LAW AND SOCIAL ENTREPRENEURSHIP

CROWDFUNDING: THE REAL AND THE ILLUSORY EXEMPTION

From the Harvard Law Review – Volume 4, Issue 2

Crowdfunding is commonly defined as raising small amounts of capital from a large number of people over the Internet. To avoid the expense of securities regulation, companies often crowdfund by giving away rewards (such as a free t-shirt) instead of selling stock or other securities. In April 2012, Title III of the JOBS Act sought to change this status quo by directing the Securities and Ex- change Commission (SEC) to facilitate securities-based crowdfunding through websites like Kickstarter. Congress and the President believed this would broaden access to sidelined capital and help companies grow and hire. But this “retail crowdfunding” exemption, open to all investors, was not the only means of crowdfunding in the bill. A last minute compromise, which has been largely overlooked, expanded the ability of issuers to use the private placement exemption, as revised in new Rule 506(c), to crowdfund from accredited investors. This “accredited crowdfunding” exemption provides a less regulated capital-raising alternative to retail crowdfunding that is available to the same companies and more.

This article is the first to examine the impact that accredited crowdfunding will have on retail crowdfunding. It claims that accredited crowdfunding is likely to dominate and, depending on SEC action, could render retail crowdfunding superfluous or a market for lemons. But it also claims that accredited crowdfunding—when compared to traditional private placements—may face a similar lemons problem over the longer term on account of rules that discourage investors from fending for themselves. These potential problems threaten to under- mine the social welfare goals of the JOBS Act: increasing access to capital, spurring business growth, and creating jobs. But the SEC can minimize these problems and promote social welfare by strengthening the bargaining incentives of accredited investors and encouraging retail investors to piggyback off of ac- credited investors’ work. The normative section of this Article provides targeted recommendations that balance the need for capital formation against a novel incentives-based theory of investor protection.

Full article can be found here

M&A UNDER DELAWARE’S PUBLIC BENEFIT CORPORATION STATUTE: A HYPOTHETICAL TOUR

From the Harvard Law Review – Volume 4, Issue 2

Noting the enthusiastic initial response to Delaware’s 2013 public benefit corporation statute, this Article presents a series of hypotheticals as vehicles for comment on issues that are likely to arise in the context of mergers and acquisitions of public benefit corporations. The Article first examines appraisal rights, concluding that such rights will be generally available to stockholders in public benefit corporations, and noting the potential for ambiguity in defining “fair value” where the corporation’s purposes extend to public purposes as well as private profit. Next, the Article examines whether and to what extent “Revlon” duties and limitations on deal protection devices may be relaxed or modified in the context of the sale of a public benefit corporation. Finally, the Article examines whether and to what extent a commitment to promote the specified public purposes of a public benefit corporation can be made enforceable against the buyer of the corporation

Full article can be found here

MAKING IT EASIER FOR DIRECTORS TO “DO THE RIGHT THING”?

From the Harvard Business Law Review – Volume 4, Issue 2

Some scholars argue that managers should take constituencies other than stockholders into account when running a corporation, and refuse to put short – term profit for stockholders over the best interests of the corporation’s employees, consumers, and communities, as well as the environment and society generally. In other words, they argue that managers should “do the right thing,” while ignoring that in the current corporate accountability structure, stockholders are the only constituency given any enforceable rights, and thus are the only one with substantial influence over managers. Few commentators have pro- posed real solutions that would give corporate managers more ability and greater incentives to consider the interests of other constituencies.

This Article posits that benefit corporation statutes have the potential to change the accountability structure within which managers operate. These statutes create incremental reform that puts actual power behind the idea that corporations should “do the right thing.” Certain provisions of the Delaware benefit corporation statute are discussed as an example of how these statutes can create a meaningful shift in the balance of power that will in fact give corporate managers more ability to and impose upon them an enforceable duty to “do the right thing.”

But this Article acknowledges that several important questions must be answered to determine whether benefit corporation statutes will have the durable, systemic effect desired. First, the initial wave of entrepreneurs who form benefit corporations must demonstrate a genuine commitment to social responsibility to preserve the credibility of the movement. Second, because the benefit corporation model relies on stockholders to enforce the duties to other constituencies, socially responsible investment funds must be willing to vote their long-term consciences instead of cashing in for short-term gains. To that end, it is crucial that benefit corporations show that doing things “the right way” will be profitable in the long run. Third, benefit corporations must pass the “going public” test. Finally, subsidiaries that are governed as benefit corporations must honor their commitments and grow successfully, if the movement is to grow to scale.

Click here for the complete article.

LEGAL SYMPOSIUM ON IMPACT INVESTING

You Are Invited…

Building a Legal Community of Practice to Add Still More Value to Impact Investments

Bingham, in conjunction with the International Transactions Clinic of the University of Michigan Law School, Aspen Network of Development Entrepreneurs (ANDE) Legal Working Group and Impact Investing Legal Working Group, is proud to present a legal symposium on Building a Legal Community of Practice to Add Still More Value to Impact Investments.

 

Panel One: Building a Legal Community of Practice for Impact Investing

∙ Ana Demel, Adjunct Professor of Law, New York University Law School

∙ Chloe Holderness, Managing Director, Lex Mundi Pro Bono Foundation

∙ Jonathan Ng, Global Legal Director, Ashoka

∙ Keren Raz, Associate, Paul Weiss

∙ Deborah Burand, Clinical Assistant Professor and Director, International Transactions Clinic, University of Michigan Law School (Moderator)

 

This panel will discuss impact investing and how lawyers add value to it, but also ways to grow the community of lawyers ready to serve impact investors and social enterprises in the U.S. and globally.

