There are good reasons to set up a social enterprise, but care must be taken to get the legal foundations right, advises Stephen Grant

The Scottish Government continues to champion social enterprise businesses and recently announced a further £1 million of funding for social enterprises and grassroots organisations – but are there fundamental issues with the legal structure of a social enterprise?

The premise behind a social enterprise business is that it operates as a business typically with a social or environmental purpose with profits being re-invested into fulfilling their mission rather than being paid to shareholders by way of a dividend.

This seems a relatively straightforward and simple idea; but how does such an enterprise with an altruistic outlook sit with age-old company law and the statutory duties which are owed to a company by its directors to promote the success of the company for the benefit of its shareholders?

It is useful to draw a distinction between a social enterprise and a charity at this point. Whilst they both have the same goal to make a positive difference in the world, charities tend to do so by way of fundraising and donations as opposed to operating as a traditional business selling goods and/or services.

HeraldScotland:

WJM's Stephen Grant 

Charities need to be registered with the Office of the Scottish Charity Regulator (OSCR) in Scotland which provides regulation of their activities and with that there is a well-worn path of guidance and good practice for charity trustees. 

In Scotland there is even a unique legal form, the Scottish Charitable Incorporated Organisation (SCIO), tailored to the requirements of operating as a charity. Social enterprises on the other hand usually take the form of a “normal” company limited by shares or sometimes by guarantee. 

Limited companies have been sculpted over the years by common law to focus on maximising shareholder value rather than a charitable or social mission statement. This then could in theory create a conflict for the directors between benefiting shareholders and the objectives that the social enterprise is seeking to achieve.

The Companies Act 2006 provides that a director must act in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members (aka shareholders) as a whole, and lists a number of factors to take into account when so doing. This includes the need to act fairly as between members of the company. Is there an issue for social enterprises against this apparent backdrop of profit for shareholders?

Fortunately for budding social entrepreneurs there is a rising tide of corporate social responsibility and recent legislation includes a requirement for certain companies to include a section 172 compliance statement. 

Deliberations on this legislation rekindled previously intensely debated matters as to who should feature in the “success of the company” and if it includes employees, suppliers and local communities affected by company activities as stakeholders. Recent legislation and guidance clearly states they should.

There is a lesser known section of the Companies Act, Section 172(2), which is of particular importance when considering a social enterprise as it pulls in the company’s purpose(s) to the mix. 

Where the company’s purposes consist of or includes purposes other than for the benefit of its members, the directors must act in a way they consider, in good faith, would be most likely to achieve those purposes. It then becomes of paramount importance to state these purposes in the company’s constitution (ie the articles of association).  

Adopting a set of articles of association which clearly outlines the social aspirations of your business and having a substantive conflict policy will go a long way to quell any conflict fires.

If you are considering setting up a social enterprise it pays dividends to think about your legal structure at the outset and have clarity on your purposes to allow you the flexibility to operate as you wish to.  

Stephen Grant is an Associate at Wright, Johnston & Mackenzie LLP specialising in corporate and commercial legal work.