LAW AND SOCIAL ENTREPRENEURSHIP

SOCAL ENTERPRISE BY NON-PROFITS AND HYBRID ORGANIZATIONS

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.”

Kauffman Foundation Announces Renovated and Expanded EshipLaw Website

Long a supporter of entrepreneurship, the Ewing Marion Kauffman Foundation has announced the renovation and expansion of its Entrepreneurship Law (“EshipLaw”) website. The improved website “includes a collection of resources on intersections of law with entrepreneurship and entrepreneurship education that can be relevant in several settings, whether you are an entrepreneurship educator, a student, an inventor, a business owner, or a lawyer or other advisor to entrepreneurs.”

The renovated and expanded EshipLaw website also hosts a brand new section focused solely on social enterprise law. This new section contains unique information and materials that law professors and other educators will find useful in connection with teaching social enterprise law in their classrooms and clinics. Check out the new social enterprise section of the EshipLaw website here.

Thanks to the Ewing Marion Kauffman Foundation for providing this terrific resource.

PS: Please forgive the shameless self-promotion, but yours truly is one of the new editors of the EshipLaw website. Suggestions for improvements to the website as well as contributions of new materials are welcome. Furthermore, in connection with the renovation and expansion, EshipLaw has published my essay entitled, “Gift Horses, Choosy Beggars, and Other Reflections on the Role and Utility of Social Enterprise Law.” I hope that you will find my essay an informative and entertaining read.

HYBRID BUSINESS ENTITIES IN 2014

Happy New Year from SocEntLaw! And, for my fellow academics, welcome back to school!

As we begin 2014, I decided to post on the current state of the law concerning hybrid business entities: benefit corporations, flexible purpose corporations, social purpose corporations, benefit LLCs, and low-profit limited liability companies (“L3Cs”). For more detailed information on these new entities (including citations to the relevant statutes), see my updated social enterprise entity comparison chart posted on SSRN here.

L3Cs: First, with respect to L3Cs, North Carolina conspicuously repealed its L3C statute effective January 1, 2014. Therefore, only eight states now authorize L3Cs: Illinois, Louisiana, Maine, Michigan, Rhode Island, Utah, Vermont, and Wyoming.

Benefit LLCs: The number of benefit LLC states remains at two. Only Maryland and Oregon authorize benefit LLCs.

Flexible/Social Purpose Corporations: Only one state, California, authorizes flexible purpose corporations, while only two states, Texas and Washington, authorize social purpose corporations.

Benefit Corporations: The current number of benefit corporation states is trickier to determine. Altogether, nineteen states and the District of Columbia have enacted some form of benefit corporation legislation; however, a couple of those states have delayed the effective date for their benefit corporation statutes. Jurisdictions with currently effective benefit corporation legislation include the District of Columbia and seventeen states: Arkansas, California, Delaware, Hawaii, Illinois, Louisiana, Maryland, Massachusetts, Nevada, New Jersey, New York, Oregon, Pennsylvania, Rhode Island, South Carolina, Vermont, and Virginia. Two states have passed benefit corporation statutes that (absent further action) will become effective at a future date. Specifically, Colorado’s benefit corporation statute becomes effective April 1, 2014—Really? April Fools’ Day?—while Arizona’s benefit corporation statute becomes effective January 1, 2015.

Predictions: What will 2014 bring with respect to hybrid business entity statutes? Only time will tell, but I’m willing to make a few reckless predictions. I believe that the count of states with benefit corporation legislation roughly will double in 2014. Therefore, I predict that by January 1, 2015, thirty-five or more states will authorize benefit corporations. I predict that the number of states authorizing flexible purpose and social purpose corporations will increase slightly in 2014, but I would be surprised if more than five or six states have flexible purpose or social purpose corporation statutes by January 1, 2015. Finally, I predict that no additional states will enact either L3C legislation or benefit LLC legislation in 2014. In fact, I would not be surprised if more states follow North Carolina in 2014 and repeal their L3C statutes.

Regardless of my predictions, there is one thing we absolutely can count on in 2014 with respect to hybrid business entities: CHANGE!

