The major challenge for social enterprises in NZ

A couple of weeks ago Ākina released its Law Foundation-funded report on social enterprise legal structures (SELS) for Aotearoa New Zealand. I’ve got a strong interest in this area and have written about it in the past, given its relevance to a lot of the organisations I’m involved with.

This blog is written to summarise from my perspective what the report is saying, what it says without actually saying it, and what comes next. It is written for people working in or on social enterprise-esque things themselves as food for thought. If anyone feels they don’t understand the difference between a limited liability company and a trust, or how charitable status works, or the basics of grants vs loans vs investment for equity then comment below and I’ll add some 101 definitions too.

A general comment is that the Ākina report was written for David Parker, Minister for Economic Development, so that he may consider the merits of making changes or not to the companies act (which defines the current structures). He is “interested in learning about specific examples of social enterprises that have been unduly affected by the perceived challenges associated with their legal structure”. The main aim of the report was to put the challenges of legal structure in black and white so they can be considered more clearly, rather than necessarily solve them. This summary is written to pull out the points of interest to social enterprises themselves, a different audience and purpose than that intended for this report, so consider this an opinion piece or semi-informed commentary written in conversation with the lead authors. Thanks to Jackson Rowland and Jane Horan for their conversations, and Steve Hamlin for being an excellent mirror and sounding board.

What the report is saying

In summary, the report asserts through quotes and case studies that existing legal structures don’t work in the best interest of social enterprises. The bulk of the problems described in the case studies have little to do with shortcomings of the actual legal structures themselves though. The main problems are things that arise because of other people’s perception and assumptions that are based on legal structure. Many organisations face difficulties of where other people/stakeholders don’t believe, understand, or trust that a social enterprise can be legitimately good, and legitimately for profit, and instead instinctively make assumptions and decisions about a social enterprise based on it’s legal structure. The structures are not flawed, but the interpretation of what a structure means about the social enterprise using it doesn’t work well for social enterprise.

This problem is connected to quite a deep philosophical difference in how people think about everyday business and charity, compared to how an effective social enterprise sees the world. Traditionally, people would think of charity as good and business as money and sometimes representative of bad. Social enterprise asserts, through it’s existence, that you can be legitimately good and also for profit without having to trade one for the other. In this sense, social enterprise is not shades of grey along a black-white scale of charity-business, it’s more like introducing a rainbow into the conversation - something quite different than previous options. This philosophical difference is articulated well through this diagram and one of the accompanying paragraphs on page 11 of the report:

“The LLC and the other legal structures available in New Zealand are products of the logic where charity and doing good are separate from doing business. Therefore, the fundamental nature of …[social enterprise]… is not accommodated by the LLC structure or other for-profit legal structures. While the Companies Act and the structure of the LLC is accessible to SE…it is difficult to operate as a SE without undue hindrance, let alone thrive, without significant, entrepreneurial capacity and expensive creative legal work.” – SELS report, pp 11.

This is, for me, is a brilliant articulation of some of the challenges that we as social entrepreneurs face. We’re coming from a perspective that other people often don’t understand or even know exists. What we are trying to do is fundamentally different than much of the world around us, even if we’re all trying to achieve the same thing at a deeper level. The capitalist economy is rooted in the assumption that making more money does good for more people, and it’s the basis for much of the (western) world. The human economy (where social enterprises come from), on the other hand, is rooted in the observation that capitalism is increasingly failing more people than it is benefitting. The human economy contrasts with the capitalist economy in that it is supported by practices that not only generate profits, but also creates more and other real value for human beings and the natural world that sustains us.

In reading the full report you can almost feel the authors slowly getting a glimpse and understanding of what’s actually involved in delivering positive impact in a financially sustainable way. At several moments there are long quotes from powerful thinkers like Michelle Sharp of Kilmarnock and Cliff Colquhoun at CBEC, who clearly made a mark. The two give in-depth views of the differences between things like responding to an existing challenge vs changing the conditions which gave rise to the challenge existing in the first place. There are direct contradictions between case studies who sit on each of the camps in that example, hence the report shows a snapshot of some of the complexities of talking about ‘doing good’.

