LAW AND SOCIAL ENTREPRENEURSHIP

ELLO AND SOCIAL ENTERPRISE

Cross-posted at Business Law Prof Blog.

My co-blogger Stefan Padfield [at Business Law Prof Blog] passed along this article from The New York Times Dealbook on the social network Ello.

Ello is a Delaware public benefit corporation. The social enterprise terminology is proving difficult, even for sophisticated authors at the New York Times Dealbook. The article calls Patagonia and Ben & Jerry’s public benefit corporations. Patagonia, however, is a California benefit corporation. I wrote about the differences between public benefit corporations and benefit corporations here. Ben & Jerry’s is a certified B corporation, but, as far as I know, Ben & Jerry’s has not yet made the legal change to convert to any of the social enterprise forms. I wrote about the differences between benefit corporations and certified B corporations here and here. Just as my co-blogger Joshua Fershee remains vigilant at pointing out the differences between LLCs and corporations, so I will remain vigilant on the social enterprise distinctions.

Besides my nitpicking on the use of social enterprise terminology, there are a few other things I want to say about this article.

First, Ello raised $5.5 million dollars, which is not that much money in the financial world, but puts Ello in pretty rare company in the U.S. social enterprise world. The vast majority of U.S. social enterprises are owned by a single individual or family; some social enterprises have raised outside capital, but not many. The increasing presence of outside investors in social enterprise means two main things to me: (1) the social enterprise concept is starting to gain some traction with previously skeptical investors, and (2) we may see a shareholder derivative lawsuit in the near future, which would give us all more to write about.

Second, Ello included a clause in its charter that “forbids the company from using ads or selling user data to make money.” This provision seems a direct response to the eBay v. Newmark case. The business judgment rule provides significant protection to directors and, at least theoretically, should calm many of the fears of social entrepreneurs. But risk adverse individuals may seek additional layers of protection.

Third, Ello claims that their charter provision “basically means no investor can force us to take a really good financial deal if it forces us to take advertising.” This seems overstated.  Charters can be amended, but at least the charter puts outside investors on notice. This provision in the charter does not, however, protect against a change of heart by the founders and a selling of the company (such as in the case of Ben & Jerry’s sale to Unilever).

Fourth, this October 4, 2014 article claims that Ello is pre-revenue. The NYT Dealbook article notes that “[u]sers will eventually be able to download widgets and modifications, paying a few dollars for each purchase.” (emphasis added). Ello seems to be one of the growing number of technology companies that are being valued by number of users rather than by revenues or profits. Ello “grew from an initial 90 users on Aug. 7 to over a million now, with a waiting list of about 3 million.”

Fifth, even if traditional investors are (somewhat) warming up to social enterprises, social entrepreneurs still seem to be a bit skeptical of traditional investors. When raising money, Ello “drew the attention of the usual giants in the venture capital world. . . . But Mr. Budnitz said he instead turned to investors whom he could trust to back the start-up’s mission, including the Foundry Group, whom he came to know when he lived in the firm’s hometown, Boulder, Colo.” There are increasing sources of capital for social enterprises from investors who also have a stated social goal (See, e.g., JP Morgan’s May 2014 survey of impact investors).

Some in the academic world have wondered if social enterprise is just a fad. While I am confident that the space will and must continue to evolve, if it is a fad, it has already been a long-running one. The names and details of the statutes may change, but I see a growing interest in marrying profit and social purpose, and I think that interest is likely to continue in some form.

SOCIALLY RESPONSIBLE PURCHASING?

Over at the Business Law Professor Blog, I have a post examining my purchasing habits, providing a few links to further reading on consumer behavior, and profiling a glorious picture of my well-loved Patagonia shoes.

PLERHOPLES ON “REPRESENTING SOCIAL ENTERPRISE”

Alicia Plerhoples is leading an innovative Social Enterprise and Nonprofit Clinic at Georgetown University Law Center.  She presented her “Representing Social Enterprise” article at AALS in 2013, and her article was recently published by the Clinical Law Review.  I recommend the article to all those interested in social enterprise and/or clinical education.  The article will be helpful to the academic, practitioner, and clinician (perhaps because Professor Plerhoples has experience in all three roles).   “Representing Social Enterprise” includes a deep discussion of the models of social enterprise, thoughtful analysis of the corporate governance issues that are likely to arise when representing social enterprises, and interesting insights into Georgetown’s clinic.