PRELIMINARY OBSERVATIONS CONCERNING DELAWARE’S NEW BENEFIT CORPORATION ACT

Two days ago, Delaware enacted benefit corporation legislation that is scheduled to go into effect August 1, 2013. Delaware thus becomes the 19th state to sanction benefit corporations. Although only the 19th benefit corporation state, Delaware’s strong influence on U.S. corporate law indeed makes Delaware’s passage a big deal and conceivably a watershed moment for the social enterprise movement.

Before anyone gets too excited, though, some preliminary observations are in order:

1.    A Race to the Bottom? Like Colorado’s benefit corporation law that was adopted in May, Delaware’s statute diverges significantly from the so-called model benefit corporation act published by B Lab (hereinafter the “B-Lab mockup”). In many ways, the Delaware and Colorado acts are “watered down” (pun intended) versions of the B-Lab mockup because they are not as strict in certain respects as prior statutes passed in states (e.g., Arkansas) that closely follow the B-Lab mockup. For specifics, see my high-level comparison table posted here and Professor Haskell Murray’s (Belmont) more detailed chart posted here. On the other hand, as noted below, in at least two respects Colorado and Delaware may be more stringent than the B-Lab mockup.

2.    Hard to Become a Colorado or Delaware Benefit Corporation, But Easy to Get Out? Delaware requires a 90% or higher vote (including otherwise nonvoting shares) to elect into benefit corporation status and grants appraisal rights to any dissenters. Colorado and the B-Lab mockup require only a two-thirds vote (including otherwise nonvoting shares) to elect into benefit corporation status. Colorado grants dissenter’s rights upon election into benefit corporation status, while the B-Lab mockup does not. On the other hand, all three (Colorado, Delaware, and the B-Lab mockup) require a two-thirds vote (including nonvoting shares) to terminate benefit corporation status, and none of the three grant appraisal rights to dissenters upon termination of benefit corporation status (apart from any such rights that may exist under the state’s regular corporate law).

Interestingly, however, only the B-Lab mockup requires a two-thirds vote to approve a liquidation or sale of substantially all the assets of a benefit corporation, while Colorado and Delaware require only a majority of voting (not nonvoting) shares to sell assets and/or liquidate.

Therefore, a clever attorney might advise the directors of a Colorado or Delaware benefit corporation that benefit corporation status may be terminated by a simple majority vote so long as the termination takes the form of an asset sale and liquidation. Further, such a transaction could avoid being taxable through a so-called “C” (stock for assets) reorganization. Thus, a carefully orchestrated asset sale and liquidation appears to be an easy escape hatch out of benefit corporation status under Colorado and Delaware law. Perhaps this result was intended, but if so, what is the rationale for such an escape hatch?

3.    Only Nonpublic, Biennial Benefit Reports Required Under Delaware Law. A hallmark of benefit corporations is the requirement to produce a “benefit report” that assesses and publicly discloses the corporation’s performance towards achieving social and environmental benefits. The B-Lab mockup explicitly states that the benefit report must be published annually and that it must be made public. Colorado appears to follow the B-Lab approach (although the timing of the publication of the report is not clear under the Colorado statute.) Delaware, however, requires only biennial publication of a benefit report (unless otherwise required by the corporation’s certificate or bylaws). Moreover (unless otherwise required by the corporation’s certificate or bylaws), a Delaware benefit corporation’s biennial report is required to be disclosed only to the corporation’s shareholders, not to the public.

4.    No More “Independent” Third-Party Standard (At Least in Delaware). Unlike the B-Lab mockup, Delaware does not require a benefit corporation to adopt a “comprehensive, independent, credible, and transparent” third-party standard for its benefit report. Instead, the board of directors of a Delaware benefit corporation may make up its own standard against which the corporation biennially (not annually) reports. Colorado is not quite as strict as the B-Lab mockup, but implicitly (not expressly) requires a Colorado benefit corporation to adopt a third-party standard created by an organization that is not “controlled” by the adopting corporation or its affiliates. Thus, with respect to requiring a third-party standard, the Colorado benefit corporation statute is more demanding than Delaware’s, but arguably is not as demanding as the B-Lab mockup.

