How and why did social enterprise crowdfunding platform, Chuffed.org create a new legal structure and what are the implications? Founding CEO Prashan Paramanathan explains.

Chuffed.org was launched in October 2013 with the mission to transform the nature of non-profit fundraising.

Our goal was to provide donors a compelling alternative to being accosted by fundraisers in the street. We believed that people wanted to give to causes that they were passionate about; they just needed a platform that gave them an enjoyable experience while doing so. For us, this came down to three things: being inspired, rather than being made to feel guilty; knowing where your money was going; and being relevant to what a donor is interested in.

We thought of Chuffed.org as a ‘social enterprise’ – a business which creates social impact – so neither the ‘charity’ structure nor the ‘for-profit’ proprietary limited (Pty Ltd) structure seemed quite the right fit.

However since we had all worked in the non-profit sector and were familiar with how philanthropic funding worked, we chose to incorporate as a charity – formally as a company limited by guarantee, without deductible gift recipient (DGR) status.^[1] This structure enabled us to secure initial grant funding of $460,000 from the Telstra Foundation to kick-start the business.

After launching in October 2013, in our first two years, we raised $5.1m for around 1,800 projects in 19 countries through the platform. Domestically, we had grown to become the biggest social cause crowdfunding platform by 4 to 5 times and our optional donation revenue model, where donors choose how much they give to us, was averaging out well. With our strong year-on-year revenue growth – we had more than doubled our first year’s revenue in our second year – it was clear that there was market demand for our product both domestically and globally.

Limitation of philanthropic funding

We could see the potential in Australia, and – with 20% of our projects now originating in the UK, Canada and the US – the opportunity in the international market. Our challenge was that to capture market share quickly, we would have to raise capital.

This is where the charity model breaks down.

“Unfortunately raising equity is not possible within a charity, so we had to convert our structure.”

Philanthropy is great at funding shiny new 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.

We knew that to raise the capital we needed, philanthropic funding wasn’t likely to work. That left us with debt or equity. We decided quickly that debt funding wasn’t right for the business at this stage – there was no security to back debt, we’d be spending too much money on the interest payments, and debt would make us act more conservatively as we focused on making our loan repayments rather than on growing the business. The other significant downside of debt was that the funders that we would have brought into the organisation would be essentially bank-lenders, rather than co-owners.

Like most tech startups at our stage, equity seemed like the better option. Unfortunately raising equity is not possible within a charity, so we had to convert our structure.

But what legal structure to adopt?

“… we knew that any legislative changes to enable a new structure were going to be too slow for us.”

In raising equity from external investors, our control over the organisation, and our ability to direct the social mission of the organisation would weaken. We wanted a structure that would preserve and safeguard what we had originally set out to do as our ownership diluted.

While there’s a lot of discussion in Australia about creating a legal structure for ‘social enterprises’, we knew that any legislative changes to enable a new structure were going to be too slow for us. We needed something that we could adopt immediately.

Options from overseas

We researched the models used in the US and UK for social enterprises. On the surface they look similar, however they have fundamentally different approaches to how best to lock in a social mission.

UK model: The model used most widely in the UK, the Community Interest Company (CIC), incorporates an ‘asset lock’ – a legal clause that prevents the assets of a company being sold for private gain rather than the stated purposes of the organisation – and a limitation on profit distributions to members of the organisation.

” … asset locks aren’t an effective mechanism for locking in a social mission if the person who controls the entity wants to bypass them.”

These two characteristics form the basis of the non-profit structure in Australia; you can’t distribute assets to members and in effect you can’t pay dividends to members.

While the purpose of the asset lock is to ensure that the public benefit or community benefit of any public (or philanthropic) funding is maintained, and cannot be of private benefit,^[2] it creates two significant limitations.

The first is that the asset lock and limitations on profit distributions deter equity investment. Investors – even impact investors – are unlikely to invest in an entity with an asset lock as it rules out most exit opportunities. In effect, you can’t sell the ‘investment’ and you’re limited on the dividends you can pay out.

