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New Legal Structures for Social Entrepreneurs
Originally posted in Wall Street Journal
BY: KYLE WESTAWAY
You may have noticed the emerging class of “social entrepreneurs” who are creating companies that seek profit but also are devoted to a social purpose, to create long term, sustainable value.
Social entrepreneurs believe a business can be a part of the solution to some of the world’s greatest challenges. It’s this kind of thinking that has given rise to such mission-driven companies as Better World Books, TOMS Shoes, D-Light Design and Warby Parker, to name a few.
But, until recently, social entrepreneurs would find themselves in the position of choosing whether to organize either as a for-profit company or a nonprofit organization. The problem was that sometimes a company would be too much of a business to be a nonprofit. Yet, it also might be too mission-driven to be a for-profit.
Fortunately, there are a few innovative legal structures designed for entrepreneurs who are driven as much by mission as money. The cost of using one of these new legal structures will vary depending on lawyer fees, but generally those fees shouldn’t exceed more than $10,000 for a start-up with fewer than 10 employees.
Here’s an overview:
L3C
Ideal for: companies that want to blend traditional capital with “philanthropic” capital, such as from foundations
Available to start-ups in: Vermont, Michigan, Wyoming, Utah, Illinois, North Carolina, Louisiana, Maine and soon in Rhode Island.
The Low Profit Limited Liability Company is a new class of LLC for mission-driven companies.
An L3C offers the same liability protection and pass-through taxation as an LLC. But it must be organized primarily for a charitable purpose – and secondarily for profit. Unlike a traditional nonprofit, it may distribute its profits to owners.
The L3C is designed to attract both traditional investment and a very specific type of philanthropic money called Program Related Investments (PRI). PRI is capital – in the form of equity or debt – from a foundation to a for-profit company that is doing work in line with the charitable purpose of the foundation.
BENEFIT CORPORATION
Ideal for: companies that want to create a measurable positive impact while and providing greater transparency to the public
Available to start-ups in: Maryland, Vermont, Virginia, New Jersey, Hawaii, California and soon New York
The Benefit Corporation is a new class of corporation with a corporate purpose to create public benefit, a broader fiduciary duty and is transparent about its overall social and environmental performance.
By definition, it must operate for the general public benefit – defined as a material positive impact on society and the environment. Every benefit corporation is required to publish an assessment using an independent, third-party assessment tool. To create a material positive benefit, a benefit corporation operates in a manner that not only creates value for the company’s shareholders, but also its community, environment, employees and suppliers.
The structure also calls for a high level of transparency and accountability. Within 120 days after the end of each fiscal year, a benefit corporation is required to publish a “Benefit Report,” which states how it performed that year on a social and environmental axis.
FLEXIBLE-PURPOSE CORPORATION
Ideal for: companies seeking to do good on their own terms
Available to start-ups in: California
The Flexible Purpose Corporation a new class of corporation that creates the maximum amount of flexibility for socially/environmentally conscious companies. It is designed for businesses that want to pursue profit along with a special purpose of its own designation.
The structure allows the designation of a special purpose that the company will pursue in addition to profit. For example, a flexible purpose corporation might be a for-profit developer that has a special purpose of building a public park in each of its developments.
This type of corporation must issue an annual report that is available to the public and provides details on the following: the special purpose; the annual objectives that it has set to achieve its special purpose; the metrics used to gauge the success of the special purpose; how it has achieved or fallen short of the stated objectives; and how much money was spent in furtherance of the special purpose. But it does not require any measurement against an independent third-party standard.
Patagonia Asks Its Customers ot Buy Less!
This is the type of business we should be creating!
Patagonia’s Common Threads from Dokument Films on Vimeo.
Socent Law LIVE! – NYC
This fall you have not one, but two, opportunities to attend a live lecture about the legal structures for social enterprise in New York City. Click on the date below for more details.
