August 2013 - socentlaw

WHAT DO INVESTORS THINK ABOUT BENEFIT CORPORATIONS?

An abridged version of this article ran in The Guardian Sustainable Business section. Click here for that version.

 

A quiet corporate revolution for good is sweeping across America. The Benefit Corporation, a new class of corporation for sustainable business, is being passed into law in states across the US. The Benefit Corporation is being adopted by state legislatures at light speed, with twenty states passing legislation in just over three years. By comparison, it took the LLC well over a decade to reach the twenty-state mark. In an age of intense partisanship, the law is gaining popular support across the aisle, including unanimous passage in the notoriously divided New York legislature.

The Benefit Corporation is a new class of corporation that broadens the purpose of a corporation and introduces unprecedented transparency and accountability. Traditional corporations operate under the legal duty to maximize shareholder value, which forces entrepreneurs to purse profit at the expense of purpose. The Benefit Corporation broadens the mandate of the corporation from a narrow of view shareholder maximization to consider all stakeholders in its decision-making, essentially codifying triple bottom line accounting. The Benefit Corporation’s social and environmental performance is measured by an objective third party standard and must be reported to the public every year in an annual Benefit Report.

On August 1st, Delaware followed suit and passed their own version of the Benefit Corporation, the Public Benefit Corporation. Delaware, widely seen as the most important state in corporate law, is where most venture-backed and fortune 500 companies are incorporated. One such Delaware corporation, Method Inc., a home cleaning products company, was one of the first companies to convert to a Benefit Corporation in Delaware. Adam Lowry, cofounder and Chief Greenskeeper, noted, “We started the business to show that business could be a positive force on society, and now have a legal form that is inline with our ethic.”

This new corporate form mandates that entrepreneurs take into consideration their social and environmental impact, which could have a negative financial impact on returns to shareholders. An essential question for entrepreneurs who are creating a sustainable business, but also need the financial backing of investors is:

What do investors think about the Benefit Corporation?

SHIFT FROM TECHNOLOGICAL INNOVATION TO SOCIAL INNOVATION 

As a partner at Union Square Ventures (USV), Albert Wenger has invested in some of the most successful tech companies including Twitter and Tumblr. He considers himself a pure tech venture capitalist, not an impact investor, and yet he is strongly in favor of the Benefit Corporation.

Mr. Wenger believes that the current version of capitalism has been incredibly efficient at creating and distributing a high volume of stuff at an increasingly cheaper price. Technical innovation has ensured that everything from computers to clothing is getting cheaper and much more widely available. “The problem of technological innovation is not the primary problem that we still need to solve. The primary problems are the very large-scale problems: giving people access to good education, quality healthcare, poverty alleviation and not destroying our planet. So the big change is that there was a time period where we really had to address technological innovation and where this type of capitalism that we had was quite good at bringing that technological innovation into the marketplace. I don’t think that’s our biggest set of problems anymore.” Since the biggest questions of the future cannot be solved simply by the current shareholder maximization-centered version of capitalism, Mr. Wenger believes we have to usher in a new version of capitalism that will shift the focus from purely technological innovation to social innovation and the Benefit Corporation is a great vehicle to do that.

PROTECTION FROM SHORT-TERMISM

Another key shift that Mr. Wenger sees is a shift away from hierarchical systems to networks – think Etsy and Shapeways for production and Tumblr and Twitter for communication. Indeed we are already seeing that with social media disrupting the traditional journalism and Amazon disrupting retail.

Mr. Wenger says, “So from our perspective, because we believe in the power of networks, we think Benefit Corporations are particularly important because we believe with great power comes great responsibility.” If you operate a very large network, there will be a temptation for management or newer shareholder to extract too much value too soon from the network. This tension between extracting value in the short-term and building a healthy long-term comes into clear focus when you look at the divergence between management timeframes, investor timeframes, and market place timeframes. Mr. Wenger notes, “Etsy (a USV portfolio company) could and should exist for decades or longer, but individual managers may only work at a company for 5 years or 10 years. Investors may be looking to exit even quicker. So you have very different time horizons.” There is a fundamental disconnect between the incentives for short-term profit maximization and long-term value creation. The Benefit Corporation empowers management, directors and shareholders to set a long-term vision for the health of their company and make those decisions that align with those goals without the interference of short-term focused shareholders forcing them to extract value too soon. A good example of this according to Mr. Wenger is the Myspace acquisition, “News Corp. bought it, and paid what they thought was a reasonably high price for it and then proceeded to want to recover that price very quickly. So they tried to monetize the network very, very heavily, ultimately contributing to its collapse.”

