Over the last six months I’ve been taking a crash course in company formation, treating it like any other investigation into a strange and esoteric technology. Last year I registered FoAM Kernow as a UK non profit organisation in the mould of FoAM Brussels. Starting off with absolutely no knowledge at all (but with a lot of help from FoAM’s wider friends and relations) I found a lot of confusing fragments of information online so I thought I’d document the process here as much as I can. It’s important to state that I’m not a lawyer or professional in these matters at all, so no substitute for proper legal advice – and any corrections would be most welcome.
What does non-profit mean?
A non-profit company is simply one that is not allowed to have shareholders. A for-profit company can pay a set of people who own shares part of the profits called dividends. In a non-profit the money outflow is more tightly controlled and can only go to employees or to pay costs for the company. Contrary to popular belief, there is no limitation on the size of the company, how much it pays employees or the money it makes in total (there are some very large non-profits out there).
In place of shareholders, a non-profit is “limited by guarantee” – a more legally correct term for this type of organisation. Individuals guarantee a set amount against liability (debts). The default is a whopping £1 each.
As far as I understand it “limited by shares” and “limited by guarantee” are the two main different types of organisation in the UK. There are also a cluster of other subcategories: charities, community interest groups, co-operatives and social enterprises for example. These are a little bit more fuzzy it seems, but they tend to be different flavours of limited by guarantee companies with more legal paperwork (especially in the case of charities) to determine the precise purpose and role of the organisation, and ultimately access to profits – what the money can and can’t be used for.
Why form a company?
Having a legal entity with which to work from rather than being an individual (sole trader) is better for larger projects, and bigger institutions are happier collaborating with legal entities. This is partly a matter of indirection or abstraction, e.g. if I get hit by the proverbial bus, the legal entity continues to exist. More importantly, it means multiple people can work together as part of a legal structure with a publicly stated set of shared values (called the articles of association). There is also a well established democratic process to make organisational decisions (more on that later).
Sole traders on the other hand can employ as many people as they want, but the structure would be fixed as a simple hierarchy – and the organisation has no legally defined purpose. Also things like insurance are different, but I won’t get into that yet!
Why form a non profit company?
A non-profit fits well with the goals of FoAM. Generally we focus on exploring ways of doing independent research, we are strict on non-exclusive rights to our work (participating in free software and creative commons) and finding a place between arts and sciences. None of this requires conventional fund raising by selling shares.
Another big reason is an issue of trust. We work mainly with people in spheres of arts and research – and it turns out a lot of people don’t want to work with companies that are run on a for-profit basis. In fact I would go so far as to say that some of the most interesting people we work with are wary of this. There is a somewhat justifiable worry that their contribution may be exploited via pressures to make a return on investments made by third parties.
The downsides are mainly tax related – for-profit companies can use dividends to pay investors (who can be employees too) which are not taxed – this is a very common practice. Usually small companies employ people at the minimum taxable wage then pay the rest by dividends. There is no way to do this with a company limited by guarantee – all payments to people need to be accounted for as normal employment or subcontracting and subject to income tax. It turns out that there are other upsides to being non-profit that may counteract this in the long run as you get treated differently in some contexts (e.g banking). For the next installment (if I find time!) I’d like to talk more about that and the formation process too…