The 501(c) (3) nonprofit Social enterprise

AutorCarmen Parra Rodríguez

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1 Introduction

According to some observers1, social enterprise has been a practice of American civil society since the founding of the country, though use of the actual term did not come until much later. Indeed, within the active civil society of the United States there is a long tradition of religious and community groups holding bazaars and selling homemade goods to supplement voluntary donations.2 Later, the commercial activities of nonprofits were the first to become associated with the term «social enterprise» when at the end of the 1960s nonprofits created programs to generate employment.3However, the term did not become widespread until the 1980s when the contemporary social enterprise movement began. Nonprofit social enterprise has now been cited as the most common form of social enterprise in the United States and is increasingly aligned with a definition of social enterprise that includes the generation of earned income in support of a social benefit.4

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This chapter first reviews the rise of nonprofit social enterprise in the United States and its current organizational forms and legal issues. It then examines unique nonprofit social enterprise issues relating to the nonprofit mission and board, the mobilization of capital, and integrating a business culture into the nonprofit. A concluding section reviews the pros and cons of nonprofit social enterprise, drawing on critiques by scholars in the field.

2 History – The Expansion and Prevalence of Nonprofit Social Enterprise

The initial expansion of social enterprise in the United States can be linked to the nonprofit sector. Over the years scholars have attempted to show that nonprofits relying on government funding turned to commercial activities, and thus social enterprise, as a way to fill a gap left by government cutbacks.5Indeed, it would appear that historical events pushed nonprofits in that direction. Starting with The Great Society programs of the 1960s, the federal government invested billions of dollars in poverty programs, education, health care, community development, the environment and the arts. Rather than create a large bureaucracy, many of these funds were channeled through nonprofit programs, spurring on the expansion and creation of these organizations in diverse arenas.6However, a downturn in the economy in the 1970s led to government cuts in this funding for nonprofits in the late 1970s and 1980s. Thus, increases in public funding in earlier decades set the stage for the large impact of later government cuts on nonprofits. Indeed, Salamon estimated that social welfare cuts in the

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1970s and 1980s resulted in the loss of $38 billion for nonprofits outside the healthcare field.7Hopes that private contributions would fill the gap were not realized as private contributions dropped from 26 percent of nonprofit revenue in 1977 to 18 percent in 1992.8

However, not all scholars agree that government cuts led to increases in nonprofit commercial revenue. Foster and Bradach cite Salamon’s research where he states, «Fees and charges accounted for nearly half of the growth in nonprofit revenue between 1977 and 1997 –more than any other source.»9However they contend his statistics are taken out of context with their statement that, «Fees and charges grew no faster in that 20-year period than other sources of revenue; they represented nearly half of the sector’s total revenue in 1997, just as they had in 1977.»10

To shed light on this dilemma, a new study by Kerlin and Pollak using 20 years of data from 501(c)(3) nonprofit organizations registered with the United States Internal Revenue Service (IRS) indicates there was and continues to be an increase in nonprofit commercial activity among larger nonprofits (see note 1).11These same findings also suggest, however, that social enterprise was not spurred on by declines in government grants or private contributions over the long term (see Figure 1). Findings showed that from 1982 to 2002, the commercial revenue of nonprofits increased by 219 percent, private revenue increased by 197 percent, and government grants increased by 169 percent (see note 2). The increase in commercial revenue held true even as a percentage of total nonprofit revenue over time (see note 3). In 1982, commercial income comprised
48.1 percent of nonprofit total revenue, but by 2002 it accounted for 57.6

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percent. Meanwhile, private contributions only grew from 19.9 to 22.2 percent and government grants from 17.0 to 17.2 percent during this 20 year time period (see note 4).12

Figure 1. Selected Sources of Revenue for All Nonprofits 1982-2002 in 2003 Dollars (excluding hospitals and higher education institutions)13


Source: Kerlin, Janelle A. and Pollak, Tom H. «Nonprofit Commercial Revenue: A Replacement for Declining Government Grants and Private Contributions?» The American Review of Public Administration, forthcoming.

Data from the Kerlin and Pollak study also showed there was little or no association between declines in government grants (or private contributions) and increases in commercial revenue.14While the aggregate data do not reveal trends in small categories of nonprofits nor account for the large number of small nonprofits (those with less than $25,000 in annual revenue), the data suggest that a drop in government grants and private contributions did not spur the increase in commercial activity found in the nonprofit sector as a whole, though it may have provided an

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initial impetus. An alternative explanation may be that the large growth in the number of nonprofits and rising social needs may have increased the competition for government grants and private contributions and, though still rising, these revenue sources were not able to keep up with the new demand. Thus, nonprofits increasingly turned to commercial revenue as competition grew for government grants and private contributions.

3 Diverse Organizational Forms for Nonprofit Social Enterprise

Nonprofit social enterprise has recently expanded to include a number of organizational arrangements that in some way connect a nonprofit to commercial activity (see Table 1). These arrangements can either directly involve clients in a revenue-making activity as a part of client programming or exist solely as a revenue generating vehicle with no client involvement. Sealey et al. identify several main nonprofit earned income strategies, including sales of mission-related or non-mission-related products, the formation of for-profit subsidiaries by nonprofits, partnerships with for-profit companies, and cause-related marketing (co-branding of for-profit products) among others.15

Table 1. Common Types of Nonprofit Social Enterprises and the Extent of Nonprofit Involvement in Commercial Activity

Location of Commercial Activity Extent of Nonprofit Involvement in Commercial Activity
Social Purpose Organization Whole Organization/ Internal Program Full
Trade Intermediary Enveloping Partial
Nonprofit/For-Profit Subsidiary External Connected Partial
Nonprofit-Business Partnerships External Dis/Connected Partial/Minor

Informed in part by Alter (2007); Young (2006, 2007).

The first arrangement, the internal commercial venture or social purpose organization, involves the generation of earned income through

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the in-house sale of products or services (see note 5). Examples include the Girl Scouts’ annual cookie sale and recreational services provided by the Young Men’s Christian Association (YMCA). Also included are sheltered workshops for those with disabilities and job training initiatives where the commercial activity provides both social programming and revenue for the nonprofit. Nonprofit-owned franchises are also included in this category. One example includes the Latin American Youth Center that owns and operates a Ben and Jerry’s ice cream franchise shop to provide on-the-job training for youth.

Sales of products or services can also be arranged through a nonprofit or for-profit subsidiary. Indeed, Yetman and Yetman find that taxable subsidiaries produce at least as much taxable revenue as unrelated business activities operated within the nonprofit.16 The creation of subsidiaries allows a nonprofit to engage in activities that may only be peripherally related to its mission or to reduce its risk as it experiments with new program or business ideas. In particular, nonprofits create nonprofit subsidiaries when a parent nonprofit seeks to establish a large-scale program that differs from its parent organization’s main operations. These subsidiaries are considered social enterprises when they include an earned income component. For example, a comprehensive social service provider might establish an employment agency for hard-to-place inner city residents as a separate nonprofit subsidiary. While the parent organization may provide start-up funding and administrative services, the subsidiary is able to adopt its own structure and create a business-like culture.17

The for-profit subsidiary is chosen most often when a nonprofit wants to protect its tax-exempt status while engaging in substantial business activity that is not related to its charitable exempt purpose. Profits from the for-profit subsidiary are taxed at normal corporate income tax rates even though they support the charitable activities of the nonprofit.18

Yetman and Yetman note that there are some...

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