INVESTOR ALLIGNMENT

After a long career in investment, including serving as co-Chairman for the $21 billion asset management firm Genworth, Ron Cordes has shifted his focus from simply investing in great companies, to investing in great companies that have a positive social and environmental impact. These days he’s looking to maximize both profit and purpose, and is one of the leaders in the impact investing movement.

Most investment rounds include multiple investors and, more often than not, they have never met each other – the other investors are simply names on a capitalization table. There is no way to understand the other investors’ motives for making the investment. Typically, the investor would have to rely on the CEO of the company to bring together a group of investors that are aligned around a common mission.

This works well so long as the company is meeting or exceeding their financial projections, but, Mr. Cordes notes, “growing a business is never a linear path. So it’s always two steps forward, one step back. Markets and economies are at play. Crashes like 2008 happen, and generally issue occur that were unexpected in a negative way. Investors sometimes react in unusual ways. They may say, ‘wait a minute, that was great when we were performing well. But now we’re down here and you’re asking me to put extra money up and you’re saying we still have this employee and stakeholder engagement policy.'” For individual investors to continue to support the social and environmental mission of a company even when the company is struggling financially is challenging. In another instance, a shareholder may transfer the stock to someone else, say in the event of death or divorce. Now all of a sudden, there is a new person in control of voting those shares who may or may not align with the mission of the company.

“Things like that can happen,” says Mr. Cordes. “If the values are not codified, you’re going to be relying on the collective good intentions of the group, which is hard. So if I’m a shareholder and I truly don’t know the other shareholders, then the Benefit Corporation at least says, okay I’m not going to have that issue come out of the left field here, because everybody is signing up to the baseline goals. If in any point somebody was wrong and misread the intentions of an investor, you have it in writing and baked into the articles, which gives you a recourse that you don’t have otherwise.”

INVESTOR SKEPTICISM

Though it sounds lovely to pursue profit and purpose, David S. Rose, angel investor and entrepreneur who has founded or funded over 75 companies, says that when the rubber meets the road, you need to choose profit or purpose, but you can’t build a successful company trying to pursue both simultaneously.

Mr. Rose says, “It’s wonderful to think that one can have one’s cake and eat it too. That one can benefit society, make a lot of money, make everybody happy, end wars, cure cancer. In the real world however things tend to optimize in one area. It is nearly impossible to try and truly optimize for a double bottom-line. But in the case of making money and creating social good the underlying challenge is that starting a new venture is insanely tough. It’s really, really difficult. Given the fact that the majority of new business fail when entrepreneurs are busting their rear ends to try and make it succeed economically, to then overlay on top of that a secondary goal is really, really challenging.”

For Mr. Rose, there is a clear dividing line either an organization is primarily pursuing profit or primarily pursuing purpose, a company has to choose one or they will fail. “When the rubber meets the road in the real world, I think you have to choose, because if a company is going to prioritize the public benefit by 0.1%, then ultimately it cannot survive. It will go out of business.”

Mr. Rose believes in doing good through business. He just believes the only way to do that is to give clear priority to profit over purpose. In fact, he has invested in, and serves as the chairman of the board for Porti Familia – a company bringing modern healthcare to the slums of Lima, Peru – a company that is certainly doing a great deal of good in the world. His other investors are some of the biggest impact investment funds in the world, such as Acumen and responsAbility. Rose says, “we all agree that the company is doing good things, but I invested in it not to do good things – I can give money to charity for that. I invested in this company to make money, and oh, by the way, it’s making money in a good way by doing good things.”

So, when it comes to the Benefit Corporation, which is designed for companies pursuing both profit and purpose simultaneously, his conclusion is, “I don’t think Benefit Corporations are evil. I just think that they are ultimately naïve, because in the real world, you have to choose. You can’t have your cake and eat it too.”