5.    Special “PBC” Moniker Under Colorado and Delaware Law. In at least one respect, Colorado and Delaware go further than the B-Lab mockup when it comes to the transparency requirements imposed upon benefit corporations. Specifically, the registered name of a Colorado or Delaware benefit corporation must contain the phrase “public benefit corporation” or the abbreviation “PBC” (or “P.B.C.”). This requirement should promote accountability by making Delaware and Colorado benefit corporations easily identifiable.

6.    “Balancing” Versus “Considering” Nonshareholder Interests. Further, in another respect, Colorado and Delaware may demand more of benefit corporations than the B-Lab mockup. My colleague, Professor Murray, points out to me that Colorado and Delaware require the directors of a benefit corporation to “balance” the pecuniary interests of the shareholders with the other interests of nonshareholders, whereas the B-Lab mockup only requires “consideration” of nonshareholder interests. Only time will tell, but the practical difference between “balancing” versus merely “considering” nonshareholder interests could be tremendous.

7.    Unfortunately, There Is No Easy Button, Especially in the Law. If (as is probable) future enacting states follow Delaware and Colorado instead of the B-Lab mockup, the status of being a “benefit corporation” may come to mean less and less. Such decay in “uniqueness” ultimately could undermine a central purpose behind the benefit corporation movement: instilling public trust that a benefit corporation truly is different and better for society and the planet.

8.    Conclusion. Perhaps the ultimate lesson here is that absent a much more uniform and rigorous qualification and enforcement regime under prevailing law—like the regime that exists for tax-exempt entities—only a few, overly diligent individuals will know whether and which companies genuinely care about stakeholders as opposed to shareholders. If this is indeed the case, then maybe all that is really needed and in fact effective to instill public trust in socially beneficial businesses is a commonly-accepted rating system, not a change in corporate law. B Lab and other such rating agencies already understand and are responding to this reality.

In short, I am not convinced that Delaware’s passage of benefit corporation law truly is a “tipping point in the evolution of capitalism,” especially if the expectation is that the benefit corporation form ultimately will instill public trust in a new way of doing business. Public trust is not a realistic expectation when the qualification and enforcement regime backing up that trust is vastly different from state to state.

Nevertheless, I am pleased that Delaware and Colorado have adopted a significantly different form of “benefit corporation,” even if that different form may be “watered down,” may engender some confusion, and may weaken the brand. Why? Because I believe that experimentation in the law among the states is a very positive development in the evolution of the law of social enterprise. May the best form win!

TAXING SOCIAL ENTERPRISE

To date, not much scholarship or research has focused upon the income tax aspects of social enterprise, but this editor is delighted to report on three recent works that do.

First, Professor Lloyd Mayer (Notre Dame) and Joseph Ganahl (J.D. Notre Dame 2013) have written a fascinating article examining whether social enterprise organizations should be entitled to tax preferences similar to that given to tax-exempt nonprofits. The article, Taxing Social Enterprise, weighs the arguments pro and con for affording charity-like tax benefits to social enterprise organizations. The article ultimately concludes that such benefits are not appropriate. Nevertheless, the article views the new legal forms for conducting social enterprise as a permanent part of the legal landscape and offers suggestions for favorable but modest reform to treat them appropriately for tax purposes. The excellent article, which will be published in the Stanford Law Review, may be found on SSRN here.

Second, Emily Cohen (J.D. William & Mary 2013) has authored a student note analyzing how the socially beneficial expenses of a benefit corporation fit within the IRC § 162 requirement that expenses be “ordinary and necessary” in order to be tax deductible. The note essentially argues that although “benefit expenses” may not fit neatly within the traditional understanding of IRC § 162, such expenses nevertheless should be fully deductible by a benefit corporation because they presumably are “appropriate and helpful” to a benefit corporation’s for-profit purpose: creating or furthering a general or specific public benefit. The note may be found here.

