What is a social enterprise and how different is it from a commercial business or a charity ?
The key distinctions are as follows:
- Object and purpose
A social enterprise is an entity with its sole object and purpose exclusively on specific social or environmental goals and whose profits are reinvested for that purpose, rather than being driven by the need to maximise profit for shareholders and owners.
A charity is an entity with its sole object and purpose on charitable activities benefitting wholly or substantially a certain community eg Homeless community in Singapore or providing education to vulnerable children in Africa. A charity need not be loss-making or expected to run its business at break-even. In fact it is expected to be profitable so that it can sustain and continue its charitable mission for the long-term. Whilst profit-making is not a sin, it should be noted that the main objective of a charity is it charitable purpose and profit-making in a means to that charity end.
A commercial business has a much wider object and purpose as it is not restricted to only charitable activities. It is usually commercial centric and profit driven with its main business objects and activities provided in its Constitution. It thrives and strives on profit making.
In fact the object and purpose of a social enterprise and a charity are very similar both focusing on a social, environmental goals with the only distinction lies primarily on the business model. Whilst social enterprise needs to have a sustainable business model of profit-making to ensure its continuity, a charity does not need to be profitable as it relies mainly on donations and funding for its existence.
- Nature of business activities
A social enterprise relies on a sustainable business model to drives its social or environmental objectives. Therefore its business activities is not very different from a commercial business. The distinction is that the business actiivities of the social enterprise must have a direct or indirect social impact (in line with its object and purpose). RaiSE (Raising awareness of social enterprises) provides guidance on the defintion of social enterprise as “business entities set up with clear social goals; and where there is clear management intent and resources allocated to fulfil their social objectives”. It also provides social values toolkit and enterprise model canvas to help quantity the social impact and articulates the business models (its related business activities) respectively.
A charity would usually has 3 different types of business activities:
- Primary purpose business activities: These are activities that contribute directly to the advancement of a charity’s objects stated in its governing instrument. Eg providing family counselling services at a fee by a family service centre which aims to help dysfunctional families.
- Incidental business activities which support its primary activities or advancement of its main object. Eg providing childcare services for a fee at the centre for the parents of dysfunctional families who attend counselling services.
- Non-primary purpose business activities: These are business activities that do not directly advance or support the objects of the charity, and usually involve the provision of goods and/or services solely in return for income (charity object must come before profit-making as in earlier point). Eg income for a running a counselling academy.
The charity may also involve in fund raising or donations activities but these are not business activities.
A charity must have a significant part of its income from its primary business activities and the contribution from its non-primary business activities (“the profit making business activities”) cannot forms a significant part of its financials.
A commercial business, however is free to engage in any business activities for the pursuit of profits. The distinction of its main business activities and other income is purely for financial reporting treatment and disclosure, business model sustainability, investor relationship management and tax reporting.
The fundamental part of this restriction on the type of business activities hinges on the risk warehousing (this is more restrictive for a charity) which we will discuss in the next point.
- Risk warehousing
A social enterprise risk model is very similar to a commercial business and its legal formation is not restricted. It can take various form similar to any commercial business from sole proprietorship, partnership, limited liability partnership, company limited by share capital etc. Generally, its risk model will follow that of its legal formation.
A charity business risk should be restricted and warehoused within its primary charitable activities. All charities are restricted to certain legal formation eg companies limtied by guarantee, society or trust. Different business activities carry different risks and in some activities, the risk is not just different but higher or more complex. Therefore, it is important a charity should safeguard against any potential use of its resources eg money, assets to cover any eventual losses incurred from investments or running a non-primary business activity. A non-primary business activities if it is undertaken with approval from the charity directors or trustees have to minimally not to require sustained funding from the charity. Directors or trustees of a charity is advised to conduct detailed due diligence on long-term business viability before any non-primary business activities is undertaken.
A commercial business engages its business activities and business on its risk appetite under the maxim of higher return, higher risk – there is no free lunch in the market. Fundamentally, a commercial company is allowed to fail and it is a norm in this competitive market. However, the regulatory regime, governance structure and agency structure offer the protection of the corporate veil and limited liabilities for company shareholders. This is unlike the legal structure of a charity which more onerous from a members’ liabilities of a certain sum (company limited by guarantee) to unlimited (society or trust).
- Members’ liabilities
The members’ liabilities of a social enterprise will follow its legal formation. If it is registered under sole proprietorship or partnership, its members (or owners) liabilities will be unlimited and if it is under a corporate structure, it members will enjoy limited liabilities. This is no different from any commercial business.
The members of a charity under a company limited by guarantee will be restricted to a predetermined fixed sum while for charity under society or trust, the members or trustees will be personally liable.
The members’ liabilities of commerical business, similar to a social enterprise, takes on the form of its legal formation. The shareholders of a commercial company enjoy limited liabilities and is not liable for any liabilities upon winding up. Shareholders only lose their investment in the shares of the company and nothing else.
- Profit distribution
A social enterprise and commercial business are free to distribute profits to their members. A social or commerical company distributes any surplus or profit to its shareholders by way of dividends based on its dividend payout policy. Any surplus on winding up goes to the shareholders.
A charity can never distributes any profit or surplus from its business activities to its members or directors/trustees. Even upon winding up, any surplus assets must be distributed according to its constitution which is usually to another charity (eg. an approved charity or charities in Singapore) whom has the similar distribution policy as the winding up charity.
- Income tax exemption
A registered charity (with the Singapore Charity Council) enjoy income tax exemption on its income.
A social enteprise or commercial business is taxed at normal tax structure. For a sole proprietorship or partnership structures, it is taxed under individual income tax rate from 0% to 22%. A company is taxed at flat 17% for all its income albeit company tax resident in Singapore enjoys a partial tax exemption to up to $300,000 of its chargeable income.
- Tax deductible receipts – unique only to certain charities
A charity which is also an approved IPC (Institute of Public Character) can issue tax deductible receipts for qualifying donations to donors. This enables the donors to claim tax relief from their assessable income based on the amount donated, at prevailing deduction rate of 2.5 times of the amount donated.
In summary, profit motive is paramount in commercial business. Social or environmental objective is paramount for both charity and social enterprise. Whilst running social or environmental ohjective is paramount to both social enterprise and charity, achieving these goals through a charitable means (or charitable business model that relies on donations) is only unique to charity.
The profit motive is important to both commercial business and social enterprise as their continuity rely solely on it. For charity, it is a bonus if it can sustain its continuity partially on it own operations instead of donations, but it will be quite unlikely for any charity to rely its sustainability solely on internally generated profit as frankly, it is in essence a charity.