Seeing this more nuanced understanding of impact start to unfold through the report reinforces for me that the main challenge facing social enterprise is not internal to social enterprise itself, it’s in the mindset shift of everyone who simply doesn’t yet understand the fullness of possibilities that social enterprise represents. And that includes a whole lot of us who identify as social entrepreneurs - we all have much to learn.

In response to this fairly fundamental challenge of perception, the report recommends creating a new legal structure - provisionally called an ‘Impact Company’. This would be based on the super-flexible Limited Liability Company (LLC) structure, and it is intended that this new structure would make it easier for banks, philanthropists, investors, consumers…whoever, to understand and identify an organisation that is both legitimately ‘good’ and legitimately ‘for profit’. Each of these other stakeholders could make specific provisions for Impact Companies, as they currently might for charities. It is proposed that this would solve the main challenges identified and hence make it easier to be a social enterprise in NZ.

An Impact Company would be a for-profit structure that prioritises impact - presumably over or at least alongside profit. It could sell goods or services, accept grants (subject to the grantee provisions as above), loans, debt, take on investors, allocate equity (voting or non-voting), and be sold, all in the name of delivering more positive impact. The ‘prioritising impact’ bit would be acted on through two key elements: an impact mandate and impact reporting. There are no specific details about what these two elements would be, but some fairly clear direction is given as to how this might look and feel.

Impact Mandate

“Each Impact Company would be required to adopt a constitution including a statement that sets out the impact the entity is seeking to achieve and the prioritisation of impact alongside distribution of profits” – SELS pp 31. This is very similar to how charitable organisations articulate their intent currently – enshrining specific language into the constitution/deed, which Charities Services judge to be valid or not relative to the Charitable Purposes.

Impact Reporting

“An Impact Company would be required to prepare and publish an annual report that outlines how it has performed in achieving its impact mission, not dissimilar to the performance reports required for most charities” – SELS pp 31. This also makes sense, as it essentially forces the organisation to consider the question “what have we achieved?” on a regular basis and publish the results. This is something that has only recently been introduced for Charities in New Zealand, and to mixed success. A lot can be learned from the roll out of the new reporting standards for charities, but starting with a clean slate could result in something much more nuanced and useful for the organisations themselves and for external stakeholders. It wouldn’t necessarily mean that good is guaranteed to happen, but would bring a level of probably standardised transparency that makes it easier for other stakeholders to make informed opinions about an organisation.

Each of these elements on their own show the need for some sort of measuring stick against which to compare the organisation – like the charitable purposes for charities – otherwise they open some fairly huge scope for green washing/social washing or other misuses. The report acknowledges this by discussing how “a set of standards or types of impact that would qualify for the new Impact Company would need to be defined to provide legitimacy to the model and criteria that applications could be assessed against”. I’ve written in the past about this, making the case for a discussion about “what we count as being legitimately good, which may or may not also be charitable”. More on this proposed set of standards / framework in the ‘what comes next?’ section below.

Lastly, the report names some specific things that an Impact Company would not include.

• An upper cap on dividends that may be paid to shareholders

• Asset lock, preventing assets being transferred to orgs without a similar intent

• Blanket tax exemptions like those offered to charities in NZ

• Any other types of legal structures based on NZ or overseas structures (there will be only one)

I agree with each of these being excluded, and am happy to unpack more on why if anyone vehemently disagrees.

What the report says without actually saying it

From the perspective of social enterprises, there are a few significant statements that are not in this report - probably because of the intended audience – that are worth taking away.

1. Use the Limited Liability Company (LLC) structure

There aren’t any fundamental limitations to the structures available to us, and the proposed Impact Company is a bit like adding some roof racks and a tow bar to the car you already have. If you’re running a younger social enterprise and can’t find a workaround with the LLC then either keep trying, find a partner to work with to get around your challenge, or keep waiting. Existing mature social enterprises with a robust impact model and validated business model tend to be forced into a particular shape now, and will have significant work to take up the new structure if it happens. But that might create wonderful opportunities for the reinvention of services and models – particularly for larger established charities – of which NZ has plenty. If I was involved with running large charitable organisations, which I am, I’d be going back to the drawing board and considering what we would want to be if we had the chance to start again. Which we are. Maybe you can start those conversations at your board table?

