Entity Selection for Social Entrepreneurs
By Kelsey J. Nunez
Social entrepreneurs believe that a for-profit business model can improve environmental quality, community health, and worker well-being while also earning profits. As there is no one-size-fits-all approach to focusing on a triple bottom line (people, planet, and profits), this article provides thoughts to consider when helping social entrepreneur clients decide whether to become a benefit corporation (a legal entity form), a Certified B Corporation (a third-party certification), both, or neither.
Entity selection involves analysis of many issues, including ease of formation, flexibility in management, limitation of owner liability, transferability of ownership, characterization, and allocation of profits and losses, ability to fundraise, and tax considerations. This article focuses on how creating social or environmental benefit fits into this conversation. The idea is to help a client achieve its purpose-driven goals while putting itself in the best legal box(es) for other goals.
Benefit corporations have different rules
In 2010, Maryland became the first state to create a new type of corporation called a benefit corporation. Currently, 34 states have benefit corporations, including Idaho.[i] Idaho benefit corporations are governed by both the Idaho Benefit Corporation Act (Idaho Code §§ 30-2001 et seq.) and the Idaho Business Corporation Act (Idaho Code §§ 30-29-101 et. seq). Chapter 20 imposes requirements that are in addition to, or in lieu of, the general business corporation laws in Chapter 29.[ii] The most significant additions and distinctions in Chapter 20 relate to corporate purpose, standards of conduct, accountability, transparency, and enforcement.
This corporate form was created in response to shareholder primacy litigation.[iii] Strong precedent and philosophical force supported the rule that corporate boards must justify decisions in terms of creating shareholder value. Directors who made choices based upon impacts on the environment, workers, or community, or who chose to reduce or delay profits to help non-shareholders, were getting fired and sued. This legal framework discouraged entrepreneurs from using the corporate form if their business model was centered around creating positive impacts on external stakeholders and non-shareholders.[iv]
Prior to any benefit corporation legislation, many states changed the common law rule of shareholder primacy by enacting “constituency statutes,” which permit consideration of other constituencies, i.e., non-shareholders, in certain situations.[v]
Constituency statutes allow – but do not mandate – consideration of non-shareholders.
Idaho has two constituency statutes. Both the Business Combination Act and the Control Share Acquisition Act state, “[A] director, in considering the best interests of the corporation, shall consider the long-term as well as the short-term interests of the corporation and its shareholders including the possibility that these interests may be best served by the continued independence of the corporation. In addition, a director may consider the interests of Idaho employees, suppliers, customers and communities in discharging his duties.”[vi] Notably, these constituency statutes do not require directors to consider non-shareholders when combining with another business or selling/acquiring a controlling share, and shareholders remain at the top of the hierarchy.
Advocates for social entrepreneurship were not satisfied with constituency statutes because they were limited in scope and permissive in nature. So, they created a new corporate form, the benefit corporation, which made it mandatory to pursue public benefits and consider impacts on non-shareholders.
Benefit corporations opt-in to new statutory duties
Recall that a benefit corporation is subject to the same statutes and case law that govern general business corporations unless the Idaho Benefit Corporation Act provides a different rule. There are many reasons why a social entrepreneur would want to form a corporation, including a defined and well-regulated mechanism for raising money. Assuming your client is already leaning toward a for-profit corporate entity, the question becomes: “should the client be a benefit corporation or a regular corporation?” While there is plenty of overlap, the distinctions are profound.
For example, a benefit corporation’s very purpose distinguishes it from a regular corporation. “A benefit corporation shall have the purpose of creating general public benefit,” which means “a material positive impact on society and the environment, taken as a whole, as assessed under a third-party standard, resulting from the business and operations of a benefit corporation.”[vii]
Benefit corporations may also commit to “specific public benefits,” such as (i) providing low-income or underserved individuals or communities with beneficial products or services; (ii) promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business; (iii) protecting or restoring the environment; (iv) improving human health; (v) promoting the arts, sciences, or advancement of knowledge; (vi) increasing the flow of capital to entities with a purpose to benefit society or the environment; or (vii) conferring any other particular benefit on society or the environment.[viii]
This corporate purpose is a key element in eliminating shareholder primacy constraints. In a benefit corporation, creating value beyond shareholder profits is the point.
