Cap it and lock it: a new, hybrid structure of the future.

The following statement lies somewhere between a prediction and a proposal: At some point in the next several years, the United States will create a corporate structure specifically designed to promote social enterprise.

The issue of hybrid corporations was covered in this column a little more than a year ago (see "Mix and Match" May 2006). It noted that England had already adopted a vehicle called a community interest company, or CIC. There is a potential need for such a corporate designation in the United States. The reason for the need is that nonprofits increasingly find the need to create wealth instead of depending on its donation, while for-profit companies in some sectors find it desirable to adopt an explicit social mission.

The problem is that socially-minded entrepreneurs in either nonprofit or for-profit companies must improvise within their respective conventions and restrictions. Nonprofits dabble with existing nonprofit structures or establish esoteric subsidiaries, while socially-minded profit entrepreneurs must risk the disapproval of shareholders or owners and be willing to be seen as goofy re-treads from the 1960s. This is a rickety system for financing social enterprise.

But what exactly would such a structure look like? What would make it different from either a traditional for-profit company or a traditional nonprofit? Perhaps most important, what benefit would it bring?

TWO ESSENTIAL FEATURES

Begin with the two central features of for-profit companies that nonprofits cannot mimic. For-profit companies can sell shares of ownership on which the issuing company pays dividends, and the shares themselves can be sold on the secondary market, better known as Wall Street.

The ability to sell shares means that they can raise outside capital, instead of just gaining it from profits or borrowing. In turn, raising capital means that they can grow their operations faster and to a scale not typically within range of a non-profit organization with its limited ability to acquire capital for growth.

Social entrepreneurs need capital, and owners of capital need a return on its use. But when one has the option to sell shares on the open market at any time it means that, while the capital is locked in with the company that issued the stock, any given investor can sell their shares and walk away. While this marketability theoretically encourages the efficient use of capital, it also gives the investor an exit door. This means the investor approaches the whole process as a transaction, not an investment relationship with the enterprise and its intended social purpose. Social entrepreneurs need long-term investor support, not a series of transactional investors. So there needs to be a way of keeping the investor connected to the initial investment and thereby to the community it was intended to benefit.

This is how to arrive at the two essential features of a future structure whimsically called the Cap and Lock[TM] Corporation. In this model, the investor is rewarded by being promised a return on the investment, but the rate of return is capped at some reasonable level (say, 95 percent of the prime rate). In return, there is a double lock on the invested capital. It is locked into the organization and it is locked to the original investor, never to be re-sold on the secondary market. In effect, this would be a special form of debt.

Economists will say that there are already somewhat similar models. For example, charitable remainder trusts have similar features. In these, the donation goes into a trust with the interest on the investment going to beneficiaries that the donor stipulates. At the end of a specified term or the life of the donor, the remaining corpus (remainder) goes to the charity.

In a Cap and Lock[TM] corporation, the body of the investment leaves the investor's hands and gets locked into the social enterprise, with capped interest payments going to the investor (or, the investor could choose to leave the payments in the entity in return for an enhanced tax deduction). In spirit, this would be a rough nonprofit analog to preferred stocks, which have limited dividends and no voting rights.

Still, the fact is that one could probably duplicate the essence of a Cap and Lock[TM] corporation within the existing laws and regulations governing profit corporations today. But doing so would require costly individualized attention and expenses far beyond what most organizations would want to incur. Moreover, those proposing such a structure would be regarded as mavericks rather than smart pioneers.

What is needed is a template, a pre-approved choice in the same way that entrepreneurs on both sides of the aisle currently have many different legal and financial templates available to them. Cap and Lock[TM] would be just another one.

HOW CAP AND Lock[TM] MIGHT CHANGE THINGS

This approach would admittedly put pressure on the social enterprise's managers to be responsible with that initial investment in a way that no nonprofit manager feels pressure today. The social entrepreneur's job would be to turn capped and locked private wealth into community wealth.

Incidentally, do not be put off by the term social entrepreneur. Like the man who spoke prose and did not know it, many nonprofit managers are social entrepreneurs who just do not put that label on themselves. Any nonprofit organization with a sound model and a growth opportunity comes very close to being a social entrepreneur minus the outside investors.

Not every nonprofit would aspire to a Cap and Lock[TM] corporation. Where foundations and major donors remain willing to donate their funds in search of social impact the approach would have little appeal. Cap and Lock[TM] would have its biggest impact in those areas where the most entrepreneurial nonprofit managers and the most socially conscious profit managers reach toward each other but are kept economic miles apart.

Ironically, other industries might find Cap and Lock[TM] attractive because their basic model does not fit comfortably within the unforgiving dictates of the free market. Take newspaper publishing, for example, where there is a constant and ever-growing tension between editorial independence (read, community orientation) and the desire to make large profits using investors' funds. Many newspapers and similar enterprises are too large for a geographically narrow community focus but are rarely seen as desirable investments on Wall Street, the source of major investment capital. Cap and Lock[TM] would begin to steer media operations away from the threats of an unchecked quest for profit, provide capital for growth, and still hold out the potential for a reasonable return on investment.

Of course, there would have to be proscriptions as well. For example, with increased access to capital and a lock on what is raised, the entity would be a more inviting target for misfeasance. Regulators would want to be assured that the capital wouldn't leak into private hands. The most likely source of leakage would be excessive salaries, so something like intermediate sanctions would have to apply, and it would be likely that at least some of the Sarbanes-Oxley provisions would also transfer.

There's nothing new under the economic and financial sun, and the elements of this entity are not truly new. What is new is that in total they offer a way of packaging opportunities and prohibitions that currently exist in parallel. There are things worth doing that can be done in the private sector with private money. And there are things worth doing in the social economy that could be done with private money, too. What is needed is a way to make that happen most efficiently. Cap and Lock[TM] is one possibility.

Thomas A. McLaughlin is a national nonprofit management consultant with Grant Thornton in Boston. He is the author of the book Nonprofit Strategic Positioning (John Wiley and Sons, 2006). His email address is [e-mail]