2. Start formalising your decision-making and reporting your impact

If you make decisions that try to maximise something other than profit, but you can’t describe exactly you’re maximising, you have a problem. It’s the answer to the question “What’s the needle you’re trying to move?” If you don’t know where to start, give me a call. Existing mature social enterprises with a robust impact model and validated business model tend to know this answer already, but if you don’t have it clear in your constitution/deed/shareholders agreement then it could be wise to get onto that. If you don’t keep reliable minutes of board meetings that show how decisions are made and on what grounds, then you need to start doing that. If you are making significant decisions with no real-world basis upon which to make them, that’s something you will want to change too – both for impact efficacy and impact reporting (and also good governance). With processes like these in place it typically gets easier to start publishing impact reports too – showing the changes in the smaller needles that sit around and contribute to the movement of your big needle. It doesn’t need to be all bells and whistles in the first instance, just good robust numbers and possibly some stories and pictures for the visual among us. These types of things will become very important if David Parker accepts the recommendations of this report.

3. Speak the language of whoever you are speaking to

In my experience working with and alongside social enterprises , we have a tendency to pitch the things we care about rather than talking about the things that matter to whoever we’re speaking with. This can be a fatal error in the early stages of an initiative, but it’s also simple marketing 101. Pragmatically speaking, we know that e.g. a bank is going to look sideways at a charity asking for a loan, so social enterprises with charitable status need to front foot that with the ways that they talk and what they talk about. Know the audience, their drivers, assumptions, risk aversions, and who they trust. Some perhaps confronting advice: sell to people who don’t have your same passions and values - only by speaking their language can you change their mind in time.

4. There’s no such thing as a perfect ‘mission lock’

In several of the case studies the organisational leaders struggled with the idea of losing control of the organisation (e.g. when taking on equity) and the inability to ‘keep the mission primary’ or ‘prove it is primary’ to e.g. get access to grant funding. The cold hard reality is that this is the case with all legal structures. Being involved myself with the governance of several large organisations, small companies, and local trusts, I’ve found things are essentially the same in all structures, sizes, and contexts: keeping ‘the mission’ primary is about decision making and interpersonal relationships. It involves having people ‘around the table’ who have a deep understanding of what the organisation is trying to achieve, and who individually decide to work together in pursuit of something bigger than each of them. The people can change, the table can change, and so can the goal – and in a successful organisation they will change as frequently as is found to be necessary. Incidentally, this is the exact case also with getting access to finance. And it’s good governance. All of the structures allow for a ‘locking down’ of ideas in some way, and each one can be changed too. Formal documents help to contextualise human relationships and codify historical decisions, but absolutely are not and should not be seen as a substitute for robust discussion and debate among directors/governors of an organisation. There is no perfect result for ‘locking down’ the mission of the org, only things that work currently and might still work tomorrow. If you’re getting caught up in the ‘how’ of locking things down then you have missed something earlier that you need to go back and rectify. It’s probably to do with a relationship that isn’t very strong, or an insecurity that you haven’t explored fully.

5. This report is not about positive impact, it is about social enterprise

The selected case studies are fairly diverse and interesting. There is a mix of older established orgs, newish start-ups, and one no-longer-up. Several different legal structures are utilised across each of them, and many of them have several legal structures within the one org. While they include some incredibly effective organisations it’s probably not a list of the most impactful organisations in NZ. This says to me that those commissioning the report are not trying to maximise positive impact in NZ, they’re trying to maximise the ease of being a social enterprise in NZ. I wonder how the report may have differed if the case studies were based around impact efficacy - covering all range of interventions rather than just individual organisations. We have what we have though, and it makes me consider that there are likely some spectacularly powerful social enterprise models sitting out in the world that just haven’t made it to the surface yet. We need to be certain that the conversation moving forward continues to focus on meaningful positive change, and that we don’t get stuck in our own short history or ideas of what works and doesn’t in the current context.

