87 PBCs formed in Delaware. California leads with 139 benefit corps.
More information available here.
87 PBCs formed in Delaware. California leads with 139 benefit corps.
More information available here.
This post, originally posted in on the Harvard Corporate Governance Forum, is a summary of the main claims I make in my recent paper, The Law of Social Enterprise and Hybrid Organizations, which was recently posted on SSRN as a Yale Law & Economics Research Paper. The goal of this paper is to advance an economic theory of social enterprise that can inform legal policy. I am also working now on a policy paper that will make policy recommendations in light of the theory.
In my paper, The Role of Social Enterprise and Hybrid Organizations, which was recently made available on SSRN, I advance a theory of hybrid organizations that combine profit-seeking and social missions.
Recent years have brought remarkable growth in hybrid organizations, including firms that pursue corporate social responsibility (“CSR”) policies, socially responsible investment firms, and environmentally-friendly firms. In addition, much attention has focused on a broad but vaguely defined group of hybrid organizations which are commonly referred to as “social enterprises”; these include microfinance institutions, businesses that sell fair trade products, work integration firms, and companies that sell affordable products in developing countries (e.g., eyeglasses and bed-nets). Despite popular enthusiasm for hybrid organizations, legal reforms to facilitate their formation and growth—including, in particular, special enabling statutes for hybrid firms (e.g., the Low-Profit LLC and the Benefit Corporation)—have largely been ineffective. This failure stems in large part from the lack of a theory that identifies the structural and functional elements that make some types of hybrid organizations more effective than others. Rather, legal and economic scholars tend to treat different forms of hybrids, especially social enterprises and firms implementing CSR policies, as essentially the same form of enterprise, i.e., firms with a mixed profit and social mission.
However, defining hybrids by reference to their mission is problematic because verifying and measuring social missions is virtually impossible. Instead, I define hybrid organizations, including social enterprises, as commercial firms that channel subsidies to a class of beneficiaries. If there is no subsidy, the firm is simply a standard profit-maximizing firm. In this respect, I take a broad view of subsidies, to include not only government subsidies and donations, but also premium prices and subsidized investments at below-market rates. For example, a consumer may pay a premium for products if the firm has a strong CSR agenda, or if its products are sourced from fair trade producers. To evaluate hybrid organizations, we thus need to ask what forms of organization utilize subsidies more effectively than others.
The theory in the paper focuses on social enterprises, such as microfinance institutions and work-integration firms, and distinguishes them from all other forms of hybrid organization. Social enterprises have been relatively effective in addressing complex development problems, such as increasing access to capital, improving employment opportunities, and enhancing consumer welfare. The key common characteristic of social enterprises is that they transact with their beneficiaries as patrons, i.e., the beneficiaries are either purchasers of the firms’ goods or services, or suppliers of input (including labor) to the firm. For example, microfinance institutions make loans to low-income borrowers, and work integration firms employ disadvantaged workers. Transactions with the patron-beneficiaries are costly either because of information asymmetries with respect to the beneficiaries’ abilities, or because beneficiaries lack sufficient abilities to transact with commercial firms; hence, the need for a subsidy.
The essence of the theory is that social enterprises perform a measurement role. The financial viability of social enterprises depends in large part on the performance of their patron-beneficiaries. For example, microfinance institutions are financially dependent on the ability of their borrowers to repay their loans. Thus, social enterprises have incentives to measure or gather information on their patron-beneficiaries’ attributes (e.g., workers’ skills or borrowers’ creditworthiness) in order to ensure that they are capable of performing their duties and tasks under their transactional relationship with the social enterprise firm. This information enables social enterprises to allocate subsidies (e.g., a training subsidy) to their beneficiaries (e.g., disadvantaged workers) effectively. In particular, social enterprises have the ability and incentives to tailor the form and amount of subsidies to their beneficiaries’ abilities and preferences as well as the commercial needs of their business.
The measurement function makes social enterprises relatively efficient vehicles for allocating subsidies to promote development goals. For example, microfinance institutions have grown substantially in the last few decades and now provide financial services to millions of low-income customers in developing countries. The relative success of microfinance contrasts with the limited effectiveness of traditional donative organizations, including governments and aid agencies, in spurring development. This paper argues that a possible reason for this is that donative organizations transfer subsidies to external beneficiaries rather than transact with them as patrons. Thus, they have limited incentives and means to gather information on the effectiveness of the subsidies they allocate. Social enterprises should also be contrasted with other forms of hybrid organizations, especially firms that engage in CSR policies. Similar to donative organizations, CSR initiatives typically involve the allocation of subsidy to external beneficiaries. In fact, firms that engage in CSR not only have limited means and incentives to measure the social impact of their policies, but they also have incentives to exaggerate it to enhance their reputations.
The article also describes the various types of commitment devices that social enterprises adopt in order to commit to transacting with their beneficiaries. Social enterprises may form as both for-profits and nonprofits. When social enterprises form as for-profits, there is a risk that their owners will expropriate the subsidies they receive to address a development mission. Commitment devices generally involve a nonprofit or a government agency assuming responsibility for ensuring that the for-profit social enterprise transacts with a class of patron-beneficiaries, such as borrowers or workers. Commitment devices may take the form of certification by a nonprofit in accordance with certain standards (e.g., Fair Trade certification), a contract with a nonprofit, or control by a nonprofit through ownership or voting rights. These commitment devices seem to work well due to their simplicity. Whereas social rating mechanisms, such as the Global Reporting Initiative or B-Corp certification, attempt with questionable success to measure the overall social impact of corporations, these commitment devices verify structural elements (i.e., transactions with patron-beneficiaries) which can be observed at relatively low costs. The transactions with their beneficiaries ensure that social enterprises haveincentives to utilize subsidies effectively.