 

 Panel Two: Aggregating Capital for Impact Investing

∙ Donald Crane, Independent Legal Consultant

∙ Alyssa Grikscheit, Partner, Sidley Austin

∙ Jim Mercadante, Partner, Reed Smith

∙ Kevin Saunders, Deputy General Counsel, ACCION

∙ Carl Valenstein, Partner, Bingham McCutchen LLP (Moderator)

This panel will discuss what organization structures for aggregating capital best accommodate the needs of impact investors and social enterprises that are intent on achieving double bottom line returns. How can impact investment funds attract a broader range of investors and achieve greater scale?

 

Panel Three: Embedding Mission Goals Into Impact Investment Documentation

∙ Aaron Bourke, Associate, Reed Smith

∙ Edward Marshall, Chief Counsel & Compliance Officer, Developing World Markets

∙ Lynn Roland, General Counsel, Acumen Fund

∙ Ben Stone, Director of Strategy & General Counsel, MCE Social Capital

∙ Mary Rose Brusewitz, Partner, Strasburger (Moderator)

 

This panel will discuss how the missions of impact investors and social enterprises are shaping investment documentation as well as how social impact goals are shaping the life cycle of impact investments.

 

WHEN

Thursday, October 2, 2014

8:00 – 8:30 am — Coffee and Registration

8:30 – Noon — Panel Discussions

 

WHERE

Bingham McCutchen LLP

399 Park Avenue

New York, NY 10022

 

RSVP (for in person or online participation)

To attend in person, please rsvp by September 29 to binghamevents@bingham.com.

 

To attend virtually and view the proceedings online, please register at:

https://intercall.webex.com/intercall/j.php?ED=306900977&RG=1&UID=1987420527&RT=MiMxMQ%3D%3D

 

 

Bingham McCutchen LLP is an accredited provider of California (#2874) and New York continuing legal education. This program is approved for 2.75 general hours of CA MCLE and 3.0 NY CLE credits in Areas of Professional Practice. The content is appropriate for attorneys of all experience levels. CLE credit in all other jurisdictions is pending.

 

 

IRS DEBUTS STREAMLINED FORM 1023-EZ APPLICATION FOR RECOGNITION OF EXEMPTION UNDER SECTION 501(C)(3)

This was originally posted on lawforchange.org

In hopes of reducing the long backlog of exemption applications and ostensibly freeing up resources for more robust enforcement, the Internal Revenue Service released on Tuesday a new short-form tax exemption application, Form 1023-EZ, for certain small charities. The release also includes instructions for completing the form.

To be eligible to use the new form, an applicant must not have had annual gross receipts exceeding $50,000 in any of the past 3 years; must project that its annual gross receipts will not exceed $50,000 in any of the next 3 years; and must not have total assets in excess of $250,000. Other restrictions apply: churches, schools, hospitals and medical research organizations, foreign entities, supporting organizations, and a host of other specialized entities are ineligible to use the abbreviated application. The instructions include a 7-page “Eligibility Worksheet” with 26 questions; if the answer to any is “Yes,” then the organization is not eligible to use Form 1023-EZ.

An applicant must submit Form 1023-EZ electronically. Submission requires payment of a user fee of $400, reduced from $850 for many applicants using the full Form 1023.

Unlike its much more detailed sibling, the Form 1023-EZ asks the applicant to attest to a series of conclusory statements about its governing documents, purposes, and activities, but does not require elaboration or attachments. Applicants using the new form do not have to provide any details about, for example, their relationships with insiders or their finances.

Certain organizations whose exempt status is automatically revoked for failure to file annual returns for three consecutive years can use the new form to apply for reinstatement. This option is available only for organizations that otherwise meet the Form 1023-EZ eligibility requirements and that seek either retroactive reinstatement within 15 months of revocation or reinstatement only from the postmark date of the reinstatement application. (These eligibility requirements correspond to the reinstatement procedures set forth in Sections 4 and 7, respectively, of Rev. Proc. 2014-11.)

We may have more to say about the implications, for individual charities and for the nonprofit sector as a whole, of the approach the IRS has taken to “streamlining” the exemption application process. For now, though, small charities that are looking for a faster path to exemption, or that want to recover after automatic revocation, should be aware of this new option.

NEW YORK & DELAWARE BENEFIT CORPORATION – SLIDESHOW

This presentation was given on April 3, 2014 at Harvard Business Law Journal Symposium on Benefit Corporations.

BENEFIT CORPORATION INFOGRAPHIC

infographic; benefit corporation

Benefit Corporation Adoption

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.”

THE RISE OF SOCIAL ENTREPRENEURSHIP IN B-SCHOOLS

Katie Smith Milway and Christine Driscoll Goulay wrote a great post in Harvard Business Review about the explosion of social entrepreneurship in the last decade. Check out the post here.

I’m ecstatic to see that the next generation of business leaders are taking social enterprise seriously. With the exception of a few schools, the legal academy is not even aware of the social enterprise movement. The legal academy is about 20 years behind the curve on this. Why does this divide across the quad exist? When will the legal academy start taking this sector seriously?

VIDEO: WSJ Interview with Jacqueline Novogratz on Impact Investing

Wall Street Journal interview with Jacqueline Novogratz