Next steps

Whether David Parker accepts the recommendations in principle or not, the next conversation / report / piece of work off the rank will probably be relating to the “set of standards or types of impact that would qualify for the new Impact Company”. The topic sounds quite simple in the first instance, and in my experience mostly anyone can form an opinion with a few minutes’ consideration. It’s also just not that simple.

As I see it now, there are a very large number of shapes that this set of standards / framework might take, and in order to even get started we need to be clear first about what we’re trying to achieve, and the fundamental nature of the challenges that we are trying to overcome. For instance, are we trying to make it easier for banks/investors/customers/philanthropists to accurately to identify ‘legitimate’ social enterprises, or trying to ensure that social enterprises move the needle on issues that are deemed sufficiently important to us? Are we trying to set up a system for New Zealand, or model a system that could be used globally? Are we only concerned with positive impact on our shores or concerned also with matters that don’t respect national boundaries? This short list of questions off the top of my head each contribute to very different brief for what the set of standards / framework would need to be, and each will have very different implications for the impacts that happen and how organisations can identify as an ‘impact company’ or not.

So what do we do? This is more a question of moral philosophy than technical policy, so I expect the people leading the next piece of work to be of a very different kind than the authors of this report. The selection of individuals will say a lot about the mindset of those commissioning the report. I am hopeful that they will utilise technical policy experts and lawyers in the drafting of the report, but that the bulk of the work will be led by people involved with a wide array of successful impact-led initiatives as governance and operational levels. I’ll be making it very clear to Ākina that I wish to be involved in this piece of work in a leadership or contributor capacity, and have a cohort lined up to back me if needed.

For those of us working on social and environmental impact this report changes nothing for us day-to-day without knowing David Parker’s response. If you are sitting in your social enterprise struggling to make heads or tails of what to do next, the recommendation now is a deeply dissatisfying ‘hang in there champ!’. Consider whether you might need to amend the ways that you speak with other stakeholders, trying to account for any differences in your worldview and theirs. Take the gentle hint that the LLC is the vehicle you should probably be using, but it’s not worth jumping ship into one for the sake of it if it’s not going to make your life easier already. If being an LLC will make your impact-led work easier then hurry up and do it already, but make sure you first educate yourself on what that actually means by reading this page and related links. Even simpler than that, find someone else doing what you want to do, and go help them.

Final reflection

Finding our place in the human economy is hard enough, as this is fairly uncharted territory for many of us. It’s easy to think that you’re doing something good only uncover a bunch of unintended consequences, or be slammed by some partially-informed external perspective. And then day-to-day challenges hit too, where the default future of any organisation is failure (90-95% of organisations fail in the first 3 years). On an operational level we don’t know if our clients / customers / funders / investors / stakeholders also understand the value of and opportunities of the human economy. As a result we are constantly testing the water, learning, adapting, and modifying our language and our practice to deliver the most benefit to the human economy, whilst also engaging the largest number of ‘non-converts’ as possible. If they do ‘get it’, things keep moving and sometimes a little bit easier. If they don’t then we need to use a different set of tools. Deciding the right tools to use let alone when to start using them is really really hard to do at all, and harder to do well. For anyone who hasn’t experienced this before, this is working in complexity – constantly exploring messy, unpredictable, winding paths in the pursuit of more and better. The more you know the more you realise you don’t know. The naming of this broader problem in the SELS report, and the proposed Impact Company give us more language and ideas to work with, and we’re all on a journey together. I look forward to the discussions about where we’re trying to get to.

Jason Pemberton is an independent director and educator based in Christchurch. He is a Director of Felt, the social enterprise online marketplace for artisan products made in New Zealand, sits at the board table for the New Zealand Law Society and the Nationwide Health and Disability Consumer Advocacy Service, and runs You Think, a facilitator of impact-led projects that span sector and organisational boundaries. He advises social enterprises of all shapes and sizes, and loves gnarly problems, moon-shot ideas, and building guitars.