July 20, 2016

The Next Stage of Social Entrepreneurship: Benefit Corporations and the Companies Using This Innovative Corporate Form

Michael Vargas

A little over a year ago, I had a client come into my office to thank me for incorporating her benefit corporation. Before I could say anything she told me how excited she was to find an attorney who took her idea seriously, explaining that a number of other attorneys she had gone to had brushed off her request and told her to form a traditional “C” corporation. One attorney, who claimed to have performed over 200 hours of pro bono service to benefit corporations, had told her that a benefit corporation was merely a public relations stunt and wouldn’t be taken seriously. As she explained, when she came to me, she was almost ready to admit defeat and go home.

The attitude of these attorneys is surprisingly common, and yet it is also based on a misperception. Though there is a public relations aspect to the benefit corporation, it is much more than that. It is a legal development many decades in the making, incorporating a wide array of policy ideas and borrowing from different legal theories. And yet, as revolutionary as the idea is, it is executed in such a way that even Delaware’s Chief Justice Strine has joined in the praise for it, describing it as a modest and effective tool for social innovation. The entrepreneurs who take advantage of this form are not merely looking to score a PR win; rather they are looking for business entity that empowers them, helps them break into crowded markets, and embraces the changing face of the American workforce. And a good business lawyer needs to know what a benefit corporation is and when it is the right corporate form for the client.

What Is a Benefit Corporation?

Let’s start by setting the record straight about what a benefit corporation actually looks like. A benefit corporation is a new corporate form designed to address two of the most common problems social entrepreneurs face when trying to start a company: (1) that traditional “C” corporations are legally required to pursue maximum shareholder value, potentially at the expense of all other stakeholders, and (2) that many large corporations have adopted the language of social impact to disguise and distract the public from very unethical behaviors (a.k.a. “greenwashing”), which has the added effect of crowding out legitimate social enterprises from the market even though a majority of consumers would prefer to spend their money on sustainable products and companies.

In 2010, Maryland became the first state to pass “benefit corporation” legislation, enshrining these values into law. Benefit corporation legislation has since been adopted in 30 states and the District of Columbia. While there can be significant differences in the details, all these statutes follow the same three-part formula designed to ameliorate the two central problems above: the corporate charter must contain a clearly articulated social purpose, the directors must balance or consider interests beyond shareholder profit, and the company must report regularly on their efforts to promote or maintain their chosen social purpose.

1. The Social Purpose

The first defining characteristic of a benefit corporation is that all benefit corporations must incorporate a social purpose into their charter. Incorporating the social purpose into the charter serves as one way of preventing “greenwashing,” since it prevents a company from hiding socially irresponsible behavior behind a well-executed PR campaign. Benefit corporations must act responsibly in all aspects of their business. The Model Benefit Corporation Legislation (MBCL), created by the nonprofit B Labs and passed in the vast majority of states, requires that the company incorporate a “general social benefit” statement, which is defined as “a material positive impact on society and the environment, taken as a whole.” This statement effectively prohibits any socially irresponsible behavior by the company.

Not all states have adopted this approach. Texas, for example, requires that the charter identify a “specific social benefit” for which the statutes offer a number of examples, along with an open ended option allowing the company to define the benefit itself. There are some benefits to this approach. A “specific purpose” statement promotes social innovation by freeing social entrepreneurs from the MBCL’s rigid focus on environmental sustainability. Professor Haskell Murray has also argued that narrower or more well-defined purpose statements promote focus and measurability, two things that are essential to effective corporate governance and enforcement.

The trend, however, appears to be a hybrid approach, allowing the corporation to choose whether to incorporate a general purpose, specific purpose, or both. Both California and Minnesota, for example, permit companies to choose which way they want to go. California separates these corporations into “benefit corporations” and “social purpose corporations,” while Minnesota labels them “general benefit corporations” and “specific benefit corporations.” Delaware takes perhaps the most laissez-faire approach in allowing any “public benefit corporation” to define their mission for themselves, leaving the specifics, broad or narrow, to the founders or managers. The differences may reflect the corporate law culture of the state, with Delaware taking the most flexible and management-friendly approach, or they may reflect an evolution in the law. As more states join the list, we will see how these trends develop.

2. Director Responsibilities

The second defining characteristic of a benefit corporation is the expanded responsibilities of the board of directors. In a traditional corporation, the board is assumed to act on behalf of the shareholders and, either by law or business norms, manages the company in pursuit of profit and shareholder value. A chief goal of the benefit corporation movement was to step away from this narrow corporate purpose, and is achieved in the statute by expanding the scope of mandatory director duties. In the majority of states the directors of a benefit corporation must consider a host of interests in making their decisions, including the interests of shareholder, employees, customers, local communities, and the environment, among others. Some have described it as a mandatory constituency statute, but the scope is much larger than traditional constituency statutes.