Finally, a new report from the Lilly Family School of Philanthropy at Indiana University finds that private foundations have increased the overall amount of their program-related investments from $139 million in 1990 to $701 million in 2009; however, the report also concludes that, when it comes to PRIs, there still is much more talk than action. As this editor has discussed previously, program-related investments, or “PRIs,” are tax-favored investments that private foundations may make to further their charitable mission. This new report from the Lilly Family School of Philanthropy contains a wealth of interesting data about PRIs. As we learn more about when and where PRIs are being utilized, perhaps social enterprise organizations will benefit. The press release summarizing the School’s report may be found here, and the full report may be found here.

DEFENDING PATAGONIA: MERGERS & ACQUISITIONS WITH BENEFIT CORPORATIONS

Professor Haskell Murray (Regent) has been busy!

First, his most recent article, Defending Patagonia: Mergers & Acquisitions with Benefit Corporations, will be published soon in the Hastings Business Law Journal. In the article, Professor Murray analyzes whether and how the Revlon and Unocal line of cases will be interpreted and applied to mergers and acquisitions involving benefit corporations. This is completely unchartered territory, so Professor Murray cleverly uses Patagonia, a well-known benefit corporation, as an example to illustrate his analysis. The article is very interesting and informative, and it may be found on SSRN here.

Second, Professor Murray and his wife, Katie, just welcomed their first born into the family! David McGahan Murray was born healthy and happy on April 3, 2013. Young David weighed in at a solid 8lbs 9oz, so all the NFL scouts have been alerted. Congrats Haskell and Katie!

MIDWEST SYMPOSIUM ON SOCIAL ENTREPRENEURSHIP | MAY 20-21 | KANSAS CITY

The Ewing Marion Kauffman Foundation and the University of Missouri-Kansas City (UMKC), in collaboration with the United States Association for Small Business and Entrepreneurship (USASBE), are sponsoring the 2013 Midwest Symposium on Social Entrepreneurship from May 20-21 in Kansas City, Missouri. This Symposium will offer a forum for academics, as well as interested practitioners, to (i) advance their understanding of social entrepreneurship, (ii) exchange knowledge and experience regarding entrepreneurship in general, and (iii) shape the future of the emerging field of social enterprise.

The Symposium begins with Opening Remarks at 8:30 a.m. on Monday, May 20, followed by morning and afternoon workshops, as well as presentations at a luncheon and early evening reception that day. The Tuesday, May 21, schedule includes a morning workshop, luncheon presentations, and, in the afternoon, a business plan competition showcasing socially entrepreneurial initiatives developed by students participating in The Aaron L. Levitt Social Entrepreneurship Challenge. All workshops and events will take place at the Ewing Marion Kauffman Foundation Conference Center (4801 Rockhill Road, Kansas City, Missouri, 64110). As linked above, further information and registration details may be found here.

REPEAL IRC § 4944 TO ENCOURAGE INVESTMENT IN SOCIAL ENTERPRISE

A while ago, I posted to this blog a short (mildly humorous???) story illustrating how certain federal income tax rules generally prohibit “risky” investments by private foundations, even when those investments have potential for tremendous social or environmental benefit. The so-called “jeopardizing investment” rules of IRC § 4944 impose a minimum 10% (with a possible 25% additional) tax on investments by private foundations that “jeopardize the carrying out of [the foundation's] exempt purpose.”

In my prior post, I hypothesized a private foundation considering an early-stage investment in a company developing an inexpensive, solar-powered car. I further hypothesized that the private foundation’s manager reasonably and rationally believed that an investment in the car company could have substantial environmental benefits. Further, the investment was on fair terms and involved no self-dealing or other economic benefit to the private foundation’s insiders. Unless the purchase of stock in the car company qualified under the narrow program-related investment exception, however, the investing private foundation could be subject to a 10% (and possible additional 25%) penalty tax under IRC § 4944. Moreover, the investment in the solar-powered car company could be penalized even though an outright grant by the private foundation to benefit environmental causes clearly would be permissible (and even encouraged).