Finally, the measurement function of social enterprises may serve the basis for designing a new social enterprise legal form and reforming corporate subsidy programs to promote development, including the Small Business Act and the Work Opportunity Tax Credit. In future work, I consider the policy implications in greater depth; this article focuses on laying out the structural and theoretical underpinnings of social enterprises and other hybrid organizations.
The full article is available for download here.
Any comments are welcome.
Folks that follow this blog may be interested in the following fellowship announcement from WVU’s Land Use and Sustainable Development Law Clinic:
West Virginia University College of Law’s Land Use and Sustainable Development Law Clinic is now accepting applications for the Land Use and Sustainable Development Law Fellowship. The fellowship combines the opportunity to work with attorneys, planners and students at one of the leading Land Use Clinics in the United States with the opportunity to obtain the WVU Law LL.M. degree in Energy and Sustainable Development Law. The LL.M. program provides a uniquely deep and balanced curriculum in perhaps the nation’s richest natural resource region.
LL.M. in Energy and Sustainable Development Law
The WVU College of Law LL.M. in Energy and Sustainable Development Law is the only LL.M. program in the United States that provides a balanced curriculum in both energy law and the law of sustainable development. Working with WVU College of Law’s Center for Energy and Sustainable Development, LL.M. students will develop the expertise to advise clients and provide leadership on matters covering the full range of energy, environmental and sustainable development law.
The LL.M. in Energy and Sustainable Development Law provides a broad and deep offering of courses, experiential learning opportunities, and practical training for every part of the energy sector. Our broad spectrum of courses allows our students to prepare to be lawyers serving energy companies, investors, environmental organizations, landowners, utilities, manufacturing companies, lawmakers, policymakers, regulators and land use professionals.
More info here: http://law.wvu.edu/energy-llm/land-use-llm-fellow.
I am pleased to announce the publication of a new Bloomberg BNA Tax Management Portfolio: Social Enterprise by Non-Profits and Hybrid Organizations, No. 489-1st. Attorneys Elizabeth Minnigh and Robert Wexler joined me in writing this new Portfolio that we hope will become a valued resource for academics, practitioners, and students researching social enterprise law. The Portfolio addresses the legal and tax aspects of social enterprise as conducted by tax-exempt organizations and by hybrid for-profit legal forms.
A more detailed summary of the Portfolio (taken from Bloomberg BNA’s description) follows:
“This Portfolio begins with a look at traditional social entrepreneurship by tax-exempt organizations. It considers the overall tests for tax-exemption and then focuses on specific operational activities, including job training, microfinance, low-income housing, technical assistance, the sale of products to the poor, and publishing, to evaluate when those activities can be conducted within a tax-exempt organization. The Portfolio reviews other key issues that affect tax-exempt social enterprises, including the unrelated business income tax rules, the joint venture rules, and the use of for-profit subsidiaries of exempt organizations.
This Portfolio then examines the federal income tax and state law issues affecting investments in, or grants to, for-profit entities by tax-exempt organizations. Types of investments discussed include socially responsible investments (SRIs), mission-related investments (MRIs), and program related investments (PRIs). This Portfolio also examines expenditure responsibility grants to for-profit entities.
Finally, this Portfolio looks at the emergence of hybrid organizations in the United States, which are single for-profit legal entities that simultaneously serve a traditional business purpose and a social or charitable purpose. Specifically, within the past five years, twenty-five states and the District of Columbia have enacted statutes authorizing distinct types of legal entities that cater to social enterprise. The two primary types of such hybrid organizations are the benefit corporation and the low-profit limited liability company (“L3C”). Both types of such hybrid organizations, as well as certain other variants, are discussed in detail in the final portion of this Portfolio.”
I just returned from a wonderful conference at Texas A&M School of Law, sponsored by the Center for Law and Intellectual Property (CLIP) and Startup Aggieland. Megan Carpenter, director of CLIP, did a wonderful job of organizing the conference, entitled “Innovation Summit: Shaping the Future of Law & Entrepreneurship”. As I listened to the speakers (of which I was one), I was inspired to gather a list of what exactly it means to be a lawyer for entrepreneurs, or an entrepreneurial lawyer. My list is below; what have I missed?
An entrepreneurial lawyer needs to have an entrepreneurial spirit and business mindset. By that, I mean:
1. The entrepreneurial lawyer must be able to assess both risks and opportunities. The entrepreneurial lawyer should not be risk averse or focus on the negative effects of every option. The entrepreneurial lawyer should recognize that risk is tolerable where there is opportunity for reward.
2. The entrepreneurial lawyer should aim to be part of the business team and be invited into business meetings, not kept outside. If the client simply hands the lawyer a term sheet to draft the deal after the business terms have already been settled, the lawyer has failed to be entrepreneurial. To be part of the team, the entrepreneurial lawyer must know the client’s business and have a solid business and financial understanding. It also helps if the lawyer is not a naysayer and can assess both risks and opportunities (see #2).
3. The entrepreneurial lawyer must be able to help her client’s “lean start-up” strategies, which includes avoiding high sunk costs when the start-up is in its early stages (e.g., avoiding high legal fees, potentially avoiding high legal costs such as patent and trademark filings and incorporation fees, at least at the pre-concept phases).
4. The entrepreneurial lawyer must be willing to find non-legal solutions to her client’s legal problems.
5. The entrepreneurial lawyer needs to break from the mechanical confines of traditional legal representation and be creative.
6. The entrepreneurial lawyer should not have a litigious mindset.
I plan to write a paper exploring the notion of an “entrepreneurial lawyer” further and how to teach such entrepreneurial skills to law students. That paper will be presented at Lewis & Clark Law School’s Fall Forum in October 2014, organized by Susan Felstiner, director of the Small Business Legal Clinic there.