The abstract is reproduced below and the entire article can be found on SSRN here:

“This article explores the representation of social enterprises — i.e., nonprofit and for-profit organizations whose managers strategically and purposefully work to create social, environmental, and economic value or achieve a social good through business techniques — in the Social Enterprise & Nonprofit Law Clinic at Georgetown University Law Center. The choice to represent social enterprise clients facilitates a curriculum that explicitly focuses on the business models, governance tools, and legal mechanisms that these organizations use to accomplish sustainability and charitable objectives. By serving social enterprise clients, clinic students learn to solve novel and unstructured problems and engage in information sharing and knowledge creation essential to legal advocacy. Legal issues unique to social enterprises compel clinic students to question corporate law and its underlying normative values and employ transactional lawyering for public interest purposes.”

Cross-posted at Business Law Prof. Blog.

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.

MORE ON INTEREST CONVERGENCE: CONSERVATIVE & LIBERAL SUPPORT OF SOCIAL ENTERPRISE

I am continuing my research on interest convergence as a reason why the social enterprise movement has been successful (or at least recently gained momentum). This time I am looking at interest convergence from an ideological standpoint. Another brilliant aspect of social enterprise is that its goals do not fall neatly into conservative or liberal ideology. Consider, for example, (i) that the benefit corporation statutes adopted in twelve states and the District of Columbia generally have been passed with overwhelmingly bipartisan support, (2) social enterprises have been founded by conservative and liberal entrepreneurs alike, and (3) social enterprise missions are often couched in both conservative and liberal language (e.g., typically-conservative anti-government, anti-poverty language of “self-sufficiency” but also typically-liberal language of “doing good” and “giving back”.) Although the benefit corporation is not synonymous with social enterprise, it can be taken as a proxy—and the benefit corporation concept has widespread bipartisan appeal. The ends are attractive to liberals; conservatives like the means. Generically, liberals want the problems to be solved; conservatives want the problems solved without government and with some modicum of self-sufficiency and sustainability.

This leads me to ponder if social and environmental impact measurements also incorporate the normative values of both conservatives and liberals. Certainly, some of the typical slogans are similar. Is “Made in America” (which often makes me wary) the same as “Buy Local” (which sounds so much more pleasant and quaint)? When we talk about sustainability, what definitions of community are being employed? Is it the local community, national community, or global community? Are we talking about “us vs. them” (where “them” typically denotes Chinese laborers who are “stealing” American jobs)? Similarly, on an academic panel on social enterprise last fall, I asked a representative from an organization that sets social and environmental impact measurement standards whether or not Chick-fil-A, the infamous, privately-held fast food restaurant which claims to pay competitive wages, provides employee health and retirement benefits, prizes its environmental stewardship (which includes recycling, energy and water conservation, a sustainable supply chain, and a LEED-certified “test” restaurant) but contributes a portion of its profits to a family foundation that funds anti-same-sex marriage initiatives, can be considered a social enterprise. The response was “no.”

I have never been one to defend a company like Chick-fil-a (ever). And I am in no way defending Chick-fil-a right now (really, please take me at my word). But I am still puzzling about the distinguishing feature of social enterprise – what is the core of social enterprise? In my most recent article, I present various business models of social enterprise, including a philanthropy-based business model through which companies donate profits to foundations to do good (like TOMS Shoes or any other Buy-One-Give-One business, which I generally am not a fan of). What Chick-fil-a donates to its conservative, anti-gay family foundation may fit into this philanthropy-based business model. Perhaps what a company does with its profits (i.e., revenue minus cost) is just philanthropy, comparative to a shareholder who has received dividends off the profits of a company and then goes and donates to Goodwill. But the things that Chick-fil-a does with its core business—the employee benefits, the environmental stewardship, etc.—maybe that is a truer measure or defining characteristic of a social enterprise.

Stay with me here. Let’s forget that Chick-fil-A funds a conservative, anti-gay family foundation. Some might say that such donations are not the core of Chick-fil-A’s chicken-selling business. Instead, let’s think about Chick-fil-A’s closure on Sundays. That is, it is Chick-fil-A’s corporate policy to close on Sunday and this is for religious reasons. According to the owners, Sunday is supposed to be a day of rest. This policy can probably go in the category of “conservative values.” Nonetheless, the policy may align with liberal sympathies for employees—employees shouldn’t be overworked and should be given time off to spend with their families. For example, there is always liberal outcry against Walmart and other big box stores that stay open on Thanksgiving or Christmas day. My question is—is Chick-fil-A’s policy of closing on Sundays a “plus” on the social and environmental measurements scale? Does it matter that the policy is in place for religious reasons? What are the normative values incorporated into social and environmental measurements? Do they have room for conservative values? Or do they have room for conservative values only to the extent that the end result of those values converge with liberal sympathies?

(Note: I have to thank Haskell Murray for initiating some of this conversation over at The Conglomerate blog in August: http://www.theconglomerate.org/2012/08/chick-fil-a-as-a-social-enterprise.html).