FINAL ANALYSIS

In the end, it’s difficult to make a general statement for the entire investment community because every investor is different, and is driven by unique blend of motivations. But there seems to be openness from some leading investors to the new corporate structure. Mr. Wenger and his team at USV are looking forward to working with Benefit Corporations. “We are actively encouraging some portfolio companies to pursue the Benefit Corporation structure. It certainly would never stop us from investing.”

The best-case scenario is for entrepreneurs and investors to have clear alignment on both profit and purpose. The Benefit Corporation is a ready-made legal structure that helps codify that alignment from the outset and protects the company from mission drift in the long term. Method is an example that, Mr. Lowry says, “I’m very luck that I have mission-aligned investors. All the directors, officers and investors involved in Method, want to ensure that our mission is preserved forever into the future, so we are all excited about a new corporate form that gives directors the rights and protections to pursue a triple bottom line.”

CALLISON ON BENEFIT CORPORATIONS

Bill Callison, a partner in the Denver office of Faegre Baker Daniels, has posted an interesting article on benefit corporations to SSRN.  The article’s abstract is copied below and the article is available here.

This Article describes three approaches to benefit corporation statutes, which it terms the Model Approach, the Delaware Approach and the Colorado Approach. It discusses numerous conceptual problems with the Model Approach, most of which are repaired in the Delaware Approach, and most or all of which would be repaired in the Colorado Approach, It discusses the politics that led Colorado to adopt the Delaware Approach in the face of orthodox opposition to the Colorado Approach, and encourages greater design innovation in order that the benefit corporation story, assuming it is a meaningful one, does not become a “tale told by an idiot, full of sound and fury, signifying nothing.”

FIRST DELAWARE BENEFIT CORPORATIONS

B Lab has posted a list of companies that either converting or incorporated as benefit corporations under Delaware law today (the first effective day of the benefit corporation statute). The list of those companies is below but I’d like to highlight two significant ones here given their size and recent/ongoing acquisitions:

— Method — As in the green cleaning products found in Target. In 2012, Method became a subsidiary of Ecover Belgium NV, another global green cleaning product company.

— Plum Organics — The ubiquitous baby food line. Plum Organics is the #4 baby food company in the U.S. with $93m in sales in 2012. In May 2013, Campbell Soup announced that it was buying Plum Organics and would keep it as a distinct brand. I don’t have any updates as to whether that acquisition is still in process but as of May 2013 the deal was expected to close in the 4th quarter.

Having written about the flexible purpose corporation (a California stakeholder corporate form) being a viable way to safeguarding a company’s social mission in the mergers and acquisitions context (paper here) (Professor Haskell Murray similarly wrote about the benefit corporation in the M&A context – paper here), I am very curious as to how converting to a Delaware benefit corporation impacted or was a result of these two acquisitions. Did the companies always intend to convert in order to maintain their green missions? Was this negotiated as a part of the acquisition deal?

Another stand out amongst the Delaware benefit corporation crowd is RSF Capital Management, a subsidiary of RSF Social Finance — a major impact investor, social enterprise lender, and donor.

The other companies that incorporated or converted to the Delaware benefit corporate form are:

ALTER ECO

American Prison Data Systems

Better Than We Found It

Exemplar Companies

Fair Parenting Project

Farmigo

Grassroots Capital Management

Ian Martin Group

Imani Energy

New Leaf Paper

Plexx

Profile Health Systems

Roozt

Socratic Labs

Venture Pilot

DELAWARE BENEFIT CORPORATION – EFFECTIVE TODAY

Entities can incorporate or convert to a benefit corporation in Delaware, effective today. Some of us on this blog are trying to find out from the Delaware Secretary of State about the first incorporators today and hope keep you posted in the coming days. The CEO and co-founder of Plum Organics was at the signing ceremony for the legislation and committed to becoming one of the first Delaware benefit corporations (see video). If you don’t know what “Plum Organics” is, it’s safe to say that you don’t have young children (it is a ubiquitous toddler/infant staple). Stay tuned.