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WHAT DO INVESTORS THINK ABOUT BENEFIT CORPORATIONS?

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

 

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

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

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

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

What do investors think about the Benefit Corporation?

SHIFT FROM TECHNOLOGICAL INNOVATION TO SOCIAL INNOVATION 

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

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

PROTECTION FROM SHORT-TERMISM

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

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

INVESTOR ALLIGNMENT

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

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

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

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

INVESTOR SKEPTICISM

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

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

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

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

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

FINAL ANALYSIS

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

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

CALLISON ON BENEFIT CORPORATIONS

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

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

IMPROVING BENEFIT CORPORATION LAW

Over at Columbia Law School’s excellent, new Blue Sky Blog, I have a post on Delaware’s new public benefit corporation law and improving benefit corporation law in general.

The post concludes:

While it remains to be seen whether Delaware’s foray into benefit corporation law represents a “tipping point in the evolution of capitalism” (especially considering that only a few hundred benefit corporations have been formed over the past three years), it is encouraging to see the individual state laboratories at work, and I am interested in seeing where this pluralism in the corporate form leads.

Go over to the Blue Sky Blog to read the entire post.

HOW MANY BENEFIT CORPORATIONS HAVE BEEN FORMED?

Kate Cooney (Yale), Matt Lee (Harvard), Justin Koushyar (Emory), and I (Belmont) have asked the titular question and are contacting the various secretary of state’s offices in states with benefit corporation laws in an attempt to compile reliable data.  Getting an accurate answer is not simple, however, because many states have simply lumped benefit corporations in with traditional corporations, and do not have an easy way to separate the two.

An employee at B Lab just sent me the data they have been able to scrape together given their powerful position in the social enterprise space.  Their data is about a month old (and therefore doesn’t include Delaware, which passed about a week ago and becomes effective 8/1/13).  According to the data B Lab has been able to collect, 251 benefit entities have been formed.  This is not to be confused with the 786 certified B corporations, which includes various entity types including traditional corporations and LLCs. See below for the number of benefit corporations broken down by state.  The number 251 includes benefit LLCs in Maryland.  Also, B Lab does not have data on New Jersey or South Carolina, and a number of state statutes are not yet effective.  It is possible that this data is incomplete, but these numbers are largely consistent with the data we have begun to assemble and with the early work of Professor Eric Talley (Berkeley) on California’s benefit corporations.

Frankly, some of these numbers are very similar to the numbers I was able to get on those states during my initial attempt last summer.  Also, for a few of the states, the current number is very similar to the number of benefit corporations formed on the very first day the given state statute became effective.  For example, New York reported 14 benefit corporations formed on the first day in early 2012, and evidently only 4 in the following year.  (The number of benefit corporations formed in NY on the first day varies a small bit, depending on the source, see here for 13, but, regardless, the general point remains the same).

Given that the first benefit corporation statute was passed only 3 years ago and some of the statutes (including Delaware’s) are not yet effective, it is a bit too early to judge the success or failure of the form.  However, fewer than 300 entities–spread over all the states with effective benefit corporation statutes–is a very small drop in the bucket.  Delaware has over 1 million entities formed in its state.  That said, benefit corporations have already captured plenty of headlines and caused vigorous academic debate.  Also, based on the response at various social enterprise symposia I have attended, it seems that the current generation of students has intense interest in this space.  Time will tell if the benefit corporation form ends up attracting more companies.

Arizona

Not in effect yet

Arkansas

Not in effect yet

California

85

Colorado

Not in effect yet

District of Columbia

Not in effect yet

Hawaii

5

Illinois

22

Louisiana

8

Maryland (*included Benefit LLCs)

39*

Massachusetts

16

New Jersey

?

New York

18

Pennsylvania

19

South Carolina

?

Vermont

14

Virginia

25

UPDATED: BENEFIT CORPORATION CHART

I have updated my benefit corporation state statute chart here.  A number of states (Arizona, Arkansas, Colorado, Nevada, and Oregon) have passed benefit corporation statutes recently, but those are not effective yet and therefore have not yet been included.  Washington D.C.’s statute went effective in May, and is in this version of the chart.  D.C. seemed to follow the January 26, 2012 version of the model legislation without much deviation.

