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.
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!
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 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).
Companies in the UK are founded with two documents, the 'articles of association' and a 'memorandum of association'.
The articles of association broadly has two purposes. One is to state why the company has been brought into existence. The other is to strictly define the decision making process for those involved. You don't generally need to write these documents from scratch, as we are provided with 'model articles' from which we can base new companies easily.
The company's objects
A non-profit needs to describe it's purpose via 'objects'. This is important because, as explained in part one, a non-profit is strictly controlled in terms of access to its money. The objects describe what the company assets (e.g. cash) can legitimately be used for. You can't found a non-profit for running e.g. a school and use it later for selling cars.
In contrast the objects for a company with shareholders is to provide a return on the investment for those shareholders, no more and no less. As such, for-profits do not need to provide any objects.
Articles of association are on the public record (you can pay Companies House £1 to send them to you). Naturally I've uploaded Foam Kernow's articles on github :) These are based on the UK's model articles - the main addition are the objects, which are a distilled version from Foam Brussels' charter:
The objects for which the Company is established are to:
1.11 promote art, science and education by identifying and strengthening the areas that connect them;
1.12 embrace cultural change;
1.13 foster interdependence;
1.14 cultivate the beginner’s mind;
1.15 respecting and sharing sources;
1.16 empower participants to translate an idea into practice;
1.17 foster open source culture; and
1.18 embrace creative conflict.
So in a nutshell, the objects provide a publicly stated purpose and philosophy, such as this, for everybody involved.
Object 1.11 (the numbering scheme irks me as a programmer) was added in order to underscore the arts/sciences purpose of foam. This meant we could apply for an exemption to drop 'limited' from the end of the name, in order to highlight our independent research focus.
Memorandum of Association
The memorandum is an agreement between the individuals founding the organisation - the share of capital (in a for-profit) or the share of liability (in a non-profit), the names and addresses - and eye colour, interestingly of all involved.
The standard corporate structure in a company limited by guarantee is a democratic one consisting of two levels. 'Directors' of a company take day to day decisions and responsibility while 'Members' of the company have voting powers on important decisions and have the ability to remove or add new directors. This structure is very flexible, neither directors nor members need to be employed by the company, and alternatively it's also possible for a company to only have a single director/member who is also employed on the payroll. This is how foam kernow started, and bizarrely I had to supply minutes to Companies House for a meeting with myself to appoint a new director.
There is quite a lot of confusing terminology around all this, for example an 'executive' director is one that is employed by the company (also known as a CEO) while a 'non-executive' is one that is otherwise external to the company.
As an aside, some companies are wholly owned by their employees, where all people on the payroll are made members and given votes automatically - however this is not the norm.