October 11th / 7:00 PM / Skillshare HQ
November 8th / 7:00 PM / General Assembly
Class Description:
Have a great idea for social innovation, but trying to figure out whether it should be a nonprofit or a for-profit? Have you heard something about these new hybrid legal structures but can’t figure out what the heck they do? If so this course is for you! We’ll be digging into:
- 501(c)(3)
- L3C
- Benefit Corporation
- B Corp Certification
- LLC
- Corporation
photo: elsonpro
Introducing GIIRS – Ratings and Analytics Platform For Impact Investing
| Today at the Clinton Global Initative, B Lab announces the launch of GIIRS Ratings & Analytics, and the commitment of 15 GIIRS Pioneer Investors who declare as part of their impact investing strategy an investment preference for GIIRS-rated funds and companies. Andrew Kassoy will be on a panel at 3:45 EDT Tuesday entitled Financing Inclusive Jobs: Impact Investing and the Triple Bottom Line, moderated by Adam Davidson (NPR’s Planet Money), with Cheryl Dorsey (Echoing Green) and Christina Leijonhufvud (J.P. Morgan). Please tune-in to watch this panel live as Andrew discusses the GIIRS Launch and Pioneer Investor commitment – live-streaming will be available here.GIIRS Impact Ratings provide investors for the first time with a comprehensive, comparable, and third party verified assessment of companies’ and funds’ social and environmental impact. The GIIRS Analytics platform gives investors uniquely powerful tools to analyze aggregated, verified and comparable data on the social and environmental impact of companies and funds across geography, sector, organizational maturity, and size. The launch of GIIRS Ratings & Analytics follows a successful global beta test with more than 200 companies across 30 countries from 25 leading impact investing funds (the GIIRS Pioneer Companies and Funds, respectively).The GIIRS Pioneer Investors are a diverse group of global private equity investors and credit providers, including mainstream global financial institutions, foundations, family offices, leaders in social finance, and a multilateral development bank. They include: Annie E Casey Foundation, Armonia LLC, Calvert Foundation, Farm Capital Services LLC, Gatsby Charitable Foundation, Impact Investing Foundation, Inter-American Development Bank, J.P. Morgan, KL Felicitas Foundation, Prudential Financial, Inc., The Rockefeller Foundation, RSF Social Finance, Skoll Foundation,The Tony Elumelu Foundation and W.K. Kellogg Foundation. GIIRS expects to announce additional GIIRS Pioneer Investors in the coming months.
“These Pioneer Investors recognize that we can’t build an industry for impact investments without credible, comparable metrics on impact,” said Andrew Kassoy, co-founder of B Lab, the non-profit organization powering GIIRS. “GIIRS has the potential to catalyze hundreds of billions of dollars of sidelined investment capital to flow to the world’s most inspiring and talented entrepreneurs. These businesses demonstrably create high quality jobs that increase economic opportunity here and abroad.” GIIRS also announces today that three GIIRS Pioneer Funders – Deloitte, Prudential Financial, Inc., and The Rockefeller Foundation – have committed a combined $9 million in funding to accelerate industry adoption of the robust GIIRS Ratings & Analytics platform. With the support of GIIRS Pioneer Investors and Funders, in five years GIIRS aims to provide Impact Ratings for more than 2,500 companies and over 350 funds, and to provide over 150 institutional and high net worth investors with the ability to benchmark social and environmental impact for the first time the same way financial performance is benchmarked today. By providing credible, comparable and verified impact ratings and creating a powerful analytics platform, GIIRS provides the needed capital markets infrastructure to drive $1 trillion toward impact investments in 10 years. “The Inter-American Development Bank is committed to supporting entrepreneurs across Latin America and the Caribbean who show great potential to effect change in their societies,” said IDB Executive Vice President Julie T. Katzman. “GIIRS Ratings & Analytics provides tools to clearly measure the impact of our investments in venture capital funds – both at the level of the fund and the individual company.” “Prudential is proud to be one of the GIIRS Pioneer Investors. We are also one of the first companies to have a devoted impact investment portfolio, reflecting our ongoing support of initiatives that provide positive, sustainable impact,” said Ommeed Sathe, Director, Social Investments at Prudential. “Earlier this year we were lead investor in an innovative new technology platform to create an automated infrastructure to monitor impact investments. This and our groundbreaking work with GIIRS and B-Lab underscores our commitment to creating an investment infrastructure that will nurture the growth of the entire impact investing field.” GIIRS Pioneer Investors recognize that government and non-profits are necessary but insufficient to solve our most challenging social and environmental problems. As entrepreneurs around the world develop market-based solutions, they need investment capital to help them scale. Increasing interest in impact investing requires improved capital markets infrastructure, including generally accepted standards for defining, measuring, and comparing positive social and environmental impact. Without credible third party standards, there are significant barriers- to-scale including: a fragmented market where each investor defines impact differently, high due diligence and transaction costs, limited understanding by investors of how to manage for impact, and a weak policy environment due to a dearth of information. GIIRS helps remove these barriers to growth and attracts mainstream capital to the impact investment space.