Also, I added and updated some of the more recent versions of the model legislation.  The changes in the model legislation have been quite interesting to me.  The most interesting recent change was moving from a fairly detailed definition of “independence” for the third party standard provider to simply ““[d]eveloped by an entity that is not controlled by the benefit corporation.”

As always, please feel free to contact me with any suggestions or potential corrections.

ESPOSITO ON THE SOCIAL ENTERPRISE REVOLUTION

Robert T. Esposito’s article The Social Enterprise Revolution in Corporate Law: A Primer on Emerging Corporate Entities in Europe and the United States and the Case for the Benefit Corporation is available here.

Next month, Robert will begin his time at NYU Law as a recipient of the Jacobson Fellowship in Social Entrepreneurship.

His article is well worth reading.  The abstract is below:

Remarkably, in the face of a global recession, the social enterprise sector continued to experience extraordinary growth in both financial support and the number of newly authorized corporate entities aimed at social entrepreneurs who seek to use the power of business to simultaneously achieve profit and social or environmental benefits. This Article highlights recent developments in the social enterprise movement in Europe and the United States and focuses on the emergence of a surprisingly broad range of newly authorized corporate entities on both continents in response to the needs of social entrepreneurs. These include social cooperatives and the community interest company in Europe, as well as the L3C, the flexible purpose corporation, the social purpose corporation, and the benefit corporation in the United States. In so doing, this Article emphasizes the truly international scope of the social enterprise movement and explains the growing divergence in approaches to social enterprise between continental Europe and the United States. This Article suggests that the benefit corporation, which imposes a new duty to consider stakeholder interests, is currently the most effective vehicle through which social entrepreneurs can ensure their blended value goals are being considered and achieved. This Article concludes by responding to critiques of profit-distribution in social enterprise, making the case for the benefit corporation, and suggesting some statutory and tax reforms to further foster the social enterprise revolution.

DELAWARE PUBLIC BENEFIT CORPORATIONS: BRANDING

Cross-posted at Conglomerate.

This is my third and final substantive post comparing the Model Benefit Corporation Legislation (the “Model”) to the proposed Delaware Public Benefit Corporation (“PBC”) amendments.

“Branding” is one area where proponents of the Model may argue that the Model is better than the PBC.  As mentioned in my first substantive post, the PBC favors private ordering more than the Model, which makes the PBC more flexible, but also makes it more difficult to maintain a consistent brand.  Branding could be useful to investors, consumers, and governments that wish to quickly identify socially responsible companies.

Some proponents of the Model may point to the required annual report (PBC only requires a biennial report) and the requirement of measuring general public benefit against a third party standard (optional under the PBC) as building the Model’s brand.  In my opinion, however, neither the required annual report nor mandatory use of a third party standard is likely to facilitate creation of a useful brand under the current language of the Model.

First, the Model does not expressly provide an enforcement mechanism for assuring the public posting of an annual report and the use of a third party standard.  Currently, a number of benefit corporations are in violation of the statute, but nothing seems to be done about the violations.  Second, most of the few annual reports available are full of fluffy self-promotion and do not include much of value.  Third, the available third party standards vary wildly, so simply requiring a third party standard is not likely to lead to a consistent and valuable brand.  The updated version of the Model requires that the third party standard be “comprehensive,” “independent,” “credible,” and “transparent,” but those requirements will be difficult to enforce and, in any event, do not appear aimed at creating a consistent brand.  A benefit corporation that does not see the value in using a third party standard may use the lowest standard available, provide little to no useful information to the market, and waste company resources in the process.

If the Model proponents wished to create a brand via statute they would do better requiring an annual charitable giving floor and a partial asset lock, as I suggest here.  In my opinion, however, the heavy lifting in the branding department of social enterprise should be left to private organizations like B Lab.  The social enterprise space is evolving quickly, and I think it unlikely the state governments would keep up with the changes and engage in the type of enforcement needed to maintain a valuable brand.  Also, the term “social good” means very different things to different people, and therefore it is likely better to have private organizations develop various standards and allow the market to determine which standards, if any, are useful and valuable.