Thus, from a tax standpoint, a private foundation manager seeking to support environmental causes is better off investing in BP and then giving away returns to Green Peace than making a “risky” investment in a solar-powered car company—even when that investment might have a much larger and more lasting positive impact on the environment. This makes no sense.

Actually, the most compelling illustration I can provide as to why the “jeopardizing investment” rules of IRC § 4944 ultimately make no sense comes directly from the implementing Regulations. Specifically, Reg. § 53.4944-1(c) provides:

A is a foundation manager of B, a private foundation with assets of $100,000. A approves the following three investments by B after taking into account with respect to each of them B’s portfolio as a whole: (1) An investment of $5,000 in the common stock of corporation X; (2) an investment of $10,000 in the common stock of corporation Y; and (3) an investment of $8,000 in the common stock of corporation Z. Corporation X has been in business a considerable time, its record of earnings is good, and there is no reason to anticipate a diminution of its earnings. [Imagine BP.] Corporation Y has a promising product, has had earnings in some years and substantial losses in others, has never paid a dividend, and is widely reported in investment advisory services as seriously undercapitalized. Corporation Z has been in business a short period of time and manufactures a product that is new, is not sold by others, and must compete with a well-established alternative product that serves the same purpose. Z’s stock is classified as a high-risk investment by most investment advisory services with the possibility of substantial long-term appreciation but with little prospect of a current return. [Imagine Y or Z as our solar-powered car company.] A has studied the records of the three corporations and knows the foregoing facts. In each case the price per share of common stock purchased by B is favorable to B. Under the standards of [IRC § 4944], the investment of $10,000 in the common stock of Y and the investment of $8,000 in the common stock of Z may be classified as jeopardizing investments (emphasis added), while the investment of $5,000 in the common stock of X will not be so classified. B would then be liable for an initial tax of [$1,000 (i.e., 10 percent of $10,000)] for each year (or part thereof) in the taxable period for the investment in Y, and an initial tax of [$800 (i.e., 10 percent of $8,000)] for each year (or part thereof) in the taxable period for the investment in Z. Further, since A had actual knowledge that the investments in the common stock of Y and Z were jeopardizing investments, A [the foundation manager] would then be liable [personally] for the same amount of initial taxes as B.

WHAT??? So the investment in Y is “promising” and at a “favorable” price, but still subject to a penalty tax? The investment in Z has “the possibility of substantial long-term appreciation” and is at a “favorable” price, but likewise is prohibited? Er, okay, let me get out my crystal ball and discern between a “promising” or “substantial long-term” investment and a “jeopardizing” one. Suppose that in the above example X corporation represented Enron instead of BP? In hindsight, an investment in Enron would have been the ultimate jeopardizing investment, but it would have been perfectly fine under IRC § 4944. Oh, and that’s not all! Incredibly, if Y’s “promising” product (e.g., an inexpensive, solar-powered car) would benefit the environment, then even if the investing private foundation’s mission was protecting the environment it could be penalized under IRC § 4944 for buying stock in the company.

The federal income tax rules thus support a bizarre paradox for private foundations: a foundation can give its money away to an organization supporting the foundation’s mission, but if it makes a risky but “promising” investment in support of its mission, the foundation faces the threat of penalty taxes.

If a private foundation is not engaged in self-dealing or otherwise benefitting its managers and other insiders, why do we care how its money is invested? The rules presume that a “risky” investment is a waste. But for whom is a “risky” investment a waste? Where does the “risky” money go? Does it just vaporize into thin air? No, it goes to pay third-parties for services, or products, or ideas, or research, or whatever. From my perspective, nothing would be better than the Gates Foundation spending its billions on risky, unproven, but promising investments potentially benefitting the environment, education, and healthcare. Can you imagine the jobs that would be created? Can you imagine the innovations that might result? At worst, the money spent goes to work in the broader economy rather than being stockpiled. Who says such risky expenditures are “jeopardizing investments”? The only real jeopardy is to social enterprise companies that could use the money to take reasonable and rationale risks for the benefit of us all.