The second, more practical limitation was that asset locks aren’t an effective mechanism for locking in a social mission if the person who controls the entity wants to bypass them. They can ‘distribute profits’ by paying themselves a larger salary, change the constitution to remove the asset lock or convert the structure of the entire entity to get around the asset lock if they want to.

US model: In the US, the main legal structure for social enterprises is the public benefit corporation (or PBC). Thirty US states have created slightly varying versions of PBCs but the most widely used models from Delaware and California use a common way of locking in the social mission.

The PBC models generally consist of five elements:

1. A statement in the constitution of what social benefit the company intends to create – its social mission
2. A clarification of director’s duties which explicitly requires directors to incorporate the public benefit and the specific social mission into their decisions alongside the pecuniary interests of shareholders
3. An enforcement mechanism that allows shareholders to hold directors accountable to those duties (normally by giving them standing to sue directors if they don’t act according to their duties) – the ‘mission lock’
4. A requirement that at least 2/3 of shareholders must agree to any changes to the social mission
5. A requirement that the PBC must report on its social impact according to a publicly accepted reporting framework.

Rather than using an asset lock to lock in the social mission, the PBC models use a combination of compelling directors to consider the social mission of an organisation and a ‘mission lock’ which requires a super-majority of shareholders to change the social mission.

Solution: A social benefit company for Australia

Following research, discussions with potential investors, as well as our own legal advice, we decided to create a solution based on the US PBC model (in particular the Delaware and Californian models), which we termed the ‘social benefit company’.

The three tenets of the social benefit company model are:

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. Directors of the social benefit company are permitted and required to deliver the purpose and to consider the wider impacts of their decisions as part of their duties as a director of that company (‘director’s duties’) – again we put this into our constitution.
3. A requirement that changing the purpose or director’s duties requires a 100% shareholder vote (‘mission lock’) – note that this a much higher bar than the 2/3 majority set by the US structures. This was put into our shareholders’ agreement.

As there is no supporting legislation for this structure, we had to work within the current Corporations Act.^[3] The way we achieved this is to modify what the ‘best interests of the company’ were for our situation.

” … a legislated framework would be useful to make the structure robust in more situations.”

In common law, directors are required to act in the best interests ‘of the company as a whole’. Over the years this has been interpreted as being the financial wellbeing of the shareholders.

However, the constitution can be modified to define the best interests of a company in such a way as to affect the obligations of directors. That is, a constitution like ours can be used to define the consideration of non-shareholder stakeholders’ interests (eg. employees, the environment, suppliers) to be in the best interests of the company. This is a view supported by both the Ford’s Principles of Corporations Law (which provides authoritative commentary on Australian corporate law) as well as the former Government body, Corporations and Markets Advisory Committee.^[4]

While we believe that this is an effective way to protect the organisation’s mission within the current Act for our situation, a legislated framework would be useful to make the structure robust in more situations. However, that is likely to take three to five years to happen.

For more details on the constitutional changes see Chuffed.org.

What’s the risk for Chuffed.org?

If directors were to act willfully against the mission, our belief is that the founders could take action against directors for breach of the company’s constitution (under Section 140(1) of the Corporations Act) or for breach of director’s duties (under section 1324 of the Corporations Act).

However, as this has not been tested in case law, it is unclear whether the founders would have standing to challenge them.

“We’ve mitigated against these risks by ensuring that any new shareholders and directors who join the organisation understand what the organisation stands for …”

Also, if there was a disagreement between founders and other shareholders on who to sell the company to – it’s unclear if we could sell to the more socially conscious but lower-bidding buyer.

We’ve mitigated against these risks by ensuring that any new shareholders and directors who join the organisation understand what the organisation stands for and our intentions in putting these clauses into our founding documents.

We’ve made these decisions based on the particulars of our organisation. Every organisation is different. Don’t take any of this as legal advice; you need to get your own.

