It is imperative to the success of your third sector organisation that you select the appropriate legal structure to suit your business model. This guide will discuss the typical legal structures found in the third sector and the key things to take into consideration when deciding which legal structure to adopt.
Organisations in the third sector are also known as not-for-profit organisations. Not-for-profit organisation is a broad term for all independent organisations whose purpose is not to make private profit for directors, members or shareholders. It is not a legal structure in and of itself and many different types of organisation can be not-for-profit.
Not-for-profit organisations choose a legal structure based on a variety of factors, including:
- How the organisation will be funded;
- Whether any profits will be distributed;
- Whether the organisation will be controlled by voting members;
- Whether the organisation will be charitable;
- Whether the organisation will be incorporated to restrict liability.
Not-for-profit organisations can take a variety of legal forms and the process for establishing one will depend on
which legal form is selected. The most common legal structures found in the third sector are:
1. Unincorporated Associations
Unincorporated associations are not registered anywhere and tend to be governed by a constitution that sets out their rules and are run by a Committee elected from their membership. Sometimes, a person or persons might operate as a sole trader or partnership. Unincorporated groups do have advantages, including that they are less administratively onerous and have lighter regulation. However, all such organisations do not have limited liability should things go wrong. It can also be difficult for such organisations to obtain funding such as debt finance or grants.
2. Company Limited by Shares (CLS)
In a company limited by shares, the members of the company are shareholders who have invested money in the company. The size of the shareholding is normally proportional to the voting power of the shareholder. This is a rare form for a social enterprise and there would need to be persuasive reasons to select this model, as it would be unlikely to obtain grant funding. One example of its use is as an income generation arm of a charity, which holds all the shares, so that the profit benefits the charity.
3. Company Limited by Guarantee (CLG)
A company limited by guarantee is a type of company registered on Companies House which does not distribute income to shareholders. Instead, members guarantee a fixed sum towards the debts of the company should it go bankrupt: usually a nominal £1. This means it can be not-for-profit, if all surplus income is reinvested back into the organisation. A CLG is incorporated, and has voting members. It is controlled by a group of directors, who can be paid or unpaid.
You may set up a company and register as a Scottish charity if the company meets the criteria for being a charity. Charitable status is a badge that an organisation can wear that brings with it some benefits. It is not a structure in itself, it is added as an extra layer on a CLG. If a company is charitable then it subject to charity law and company law and regulated by OSCR as well as Companies House.
4. Community Interest Company (CIC)
CICs can be limited by shares or guarantee as it is fundamentally a limited company with an extra layer of community interest. A CIC would have to pass the community interest test and we would have to demonstrate what activities the CIC would propose to do and how they would be of benefit to the community. It will also be necessary each year to demonstrate what the CIC has done to benefit the community, as well as the usual accounting/reporting requirements.
A key feature of the CIC structure is the asset lock which protects the assets so that they cannot be sold for less than their market value and so that on dissolution those assets would be transferred to another asset locked body so that the community always benefits from them. The CIC structure clearly indicates to investors that the enterprise operates for the benefit of the community, and that this social purpose is protected by proportionate regulation.
5. Community Benefit Societies and Co-Operative Societies
Regulated by and registered with the Financial Conduct Authority, co-operatives and community benefit societies are organisations which give a broad membership equal stake and equal say in management. A Co-Operative provides benefits to its members, while a community benefit society is for the benefit of the community.
6. Limited Liability Partnership
An LLP is a limited liability partnership. They can be useful in certain circumstances, including where two or more entities wish to work together. The LLP agreement between the parties can be used to set-out and protect the social aims of the parties, whilst all original parties will maintain their identities.
7. Scottish Charitable Incorporated Organisation (SCIO)
A Scottish Charitable Incorporated Organisation is is only available to charities with a principal office in Scotland and is regulated by OSCR and subject to the Charities and Trustee Investment Act (Scotland) 2005. It provides limited liability and a separate legal identity to organisations that want to become charities but do not want or need to be governed by the complexity of company law.
Assistance selecting a structure
The choice of structure for a third sector organisation will have lasting effects. Whilst the initial emphasis of founders will likely be on how the enterprise can grow and best achieve its aims and objectives, it is important to take the time to consider the most appropriate structure and taking legal advice early can help the enterprise deliver in the long run. For help deciding which legal structure is right for you, we offer a free initial consultation during which we can discuss the activities of your organisation and explore which legal structure would fit in best with this and how to set it up. Get in touch with us to arrange a free initial consultation.