We need to fix this.  Let’s repeal IRC § 4944.

PUT YOUR MONEY WHERE YOUR HEART IS

    As I continue to research, write, and speak about the legal and tax implications of the social enterprise movement, I often encounter three types of contrarians in the law. There are the scoffers: commentators who believe that emerging social enterprise law is misguided and a little silly. Then there are the traditionalists: commentators who believe that social enterprise is stealing attention and money away from the true do-gooders in this world—charities. Finally, there are the skeptics: commentators who are not opposed to social enterprise, but who believe that social enterprise is just a glorified version of corporate social responsibility–important for business management practices but not for the law.

    To the scoffers, traditionalists, and skeptics: I understand and appreciate your perspective, but the triple-bottom line is that you’re wrong. You either need to be part of the solution or you need to get out of the way. To quote from the Borg (but without adopting their nefarious intent): “You will be assimilated. Resistance is futile.”

Of course, by stating this, especially in this fashion, I’m asking for it. And I probably will get it. But the fact remains that social enterprise is here to stay, and it is having and will continue to have a significant impact on the law. That is not because the law is leading change. No. Societal change is dragging the law along.

Essentially, the social enterprise movement and the corresponding changes in the law are the result of a simple, overriding principle that is embraced today: Put your money where your heart is. We see it everywhere. Investors and philanthropists are no longer willing to take a Jekyll and Hyde approach to managing money. Increasingly, it is considered unacceptable to make money by any legitimate means possible on the one hand while the other hand gives that money away to support charitable causes. Instead, thoughtful investors and philanthropists want their money to earn a return and benefit society. Employees and the consuming public echo these sentiments; they want their work life and their consumption to align with their values as well as their pocketbooks.

Where is the proof that this shift is taking place? College endowment funds are being pressured to divest holdings in companies that harm the environment. Private equity firms are selling positions in gun manufacturers. There is renewed interest among foundations regarding program-related investments. Oil companies are paying for ad campaigns that demonstrate how much they care about the environment. Major financial institutions are creating funds focused upon so-called “impact investments.” Consumer products companies routinely engage in “cause marketing” whereby charitable contribution dollars are tied to product sales. Uniform standards are being designed to measure a business’s social benefit alongside its financial returns. Books and reports are being written about the growing resentment in the nonprofit sector that one must accept less money to work in charity.

In response to these forces, business and tax law must and will change because it is founded on the incorrect premise that doing well and doing good are mutually exclusive. For instance, most business lawyers would agree that prevailing corporate law protects management decisions that further shareholder wealth maximization, but the same law provides considerably less protection for decisions that further the interests of other stakeholders (e.g., employees, the community, the environment). Social enterprise directly challenges this legal imbalance. Similarly, the Internal Revenue Code operates on the now false assumption that an organization falls entirely into either the for-profit, taxable model or the nonprofit, tax-exempt model. For income tax purposes, there is no middle ground. Social enterprise directly challenges this notion as well.

Thus, I say again to the scoffers, traditionalists, and skeptics of the emerging law of social enterprise: As time will tell, you’re wrong. Unless you want to become irrelevant, you should accept the social enterprise movement and work to refine and improve the applicable law. Change is coming whether you like it or not.

“First they ignore you, then they laugh at you, then they fight you, then you win.” –Mahatma Gandhi.

WHAT SHOULD MY PRIVATE FOUNDATION DO FOR THE HOLIDAYS?

First and foremost, let me wish everyone who reads SocEntLaw the safest and happiest of holidays.

Next, I want to share something that, as the Grinch would say, has me “puzzled and puzzled ‘till [my] puzzler [is] sore.”*

Specifically, I cannot figure out why the Brewer Family Foundation’s tax lawyer, Ebenezer Scrooge, is insisting that the Foundation may buy $500,000 of stock in BP or give $500,000 to GreenPeace to celebrate the season, but that the Foundation cannot risk investing the same amount in SunSleigh, Inc. a “social enterprise” developing an affordable solar-powered car. I think old Ebenezer finally has lost it, and the Foundation needs a new tax lawyer.