Delaware is unique in bucking the trend with regard to director responsibilities. Rather than listing a host of “considerations,” Delaware’s public benefit corporation statute requires directors to “balance the stockholders’ pecuniary interests, the best interests of those materially affected by the corporation’s conduct, and the public benefit or public benefits identified in its certificate of incorporation.” This three-part formulation is distinct from the long list of considerations in the MBCL, but seems to embrace many of the same objectives. The “materially affected” qualifier, however, could be read as requiring a greater focus on local communities and other groups directly connected with the company. This may be appealing to some companies looking to make a more local impact, and even for larger companies, the statute clearly does not preclude larger, even global, social objectives. As such, the Delaware statute appears to parallel the MBCL, in not in the same words.

Though the precise contours of director responsibilities remain obscure, what is clear is that directors have much more to consider when making decisions on behalf of a benefit corporation. It is, however, also unclear if these new responsibilities translate into a shift in the fiduciary duties of a director. Delaware specifically allows companies to exculpate directors from duty of loyalty liability for failure to perform the balancing described above, a somewhat understandable addition to the statute, particularly for larger companies. So, while this is perhaps the most direct rejection of the shareholder profit paradigm to date, the statute appears to be more permissive than punitive, giving the board plenty of breathing room without setting too many specific boundaries.

3. Accountability and Transparency

The third and final characteristic of benefit corporation statutes is the reporting requirement. All benefit corporation statutes require some form of reporting to the shareholders or the public. Like the social purpose requirement, the reporting requirement is intended to limit “greenwashing” by forcing companies to disclose their efforts in pursuit of their social purpose. If a company is pursuing only a narrow purpose at the expense of the environment or the community, that would show up in one form or another in the report. The model law requires annual reporting, and the report must be publicly available on the company’s website. Minnesota is a bit of an outlier, in that it requires the annual report to be filed with the secretary of state, adding still another layer of accountability on top of the model law. Delaware, most surprisingly, takes a more reserved approach, requiring only that the report be made available to the shareholders every other year, but creates the option for reporting to occur more often and to be disclosed to the public.

A point of some contention between advocates of the model law and the Delaware version is the use of a “third-party standard” to measure progress toward the company’s social benefit. The model law has very specific requirements for what qualifies as a “third-party standard,” perhaps too specific given that one of the requirements is that the standard be “comprehensive” in assessing the company’s impact on an array of interests. This is a high bar and there are very few available certifications or assessments to choose from. Some states, such as Minnesota, take a more modest approach, requiring a third-party standard, but leaving the definition more nebulous. This doesn’t necessarily let the company off the hook, however, as Minnesota requires that the company explain why it selected the standard and explain the implications of how the company performed relative to the standard.

Delaware is, again, a bit of an outlier when it comes to the third-party standard, making it optional, and the statute offers no definition at all. In the case of Delaware, home to almost 50 percent of America’s public companies, this makes some sense. Many large Delaware companies will already be subject to a stringent disclosure regime under securities laws and the exchange rules. As such, an additional disclosure requirement would not be appealing, and may even be superfluous if you consider social impact to be “material” and therefore subject to disclosure (a question that I will leave for another day). Regardless, the “third-party standard” is perhaps one of the largest disparities between the many statutes, and we have yet to see if there will be some movement toward a single standard.

4. Benefit Corporations Are Not “B Corps”

Given the popularity of terms like “S Corp” and “C Corp,” it is not surprising that clients and some other lawyers refer to benefit corporations as “B Corps,” but this is wrong. A benefit corporation is not a B Corp. A “B Corp” is a certification offered through B Lab, a non-profit organization that has been offering the certification since 2007. The benefit corporation is a business entity chartered through a state. Many benefit corporations will seek “B Corp” certification because, as discussed above, it satisfies their “third-party standard” requirement. On the other side, B Lab does require that all “B Corps” switch, within two years of certification, to a corporate structure that aligns corporate interests with stakeholder interests. For corporations in those states that allow it, that means becoming a benefit corporation. As such, there will be a large degree of overlap between these two groups. Still, it is important to understand the distinction. “B Corp” is a certification. Benefit corporation is a legal status.

Looking Beyond the Statute: Who Would Choose a Benefit Corporation?

As business lawyers, we know that a corporation is not always the right choice for every entrepreneur. Some people just want the limited liability to house an investment, and we would encourage them to form an LLC. Some people just want to run a small family business, and we might encourage them to form an “S” Corp. Some people want to use their company to invest in other companies, and we might encourage them to form a limited partnership (LP). Particularly when working with a first time entrepreneur, figuring out the right business entity is a key part of our jobs. So when might we recommend a benefit corporation? I can think of two types of entrepreneurs or businesses where a benefit corporation immediately jumps to mind: the social activist and the mission-driven company.