Result since the remodel

Having changed the structure Chuffed.org recently completed a funding round raising $1.1m in seed investment.

Led by venture capital firm, Blackbird Ventures, the round includes funding from technology /internet entrepreneur Bevan Clark and The Telstra Foundation. To our knowledge this is the first time a major Australian technology venture capital fund has invested in a social enterprise.

The investment will allow Chuffed.org to focus in three areas to drive its social mission:

1. Fundraiser education: more education for the charity sector about how they can transform their fundraising and take advantage of the opportunities that crowdfunding presents
2. Donor movements: more education for donors about the issues that effect our society through stories told by crowdfunders
3. Grow: support more campaigners around the world to build their own audiences and to access ours.

Implication

The debate about the proper legal structure for social enterprises in Australia is an important, ongoing one. Whatever structure is chosen will have long term ramifications for the success, failure, stunting or acceleration of the social enterprise industry.

Historically, in the Australian social sector, we have a cultural bias towards looking to the UK for inspiration. From our experience, in this situation, we believe that going down that path will likely long-term limit the potential of the social enterprise sector.

“… broader question of whether we can use the ‘social enterprise’ concept … to change the nature of commercial business to be more social.”

The main reason for this belief is that while the asset-locked model can support debt-financed, slow-growth entities, it misses the opportunity to support high-growth, equity-financed social enterprises. Investors (both commercial and impact) are much less likely to invest equity in entities with asset locks.

Going down this path will lock the social enterprise sector into a slow-growth dichotomy of large property-style businesses (aged care, social housing, hospitals, large retail chains, etc) and smaller cottage-sized businesses (cafes, handicrafts, etc) – both of which can use debt. The high-growth businesses that could rapidly scale from being small to very large, simply won’t have the equity capital that they need to do so.

What’s worse is that this structural issue will become hidden: whichever model gets legislated and receives the government rubber stamp will inevitably be the most popular and appear ‘successful’. Both the US PBC and UK CIC models have been wildly popular in their jurisdictions.

For us, the case for the mission-lock model extends past just a more appropriate source of financing for ventures like ours. It extends into the broader question of whether we can use the ‘social enterprise’ concept to not just create a new sector in the economy but to also change the nature of commercial business to be more social.

“This potential to reshape the entire economy into a social good economy is the real opportunity here.”

In the US, very large commercial companies like Patagonia, Warby Parker, Etsy and even Unilever, the world’s third largest consumer goods company, have either embedded social mission into their constitutions or are on the path to doing so. The PBC structure gives them an avenue to go one step further and permanently lock this mission in; many previously explicitly commercial companies are taking that path. Simply put, they wouldn’t be able to do this if the option was an asset-lock model.

This potential to reshape the entire economy into a social good economy is the real opportunity here.

I hope we don’t waste it.

About the author

Prashan Paramanathan is the CEO of Chuffed.org. Prior to starting Chuffed, he spent 4 years as a strategic advisor to Australian non-profits, foundations and corporates at SVA Consulting. Prashan has also had roles in the IFC, World Bank Group in Western China, supporting the development of emerging microfinance banks and new financial services regulation as well as with Port Jackson Partners. Website: www.chuffed.org Twitter: @pparaman

Acknowledgement

Chuffed.org relied heavily on the Clayton Utz Opinion prepared for Small Giants and the Social Impact Hub’s report.

Disclaimer

Everything contained in this article is a lay opinion and should not be relied upon as a legal opinion. Chuffed.org and SVA advise getting in touch with your lawyers who can step you through the details of creating a social benefit company in Australia.

Endnotes

[1] This was not by choice – we did not fit into any of the ATO tax categories that would allow us to have DGR status

[2] http://www.communitycompanies.co.uk/community-interest-companies#assetlock

[3] The new legal structure involved converting from a charity (Company Ltd by Guarantee) to a modified Pty Ltd company that locked in the social mission as described.

[4] Corporations and Markets Advisory Committee: The Social Responsibility of Corporations Report, 2006