workshops on business development for social enterprises and nonprofits at General Assembly, New York’s premiere center for entrepreneurship, the Social Good Summit, and social enterprise conferences at Harvard, Columbia, New York University, Brown, the School of Visual Arts, Rhode Island School of Design, and others. In 2014, she designed the curriculum for a startup business school designed to support 21st century entrepreneurial problem-solvers and creatives tackling the most pressing social and environmental challenges of our time.

A deeply committed social entrepreneur, Shana is widely recognized as the first person in New York to organize rigorous educational programming for social entrepreneurs in startup mode. To fill a notable gap in the lack of resources available, Shana co-created the Social Good Guides, a series of 20 guides focused on the essential small-business skills that would-be changemakers need to know and an 8-week workshop called Social Good Startup: Idea To Launch.

Shana is an Aspen Institute Scholar, a member of the International Academy of Digital Arts and Sciences, and a judge for The Webby Awards. In 2014 she became a Delegate to the United Nations Foundation Global Accelerator which brought together a “100 of the world’s top entrepreneurs to work together with policy leaders on global issues.” Shana was recently honored by the World CSR Congress as one of the 50 Most Talented Social Innovators. In addition to frequent travel to far-flung places, Shana loves all things chocolate, and makes her way around New York on a midnight blue Vespa. You can follow her @shanadressler and @sic_org.

THE SOCIAL GOOD GUIDES PRODUCTION TEAM

Project Manager: Sara Weinreb
Copy Editors: Kelly Cooper + Jessica Winney
Web Developer: Keyue Bao
Consultant + Strategist: Marc O’Brien
Series Producer, Art Director + Editor: Shana Dressler

whydonate_green_fullbanner_whitetext_110614Three years in the making, the Social Good Guides are the result of the generous contributions of a team of esteemed authors, designers, copywriters, proofreaders, project managers, marketing consultants, researchers and interns. Initially conceived as a “nights-and-weekends” labor of love, the project quickly expanded beyond its original scope once we realized that accessible information about the essential small-business skills needed to build sustainable social impact organizations was missing in the social impact space.

If you would like to make a general donation so we can finish the last four guides, click here. If you received value from reading this guide, and you would like to make a donation click here.

Please donate. Your support is needed and appreciated!


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TERMS OF USE

Text © 2015 Carly Leinheiser
Cover © 2015 George Aye
Graphic design and all other elements © 2015 Social Innovators Collective.

All rights reserved. All guides have been created for private use. No part of this publication may be reproduced, distributed, published, transmitted, photocopied or stored by third parties for download or for sale in any form or by any means, including electronic or mechanical methods, except with the written permission of the publisher, the Social Innovators Collective. Please see our full Terms of Use for more information.

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