The Social Activist

Social activists know what they want, and it’s anything other than a traditional “C” corporation. This year I met my first true social activist, a woman who is starting a co-op delivery service, using the Uber model. I was working with a group of students at UC Hastings, and we spent almost a month trying to figure out the right corporate structure knowing that she was adamantly opposed to the corporate form and I was adamantly opposed to recommending a consumer co-op, a business form offered in California, so early in the process. In the end, the benefit corporation turned out to be the best middle ground, and the client was quite pleased to find out that she could benefit from the corporate form without the negative associations.

For an entrepreneur that is specifically looking to buck the corporate form, the benefit corporation is an excellent alternative to an LLC or cooperative. These entrepreneurs are interested in more than just the label though, they are interested in having a corporation that reflects their values and can always be expected to do so. Since the social consciousness is baked into the dough of the benefit corporation, even many years down the line the corporation will still reflect their values even if it grows in size and takes on new directors and shareholders. For these entrepreneurs, the benefit corporation is about personal expression and realizing their dreams without compromising their principles. As lawyers we often see our jobs in terms of risk prevention, cost effectiveness, and/or cost-benefit trade offs, but sometimes our client’s business vision doesn’t fit neatly into our understanding of what is “best” for them. Social activists often just want to express themselves or be empowered by their business, and the benefit corporation allows them to do that.

The Mission-Driven Company

Not everyone is driven solely by their activism, however. For some sustainable entrepreneurs, it’s about the market. Studies and surveys continue to show that consumers lean toward sustainable products and sustainable companies. In 2014, a Neilson Global Survey on Corporate Social Responsibility found that about two-third of global consumers would choose a sustainable product over an irresponsible competitor, and 52 percent of global consumers actively check the packaging to see if their products are sustainable. The same survey also found that 51 percent of younger consumers would go a step further and pay more for the sustainable product. This means that a wily entrepreneur can cut into a given market and peel away customers if they can offer a sustainable alternative from a mission-driven company.

There are some quite well known examples of the mission-driven company already out there. Method Products, for example, offers cleaning products that use less harmful chemical ingredients and more sustainable packaging than their competitors, which includes cleaning giant Clorox. Between 2008 and 2012, Method went from relying on private equity to doing more than $100M in revenue, with their products gracing the shelves of such retail giants as Target. Following their merger with Ecover in 2012, Method’s revenue shot past $200M in 2015 making them the largest green cleaning supplies manufacturer in the world, and forcing Clorox to release their own line of green cleaning supplies, Clorox Green Works, in order to remain competitive. Other well-known examples of mission-driven company’s offering a sustainable alternative to their competitors include Ben & Jerry’s Ice Cream and Etsy.

Grasping the socially responsible portion of the market or taking it away from a giant like Clorox requires a company to consider how they will prove to consumers that they are the sustainable alternative. A benefit corporation may be a good way of “authenticating” a company as socially responsible, and appealing to the consumer who is looking for a sustainable option. Method, Ben & Jerry’s, and Etsy are all long time members of the “B Corp” community, even before there were benefit corporations out there. Method displays their benefit corporation status prominently on their website, along with a handful of other important labels that serve to authenticate their status as the sustainable alternative in the market. The benefit corporation, therefore, can be a useful tool for a mission-driven company looking to break into a crowded market and carve out a block of consumers looking for sustainable products or services.

Trending Toward the Mainstream: It’s Not Just Social Entrepreneurs Anymore

Current trends suggest that the benefit corporation may become more than just a niche option before too long. The desire to do something good for society or their community is permeating even traditional companies, driven largely by changing demographics and a generation (millennials) who don’t see a division between work and social consciousness. A 2012 survey by Net Impact found that 72 percent of students about to enter the workforce were looking for a job where they could “make an impact,” and 45 percent would even be willing to take a pay cut to work there. The New York Times has also reported that MBA programs are incorporating ethical and social elements into their programs, responding to student demands and market trends in that direction. These trends suggest that the next wave of labor and management will be looking for ways to incorporate ethics and social responsibility into their companies.

Many established businesses have already responded to this trend by incorporating different socially responsible programs. The benefit corporation may be the next logical step for these companies. Kickstarter, for example, recently converted to a benefit corporation because it just fits their younger and more socially conscious company culture better than the traditional corporation. The company wanted to align their corporate structure with its commitment to serving the arts and culture, and announced that it would donate 5 percent of its profits to arts education and organizations fighting inequality. Kickstarter’s founders are all young entrepreneurs, so this is not terribly surprising given the statistics shown above. Whether Kickstarter is an anomaly or a bellwether of conscious companies and entrepreneurs shifting over to become benefit corporations is yet to be seen.

Michael Vargas

Michael Vargas is co-chair of the ABA Joint Subcommittee on Social Entrepreneurship and Social Benefit Entities, and a business and securities attorney at Rimon, P.C. in Palo Alto.