What Is the Difference Between a Nonprofit and a Social Enterprise?

Social enterprise is a hot topic generating a lot of buzz but lacking clear definition. To help us answer some common questions about social enterprise, we talk to TechSoup's Niko Malkovich and Saerin Cho, who are currently teaching Social Enterprise: Innovations in Creating Social Value at the University of San Diego's School of Leadership and Education Sciences (SOLES).

Malkovich and Cho are members of TechSoup's Global Eligibility team, which serves as the cornerstone of TechSoup's validation services and donation programs by providing jurisdiction-specific eligibility criteria. In this post, we'll define social enterprise, dig into the differences between nonprofits and social enterprises (hint: it's tricky), and explore why this model is becoming more dynamic in both the business and social sectors.

Kate Kelly: What is a social enterprise?

Niko Malkovich: In general, a social enterprise uses some sort of earned revenue to address a social need rather than relying solely on grants and fundraising like traditional nonprofits do. It might sell a product for a profit or it might raise money for a social venture by giving investors a return. Some social enterprises operate as nonprofits; others are for-profits. They can make money, but the key is that they pursue a social mission rather than focusing solely on profit.

KK: What is the difference between a nonprofit and a social enterprise?

Saerin Cho: A nonprofit is an organization that is not conducting its activities primarily to make a profit, whereas a social enterprise is an enterprise providing social benefit and may be a nonprofit or a for-profit. The two circles can overlap for an organization that is both a nonprofit and a social enterprise. But a nonprofit isn't necessarily a social enterprise and vice versa.

While many nonprofits operate solely based on grant income, that is no longer the default scenario. Nonprofits are often expected to create financial sustainability on their own through earned income. It's a common misperception that nonprofits cannot make money. They absolutely can! They are just subject to certain rules to keep their tax and other privileges under local law.

NM: To give an example, let's say you run a soup kitchen that receives most of its funds from donors and grants. But to support your programs, you also rent out your kitchen to caterers or sell soup at a profit to people who can afford to pay for it. You can be a 501(c)(3) nonprofit and still conduct these business activities as long as you pay unrelated business income tax (UBIT) on those earnings and they don't start to overshadow your charitable mission. But you can reinvest that money in your soup kitchen to be more sustainable.

KK: Given all the tax advantages, why would a social enterprise choose not to be a nonprofit?

NM: It depends on what you're trying to accomplish and the problem you're seeking to address. Let's say you want to create a food distribution business that supports local farmers and keeps food in the community. You determine it will require $5 million to get it off the ground. To raise that kind of capital, you may want to pursue funding strategies that aren't available to nonprofits, such as bringing in outside investors and paying them a return. In that case, you might choose a for-profit structure that's subject to fewer rules and doesn't restrict you from sharing profits.

SC: Those tax advantages may come with various requirements and restrictions that a social enterprise does not want to deal with. The flexibility of a for-profit business may be just what the social enterprise needs.

For example, the Chan Zuckerberg Initiative's mission is to "build a more inclusive, just, and healthy future for everyone." With such a mission, the organization could have been established as a private foundation or a charitable trust. Instead, it was established as a limited liability company (LLC) to have the flexibility to achieve its mission more effectively.

KK: What are examples of social enterprise where things can get complicated?

NM: You can think of social enterprise as a spectrum. On one end, you have nonprofit organizations that are adopting business strategies to help them fulfill their social mission; on the other, you have traditional for-profit companies that are increasingly committing to socially responsible practices. A good example of this is Patagonia. It's a billion-dollar for-profit company that makes sustainable clothing and donates 1 percent of its revenue to social and environmental causes. Where you draw the line of "what counts as a social enterprise" can depend. Do we view Patagonia the same way as a soup kitchen? What about an employee-owned cooperative that's committed to open decision-making and democratic governance? It's helpful to consider the whole range of "social enterprise" and where we would each draw our boundaries.

KK: Do social enterprises have any oversight?

NM: This gets to the question of, "How do we know you're doing what you say you're doing?" If you're operating as a 501(c)(3) nonprofit in the U.S., there are some checks and balances to ensure you operate transparently and follow certain rules. The same applies to many charities and public benefit organizations around the world. With for-profit social enterprises, it's not so clear. The founders can put a mission out there, but they are really only accountable to consumers or shareholders. As these organizations evolve, there is usually little to prevent leadership from changing its mind to focus on maximizing profit.

KK: Do you foresee any changes coming that would create more accountability?

NM: There are some states trying to create special structures for social enterprise. For example, eight states and some tribal governments have created a legal form known as a low profit limited liability company (L3C), which is basically an LLC whose primary purpose is social or charitable. But there's no enforcement. The hope is that there will be some recognition of this special status at the federal level, and that the IRS would oversee it as they do for charities. But I don't see that coming any time soon.

SC: I agree, I do not expect a federal-level governance of social enterprises in the U.S. anytime soon, if ever. Outside the U.S., some places have a more developed concept of social enterprises and even regulate them. Examples include the United Kingdom, Hong Kong, and South Korea.

KK: Why are we hearing so much about social enterprise?

NM: There's pressure at both ends of the spectrum. For-profit companies are recognizing that their customers are demanding more in terms of social practices. Consumers want to know that a brand is not just about making money, but that it also cares about people and the planet and how it treats its employees. And that's good. It doesn't mean these companies will abandon profit for purpose, but it's a step toward more sustainable practices.

At the other end of the spectrum, nonprofits are facing more competition for donors and grants. If your staff is spending all its time writing grants and soliciting donations, it's harder to pursue your mission. If you're a traditional nonprofit, there's value in understanding that it's okay to explore business strategies in order to be more sustainable.

SC: I believe the younger generations (particularly the millennials and Gen Z) are more socially conscious and intentional about where they spend their money. Businesses are learning quickly that social impact doesn't necessarily have to mean sacrificing their profit. In fact, referring to themselves as social enterprises and producing impact reports can attract more consumers. Because we do not have a clear definition, the term is used uninhibitedly by many companies and organizations.

KK: What's the bottom line? Do you have any personal thoughts to share?

NM: There are so many ways to pursue social good, and many creative strategies for supporting that work through earned revenue. We don't want to say what's right and what's wrong. The question I would ask when evaluating a social enterprise is, "If there's a tension between purpose and profit, what is the ultimate decision?" For a nonprofit, purpose usually wins because it has a legal obligation to maintain its nonprofit status. In other cases, it's not always clear. It can depend on who is running the organization at a particular time, the legal structure, or certain provisions in it governing documents.

SC: The bottom line is to think critically and not be swept up by a flashy buzzword. I believe the term is tossed around without any discipline, making both the businesses and the consumers feel good about the alleged social impact they make together. But Niko and I strongly encourage, especially in our course, for everyone to look beyond the vanity metrics and shiny marketing tactics to critically evaluate the social enterprise for their true, lasting social impact.