Benefit Corporations: Good for Shareholders and Stakeholders
In recent weeks, benefit corporations have been in the news. First KickStarter, a well-known funding platform for creative projects, announced that it had amended its charter to become a benefit corporation. Paul Polman, CEO of Unilever announced he was going to work toward bringing Certified B Corporations (which must adopt the benefit corporation structure or its equivalent) to multinationals and the public markets. Finally, Laureate Education, a $4.5B revenue for-profit education company backed by KKR, filed an S-1 with the SEC, seeking to offer shares to the public as a benefit corporation.
These items suggest that new governance structure contemplated by the benefit corporation model is likely to have increasing impact in the capital markets, both public and private. Since Maryland first adopted a benefit statute in 2010, 30 more states and the District of Columbia have authorized benefit corporations, over 3,000 corporations have now adopted the model, and more than 600 LLCs have adopted similar structures. These numbers make it clear that that the legislation answered an unmet need. The strong interest of both small and medium sized enterprises--which make up the bulk of the community today-- and the emerging interest of multinational and public companies like Unilever, shows that this need exists at all levels of business.
This article answers some basic questions about benefit corporations and why investors might favor them.
What Is a Benefit Corporation?
A traditional corporation is governed solely for the benefit of its shareholders. While it might “do well by doing good,” traditional corporate law requires that any do-gooding must ultimately be a strategy for creating shareholder value. In contrast, a benefit corporation is structured for the purpose of creating both public benefit and profits. One simple way to think about the distinction is to imagine that the benefit corporation structure allows for-profit corporations to conduct their business in the same way an ethical entrepreneur might choose to operate her sole proprietorship—with a goal to make a market return, but also an intention to create other benefits for society as well.
The prior absence of such a structure precluded effective use of the corporate form for entrepreneurs or businesses for which commitment to stakeholders was critical. Businesses that sought outside equity investments could not use the corporate form if they wanted a governance structure that made a commitment to any value other than shareholder value. While many might believe that the shareholder value model is optimal, it was hard to imagine why the law should prohibit an institution from opting in to a broader set of commitments—after all, if investors want to commit their capital to an entity committed to creating social value, why should corporate laws prohibit them from doing so?
Benefit corporation legislation fills this void by allowing corporations to opt in to a broader purpose. With approval of the board, and two-thirds of the stockholders, a traditional Delaware corporation can adopt the benefit corporation governance model. Delaware’s statute provides that a benefit corporation is intended to “to produce . . . public benefits and to operate in a responsible and sustainable manner.” In particular, the certificate of incorporation must include “one or more specific benefits,” i.e., “a positive effect (or reduction of negative effects) in one or more categories of persons, entities, communities or interests . . .”
In order to create accountability for this intent, directors are required to balance the interests of shareholders with those of stakeholders affected by the corporation’s conduct and the specific public benefits chosen by the corporation. Shareholders owning at least 2% of the corporation (or $2M worth of stock in a public company) -- and no one else-- can bring a claim that directors failed to properly balance those interests. Moreover, the Delaware statute is drafted so that any such claims must overcome the business judgment rule, and so that failures to balance cannot result in monetary damages (if the charter so provides).
Why Businesses Are Considering the Benefit Corporation Governance Model
There is growing demand for responsible and sustainable business practices. This demand comes from the workforce, which demands meaningful employment; from consumers, who want to buy responsibly; and from geographic and other communities that are affected by corporate conduct. Moreover, responsible business practices are good business practices: one recent survey that looks at 200 academic studies found that 88% of sources found that “robust sustainable practices . . . translate into cash flows.” Accordingly, most businesses are integrating responsible practices into their operations. The level of integration differs of course, as some businesses have a greater need to embrace such practices than do others.
Public market investors also recognize the need for businesses with responsible practices. CalPERS, one of the leading voices for the long term investor, specifically calls out multiple stakeholder concerns in its Investment Beliefs:
CalPERS may engage investee companies and external managers on their governance and sustainability issues, including . . . [h]uman capital practices, including but not limited to fair labor practices, health and safety, responsible contracting and diversity [and] environmental practices, including but not limited to climate change and natural resource availability.
For business models where environmental and social values are especially critical, the benefit governance model can be a powerful tool. It allows a corporation to build relationships based on trust, because its commitment to responsible practices is not contingent on a fiduciary duty owed solely to stockholders. This provides clarity to the markets by ensuring customers, workers and communities that the corporation’s commitments are genuine, and not simply instruments of profit. This clarity creates space for a corporation to work with its stakeholders to create shared and durable wealth. Fred Wilson, founder of Union Square Ventures, made this point in a recent blog addressing the conversion of Kickstarter (which is in Union Square’s portfolio) to a benefit corporation:
There are those who say that benefit corporations and venture capital are not compatible. We don’t agree and we think companies that align their values with their customers and communities will benefit over the long term, not suffer. And that alignment can produce value for shareholders sustainably and profitably.