DELAWARE PUBLIC BENEFIT CORPORATIONS: DIRECTOR GUIDANCE

Cross-posted at Conglomerate.

One of my main criticisms of the Model Benefit Corporation Legislation (the “Model”) has been (and still is) the lack of guidance for directors. (See, e.g., here and here).  The Model requires directors to “consider” seven different stakeholder groups (§301(a)), and directs them to pursue “general public benefit” but does not provide any priorities to guide directors. (§§102, 201(a)).  The Model allows companies to choose one of more “specific public benefit purposes,” in addition to the “general public benefit purpose,” but does not require that any specific public benefit purpose be chosen. (§201(b)).

In contrast, Delaware’s proposal does require public benefit corporations (“PBCs”) to choose one or more specific public benefits (§362(a)), though the statute is not crystal clear on priorities and requires directors to “manage or direct the business and affairs of the public benefit corporation in a manner that balances [1] the pecuniary interests of the stockholders, [2] the best interests of those materially affected by the corporation’s conduct, and [3] the specific public benefit or public benefits identified in its certificate of incorporation.” (§365(a)) (emphasis added).   (As a side note, the PBC’s requirement to “balance” the stakeholder interests seems more onerous than the Model’s requirement to “consider” the interests.)

Even if directors’ duties are owed to the corporation as a whole, I suggest that clear priorities are important.  I attempted to explain the importance of priorities in my response to Professor Lynn Stout’s thought-provoking recent book:  The Shareholder Value Myth:

Professor Lynn Stout and others reject the need for a single metric and have argued that directors, like other human beings, balance the interest of various stakeholders.   Among other examples of balancing by human beings, Professor Stout points to the ability of people to balance work and family.   This article admits that directors do and should balance various stakeholder interests and does not argue for myopic focus on a single metric, but rather posits that clear corporate priorities can make that difficult balancing job easier.

Using Professor Stout’s work/family example of balancing can help illustrate the point.  Clearly defined priorities can help an individual make difficult decisions in the constant work/family balance.  If an individual prioritizes family over work, that obviously does not mean that every decision leads to direct, short-term benefits for the family.  For example, on occasion, that family-primacy individual will rightly choose to stay late at work and miss dinner.  While that individual decision may have seemed to prioritize work over family, viewed in the long-term, the family may benefit from the resultant career security.  Even if the long-term benefits do not actually come to fruition, most would agree that the individual should not be judged for her well-intentioned decision.

The fact that humans certainly balance interests of various constituents, however, does not mean that priorities are unimportant.  Priorities can help guide and can also provide weightings for the costs and benefits of any decision.   Also, priorities most clearly help in critical situations.   To continue with the work/family example, in a zero-sum game, how does one decide between work and family when the outcome of that decision is of critical importance to both?   If an individual has clearly stated that family is a higher priority than work, this critical decision is more easily answered.  Even if the priorities are not clearly stated, priorities will still drive the decision.  Transparency as to the priorities makes things clearer to all involved and makes it less likely that the individual will drift from his or her true priorities.   Similarly, directors would benefit from a clear corporate objective that includes specific corporate priorities.

While I would have preferred the proposed Delaware amendments to have made clear that the PBC’s top priority is its specific public benefit purpose, I think requiring PBCs to identify a specific public benefit purpose is a move in the right direction and likely to aid directors in decision making.

In my third and final post, on Delaware’s proposed amendments involving the PBC, I will talk about the social enterprise statutes and branding.