 

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

Social Enterprise Business Models

As I have noted in other work, the social enterprise spectrum theoretically lies between two extremes. On one end of the spectrum are organizations that pursue social and environmental missions and eschew profit motives, as some nonprofit organizations do. On the other end of the spectrum are organizations that focus solely on profit-maximization and disregard social and environmental missions—these are often called profit-maximizing businesses. I think that mainstream media ungraciously labels all businesses between these two extremes as social enterprise and fails to acknowledge that there are significant distinctions between business models at different points along the spectrum. Closer to the profit-maximizing side of the spectrum, you might find corporate philanthropy or corporate social responsibility initiatives. Closer to the nonprofit side of the spectrum, you might find nonprofit organizations using an earned income strategy to sustain a set of social services. Within this wide spectrum, I have seen mainstream media label two particular business models as “social enterprise”—the stakeholder governance model and the “buy-one-give-one” model—which I’ll briefly describe here.

The first model is the stakeholder governance model (also called the stakeholder relationship management model) which is espoused by communitarian and team production scholars and has emerged as a prototypical business model of social enterprise. Social entrepreneurs who employ this model have shifted away from the singular focus of creating shareholder value and embraced a holistic notion that a business’s constituents all deserve a fair return on their investments, whether investments of capital, labor, natural resources, or other factors of production. I believe that this is the type of business model that B Lab, along with other social and environmental impact accounting firms, assess and certify as the gold standard in “doing business well”. [Please correct me if I’m wrong.] One might look to Greyston Bakery, the iconic social enterprise, as an example. Greyston Bakery is a Yonkers, New York-based bakery that dedicates itself to community renewal by providing sustainable employment—including fair wages, benefits, and equity participation—to low-income community members and reinvesting significant profits in the Greyston Foundation, which provides jobs, job training, affordable housing, youth services, and health care to the Yonkers community. Greyston Bakery’s motto is, “We don’t hire people to bake brownies. We bake brownies to hire people.” Greyston became the first social enterprise to register as a benefit corporation in New York when the legislation passed earlier this year. Greyston seemingly treats its factors of production—labor, capital, and land—in an equitable and sustainable manner (although it seems to emphasize labor). This is the essence of the stakeholder governance model, and possibly what many “true believers” in social enterprise think of when they use the term.

The second business model of social enterprise is quite the opposite. It is the “buy one, give one” or “BOGO” business model. Under the BOGO model, a for-profit company sells products or services in a developed nation and donates similar (but different) products or services in a developing nation. The social entrepreneurs employing the BOGO model seem to be less concerned with transforming corporate governance structures and are seemingly focused on the impact that their businesses have on ameliorating an immediate social, health, or environmental problem. The most prominent example of the BOGO model is TOMS, a Los Angeles based shoe company founded by Blake Mycoskie. For every pair of TOMS shoes sold at a luxury retail store in developed countries, the company works with humanitary organizations to identify and give a free pair of shoes to children in developing countries. Other social enterprises that have followed TOMS lead include Warby Parker which donates eye glasses and Baby Teresa which donates baby clothes. Consumers in the developed world can now purchase a wide range of clothes and household goods using the BOGO model.

The BOGO business model is based on charitable philanthropy and has many critics, including me. Corporate philanthropy is a term often used in a derogatory manner by social entrepreneurs and development social scientists that embrace sustainability. The Chinese proverb tells us that “if you give a man a fish, you feed him for a day. If you teach a man to fish, you feed him for a lifetime.” The BOGO model relies on marked-up prices in developed countries to pay for the creation of similar products and services in developing countries. The BOGO model also floods developing markets with free products thereby diminishing the need and capacity of a developing country to manufacture and produce its own products for its own markets. To me, the model also relies heavily on the charitable heartstrings of individuals in developed countries who wish to contribute to a social or environmental issue and feel guilty about their own consumerism and privilege. To many, the BOGO business model is not “true” social enterprise.

Nonetheless, this issue is not as clear as it seems. Greyston Foundation, the nonprofit arm of Greyston Bakery, is also corporate philanthropy—profits from the bakery are donated to the foundation for charitable services. What really distinguishes the two models? Would TOMS Shoes be a “true” social enterprise if it adopted a stakeholder governance model for its internal governance structure? If so, it would seem that I am comparing apples to oranges—internal corporate governance to business strategy. That is, one might consider the internal workings of a business—the corporate governance—as the feature that distinguishes regular businesses or nonprofits from social enterprise. Those businesses that adopt a stakeholder governance model of corporate governance are social enterprises, those that do not are not social enterprises, even if they do adopt a business strategy that performs charitable or philanthropic work. What’s your take? Is that distinction too simplistic? What governance or business models have I overlooked?

[Disclaimer: my interest in these business models is partly for an article that I am writing, to be presented at a panel of the Nonprofit Law and Philanthropy Section of the American Association of Law Schools Annual Meeting on January 6, 2013.]