In contrast, traditional corporations face a legal hurdle in fully integrating responsibility into decision-making, because all decisions must ultimately point towards (and be conditional upon) profit. Moreover, this fact is open and notorious, creating a justifiable lack of trust from all other stakeholders, and severely constrains the ability to collaboratively build shared and resilient value. In his recent book, Firm Commitment, Colin Meyers, the Peter Moores Professor of Management Studies at Oxford, lamented the decreasing ability of corporations to make commitments due to legal and market forces:
That is where the declining ability of owners of corporations to be able to commit is so damaging. It means that those who would otherwise be willing to make commitments will abstain from doing so.
Benefit corporation status solves this dilemma by permitting corporations to make genuine commitments to all stakeholders. The genuine responsibility of the benefit corporation model is qualitatively distinct from responsibility undertaken solely to create shareholder wealth within the traditional corporate model. While many traditional corporations create long-term value through responsible management, they may be able to go further by adopting benefit corporation governance. This step is particularly significant for those companies where stakeholder value is part of the business model, such as consumer facing companies focused on supply chain integrity or workplace issues, or companies with social impact business models. Patagonia is a primary example of the former, and Altschool (which recently raised $100M of venture capital) of the latter. In addition, benefit corporation status can be a valuable tool for companies in industries where there are multiple disreputable actors, where it can serve as a powerful differentiator. The recent S-1 filed by Laureate Education, which states that the for-profit education company will be a benefit corporation, may well serve as a good example of this type of benefit corporation, where its legal commitments to its students as stakeholders may provide greater assurance that it will provide a valuable educational experience.
Why Investors Focused on Return Should Invest in Benefit Corporations
Traditional corporate law has a single touchstone: shareholder value. As a result, any commitment to responsible conduct must be secondary to shareholder value. In contrast, benefit corporation governance allows corporations to adopt business models that include a fundamental commitment to stakeholders and to responsible conduct. Investors may have a concern that in a zero-sum world, this commitment to stakeholders means shareholders will lose. However, it is important to understand that benefit corporations may present opportunities to diversify and obtain competitive returns that are only available from businesses with the broad obligations of a benefit corporation.
These opportunities may come from several sources. In some cases, an entrepreneur may raise equity capital and insist that there in fact be a concession to another stakeholder that reduces the equity return. Investors may nevertheless determine that the concession is simply a cost of doing business and that the risk, return and diversification opportunity is favorable with respect to other investment opportunities.
Moreover, many investors have concluded that responsible business practices that consider all stakeholders can create greater long-term value for shareholders than shareholder-centric model implicit in traditional governance. This paradoxical-sounding conclusion is consistent with the view that the traditional model tends to favor short-term shareholder value over more resilient and enduring value. Many investors also believe that embedding responsible practices into the governance structure reduces risk and the volatility of their investments.
Bonus: The Scaling of the Benefit Corporation Governance Model Will Lead to More Responsible Behavior across the System, Increasing Shared Value and Reducing Systemic Risk
The leadership and strong signaling of benefit corporations will increase market pressure for all corporations to act responsibly, in order to avoid reputational damage and perception of risk. In other words, as benefit corporation legislation and adoption introduces genuine commitment into the business ecosystem, corporations that do not chose to change their governance model will have to find other ways to demonstrate their responsibility in order to maintain their reputations with workers, customers and communities. Perhaps “creating value” for shareholders by off-loading externalities onto the system will cease to be an acceptable business model.
This increased commitment should reduce long-term value destruction and systemic risk created by pressure to create short-term gains. The increased return for all equity market participants can be more important to an investor in the long term than any particular instance where immediate return on a particular investment is conceded because of a corporation’s commitment to stakeholders. Indeed, evolving standards for investor fiduciaries may require such a long term perspective. A recent joint publication of BlackRock and Ceres made this point:
Investment practices that foster intergenerational transfers of risk and wealth raise duty of impartiality concerns for long-term investors. Changes in understanding of systemic risk, and related investment management practices among global peers, demonstrate an ongoing evolution in the prudence standards against which the conduct of fiduciaries is judged.
From this perspective, the new governance model has the potential to address many systemic issues created by the shareholder centric model of corporate law and its incentive to increase share value, whatever the cost.
Originally printed in Law360 (www.law360.com). Reprinted with permission. This article been prepared solely for informational and educational purposes, does not create an attorney-client relationship with the author(s) or Morris, Nichols, Arsht & Tunnell LLP, and should not be used as a substitute for legal counseling in specific situations. This article reflects only the personal views of the author(s) and are not necessarily the views of Morris, Nichols, Arsht & Tunnell LLP or its clients.
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Frederick H. Alexander, “Why More Businesses Are Considering the B Corp. Model,” Law360 (October 22, 2015)