Photo: Buck Forester |
Three Objections to L3Cs Answered
Though many sections of the American Bar Association are in favor of L3C legislation, the Nonprofit Organizations Committee and the Limited Liability Companies, Partnerships and Unincorporated Entities Committee of the Business Law Section of the American Bar Association are planning to oppose the L3C legislation based on three primary objections. Below are the objections and the responses by leading nonprofit attorneys excerpted from their letter.
1. L3C’s are no better at receiving PRI’s than an LLC
Your letter indicates that “The L3C is no better than any other business form for receiving program related investment[s] ….” In our view, an L3C is a better vehicle for accepting program-related investments than a standard LLC. The state-law L3C restrictions will make it easier for private foundation investors to conduct the due diligence necessary in order to complete a program-related investment and comply with expenditure responsibility. Acharitable purpose would necessarily be articulated in the L3C’s operating agreement, helping to ensure that the L3C’s purposes and operations are aligned with PRI requirements. Persons who form L3Cs are likely to be better informed about the requirements applicable to private foundations for PRIs and for expenditure responsibility and so draft their operating agreements accordingly. The L3C designation automatically sets the entity apart from ordinary LLCs that may or may not be structured in a way compatible with PRI requirements.We agree, and understand that, L3C is not necessary for an LLC to serve as the vehicle for a program-related investment, and we have represented many foundations that have made PRIs into LLCs, but we believe that in many cases L3C will make it easier for foundation investors to make the findings that they need to make for a proper PRI and for compliance with expenditure responsibility.
2. Traunched investment results in private benefit for profit-seeking investors.
Your letter indicates that “tranched investing purposefully uses foundation funds to subsidize (and thereby attract) private, profit-seeking investors” so that such a PRI “almost inevitably results in private benefit.” Tranched financing does not lead to per-se private benefit, as you suggest. Private benefit depends on all of the facts and circumstances in a given situation.
In fact, a PRI (other than one made to a charity) always involves some level of private benefit, but rather than a disqualifying private benefit, it is deemed incidental to the accomplishment of charitable purposes. One example in the Treasury regulations involves a foundation making a below-market-rate loan to a “business enterprise which is financially secure and the stock of which is listed and traded on a national exchange,” in order to encourage the enterprise to establish a factory in a depressed urban area. In this example, there is clearly private benefit, since the corporation receives a below-market-rate loan from charity – but the private benefit is incidental. In any PRI investment in a for-profit entity there is private benefit, but the private-benefit doctrine involves a weighing of public good against private benefit.
In any case, there is nothing in the L3C statutes that requires or even addresses tranched financing anymore than there is in the LLC statutes. L3C is now a creature of the states and American Indian nations that have adopted it, not of some promoters. Just because some promoters of L3C have talked about tranches does not mean that tranched financing is an inherent part of L3C. It is simply not in the L3C legislation
3. Supposedly “Low Profit” companies could make significant profits.
Your letter also points to a purported “technical error” in the L3C legislation, suggesting that there is some contradiction between the requirement that “no significant purpose of the company is the production of income or the appreciation of property” on the one hand and the label “low-profit” and the involvement of for-profit investors on the other. But there is no such contradiction.
L3C requires that the primary purpose of the organization must be charitable, but permits the production of income to be a secondary purpose. As with a tax-exempt charity that must have a charitable purpose by law, yet also must, from an economic standpoint, have sufficient revenue to conduct operations, institutional decisions must be made with the L3C’s overarching charitable purpose in mind, but profit may certainly be the result. The fact that an investment produces significant income or appreciation is not, in the absence of other factors, conclusive evidence of a significant purpose involving the production of income or the appreciation of property.
In fact, an example in the Treasury regulations, in analyzing an investment by foundation “Y,” states that the investment “is a program-related investment even though Y may earn income from the investment in an amount comparable to or higher than earnings from conventional portfolio investments.” When assessing whether a “significant purpose” of a foundation’s proposed investment is the production of income for purposes of the PRI rules, the IRS finds it “relevant whether investors solely engaged in the investment for profit would be likely to make the investment on the same terms as the private foundation.”
Such an investment is less likely to be a PRI to the extent that for-profit investors would enter it on the same terms as a foundation. The clear corollary is that for-profit investors may enter such investments on terms more favorable to them than those under which a foundation is willing to invest. Thus, L3C can bring together foundations’ PRIs and investments on more favorable terms by for-profit investors to accomplish the L3C’s primary charitable purpose through a business that, because of its inherent risk and low likelihood of profit, simply would not be attractive solely to for-profit investors.
photo: Kate Gaensler
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