FROM PROFIT TO PURPOSE │ 5/7/13 │ ONLINE

Simon Mainwaring (CEO of We First), Jay Coen Gilbert (Co-Founder of B Lab), and Dave Cobban (Director of Sustainable Business & Innovation for Nike) will host a live Google+ hangout on May 7, 2013 at 4pm eastern (1pm pacific).  You can RSVP for the free event here

The text of the announcement reads:

Join us live to discuss how business can become a force of good by partnering with customers to co-create lasting social impact. Submit your questions below or by tagging them with #ProfitToPurpose. Simon Mainwaring, CEO of We First and New York Times bestselling author, will lay out a new sustainable vision for purposeful capitalism. We First provides strategic consulting and training in storytelling and community building to brands like Coca-Cola, 3M, Livestrong and the X Prize Foundation. www.WeFirstWebinar.com.  Jay Coen Gilbert, Co-Founder of B Lab, will share how the +BCorporation movement is building a new sector of the economy. Encompassing more than 700 companies across 60 industries and in 26 nations, B Corps use the power of business to solve social and environmental problems. http://www.bcorporation.net Dave Cobban, Citizen Mobilization Director of Sustainable Business & Innovation of +Nike, will talk about his role and why Nike is focused on changing “the making of making” http://nikemakers.tumblr.com/. He’ll also give an inside look into Nike’s collaborative innovation approach and their partnership with NASA, USAID, and the US Department of State called LAUNCH www.launch.org.

LAW & SOCIETY │ 5/31/13 │ BOSTON, MA

A few days ago, Kyle Westaway asked: When will law schools start taking [social enterprise] seriously?

Well, on Friday May 31, 2013 at the Boston Sheraton Hotel (Room 05) from 4:30 p.m. until 6:15 p.m. the Law and Society Association will host a roundtable discussion at its annual meeting on corporate and tax law issues in the social enterprise space.

The participants in the Law & Society roundtable include the following law professors:

Alicia Plerhoples (Georgetown) (Chair), Dana Brakman Reiser (Brooklyn), Haskell Murray (Regent), and Marcia Narine (currently UMKC, but moving to St. Thomas (FL) in the fall).

The abstract from our proposal reads:

We propose a roundtable discussion session that will focus on corporate and tax law’s expansion to accommodate for-profit businesses’ pursuit of the social good. This session ties to the conference’s theme of investigating the economic downturn’s effect on law and society by exploring the ways in which the downturn has promoted a rapid acceleration of the social enterprise movement and an increased commitment to corporate sustainability methods. Sustainability is a complex goal that requires a multidisciplinary approach that necessarily involves economic actors—businesses. Social entrepreneurs as well as corporate leaders are considering some of the most pressing economic issues of our time related to sustainability. How will businesses operate given the increased global demand for natural resources, gross economic disparity and inequality, and climate change of the twenty-first century?

Our panel will discuss the ways in which corporate and tax law are being reconceived to address social and environmental problems. We will discuss the proliferation of so-called social enterprise legislation (i.e., the benefit corporation, L3C, flexible purpose corporation, etc.) that has been hailed as an innovative step forward in business, while also criticized as being untested, unnecessary, and even irresponsible. In addition to introducing the audience to the new social enterprise legislation, the panelists will debate the various criticisms of social enterprise generally, and the legislation specifically, and discuss social enterprise in the larger context of the social and environmental pressures on the global economy. We will also offer our thoughts on the future of the social enterprise movement.

This is the only one of many panels, symposia, and conferences over the past few years that has had focused on social enterprise law.  That said, I agree with Kyle that law schools are still lagging behind business schools in the social enterprise space.  As I mentioned in the comments to his post, some of this lag is due to the fact that the U.S. social enterprise statutes are only 5 or fewer years old and, to my knowledge, there has not been any litigation involving these new forms.   This semester, I am teaching a social enterprise law course at Regent University School of Law, and it has been a wonderful class to teach.  I know a number of my co-bloggers have also taught social enterprise law classes, including Cass Brewer (Georgia State), Alicia Plerhoples (Georgetown), Deborah Burand (Michigan), and even Kyle Westaway – who asked the opening question – has co-taught a short course in social enterprise law at Harvard Law School.  I am sure there are additional social enterprise law courses being offered, and I do think law schools will start taking social enterprise more seriously as the space evolves.