Let me explain. Although not huge in terms of value, the imaginary Brewer Family Foundation’s mission is nonetheless a big one: to save the world, especially the environment. The Foundation’s endowment is $100 million and as required for tax purposes every year the Foundation distributes to charity at least 5% of the value of the Foundation’s assets. We’ve already met our 5% goal this year, but because our endowment is really well managed and generating an average 10% annual return, we’re feeling more generous than usual this December and have an extra $500,000 to spend. We’ve narrowed down our choices to the following three:

• Buying stock in BP (because we think BP stock is a really good investment right now even though it runs contrary to our mission of protecting the environment); or
• Giving money to GreenPeace expressly because we think GreenPeace hates oil companies and cares about the environment more than any other charity (except, of course, the Foundation); or
• Investing in SunSleigh, a local, privately-held company raising money to develop an affordable solar-powered car.

Personally, I would like the Foundation to invest the extra $500,000 in SunSleigh, but Ebenezer says we can’t.

More background: As I mentioned, SunSleigh is a private “social enterprise” company located here in Atlanta that is developing an affordable solar-powered car. A $500,000 investment in SunSleigh would equate to 1% of the SunSleigh stock. Like the Foundation, the owners of SunSleigh are so committed to the environment that they plan to sell the SunSleigh for as little as possible so long as they can generate a 2% return on invested capital. No doubt the investment will be very risky, and the Foundation might lose all $500,000, but in my well-considered judgment, SunSleigh really could help save the environment if it is successful. In fact, I sincerely and realistically believe that the Foundation might do more to save the planet by investing in SunSleigh than it could ever accomplish through all of its other investments and annual grants to environmental charities like GreenPeace. Moreover, SunSleigh really needs the Foundation’s $500,000 because it has been unable to attract normal investment capital due to SunSleigh’s commitment to keep the car’s costs low and pay only a 2% dividend forever.

So, I called my favorite tax lawyer, Ebenezer Scrooge, just to make sure that I was on solid legal and tax ground if the Brewer Family Foundation invested $500,000 in SunSleigh. After grilling me on all the particulars of the Foundation’s assets, mission, tax filings, annual distributions, and SunSleigh’s ownership, business plan, and stock offering—which, by the way, were all fine and legally compliant as far as Ebenezer was concerned—I was extremely disappointed to hear Ebenezer tell me that if the Foundation invested $500,000 in SunSleigh it could face a $50,000 penalty tax. Even more outrageous, Ebenezer said that I personally might have to pay a $50,000 tax as well. Further, if the Foundation invested in SunSleigh and lost the $500,000, then according to Ebenezer the IRS conceivably could revoke the Brewer Family Foundation’s tax exempt status.

I couldn’t believe my ears! After listening at length to Ebenezer explain in detail the complicated and confusing tax law applicable to private foundations, and after getting more and more frustrated, I finally said somewhat angrily to Ebenezer: “You mean to tell me that, in carrying out the Foundation’s mission to protect the environment, for a mere one-half of one percent of the foundation’s assets the tax law would prefer that I buy stock in BP or give the same amount of money to GreenPeace instead of investing in an idea that could make both BP and GreenPeace obsolete?”

Ebenezer sheepishly said, “Yes, that’s right.”

Then, I exclaimed, “You and the tax law are nuttier than a Christmas fruitcake.” I immediately hung up the phone and poured myself a spiked glass of eggnog to calm my nerves.

Do you know why Ebenezer probably is right? Revisit SocEntLaw in the future for the answer.

* “And the Grinch, with his Grinch-feet ice cold in the snow, stood puzzling and puzzling, how could it be so? It came without ribbons. It came without tags. It came without packages, boxes or bags. And he puzzled and puzzled ’till his puzzler was sore. Then the Grinch thought of something he hadn’t before. What if Christmas, he thought, doesn’t come from a store. What if Christmas, perhaps, means a little bit more.”
― Dr. Seuss, How the Grinch Stole Christmas