Assessing the performance of a benefit corporation requires the use of a third-party standard. Idaho Code does not mandate the use of a particular third-party assessment, but it establishes requirements that narrow the field of options.
The assessment must be “a recognized standard for defining, reporting and assessing corporate social and environmental performance.”[ix] It must also be: (i) comprehensive in how it assesses the business and its impacts on shareholders and external stakeholders; (ii) developed by an entity that is not controlled by the benefit corporation; (iii) credible, in that it was developed by an entity qualified to assess overall corporate social and environmental performance and uses a balanced multi-stakeholder approach to develop the standard, including a reasonable public comment period; and (iv) transparent in that information about the standard is publicly available, including information about the criteria and weighting of such criteria, the identity of those who developed and revised the standard, an accounting of the revenue of sources of financial support used to develop the standard, and disclosures of any potential conflicts of interest.[x]
Benefit corporations are most likely to choose the Certified B Corporation as their third-party standard because it meets all of these requirements. This is by design, as the entity that created that standard, B-Lab, also drafted the model benefit corporation legislation.[xi]
A benefit corporation’s standard of conduct also distinguishes it from a general business corporation. General business corporations have a standard of conduct for directors and officers—they must act in good faith, in a manner that the director reasonably believes to be in the best interests of the corporation, and with the care that a person in a like position would reasonably exercise under similar circumstances.[xii]
The Idaho Benefit Corporation Act goes further by mandating an analytical process when determining what is in the best interests of the corporation.
In a benefit corporation, the directors and officers shall consider the effects on: (i) the shareholders; (ii) the employees; (iii) the subsidiaries and suppliers; (iv) the interests of customers as beneficiaries of the general public benefit or specific public benefit purposes; (v) community and social factors, including those of each community in which offices or facilities of the benefit corporation, or its subsidiaries, or its suppliers are located; (vi) the local and global environment; (vii) the short-term and long-term interests of the benefit corporation, including benefits that may accrue to the benefit corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the benefit corporation; and (viii) the ability of the benefit corporation to accomplish its general public benefit purpose and any specific benefit purpose.[xiii]
For some investors, this shift in how shareholders and profits are prioritized presents unacceptable risks because the managers entrusted with the investors’ capital are not constrained by conventional limits on their discretion and the non-financial results are not as easy to measure.[xiv]
The corporate purpose and standard of conduct requirements for benefit corporations are given teeth by reporting and enforcement mechanisms. Benefit corporations must prepare an annual benefit report that discusses its pursuit of public benefits (including anything that went wrong or did not succeed), explains the third-party assessment used, and discloses compensation and conflicts of interest.[xv]
The statute also creates the Benefit Enforcement Proceeding, the exclusive forum to sue for failure to pursue or create public benefit or for violating the duties or standards of conduct.[xvi] This enforcement mechanism, including how to prevent or prevail in one, is examined in the August 2019 issue of The Advocate.[xvii]
Another option is to become a Certified B Corporation
For a benefit corporation to be the right choice for a client, it must first be the right choice for the client’s entity to be a for-profit corporation. Then, the company must decide if it is ready and willing to commit to a wide range of stakeholders, submit to the judgment of a third-party standard, be transparent in its reporting, and be subject to civil litigation if it fails to pursue or achieve its goals.
Shareholders investing in a benefit corporation must understand that they are not assured of shareholder primacy at any stage of the corporation’s life (operation, merger, sale, etc.). Benefit corporations certainly aren’t for everyone! For those unwilling or unable to utilize a benefit corporation, there are other options.
Any legal entity form can apply to become a Certified B Corporation[xviii]. This process is inspiring and humbling. It sets high standards for practices relating to governance, workers, environment, community, and customers. The “B Impact Assessment” is used by a company to measure its impacts, set goals, learn best practices, and shine as an example of “using business as a force for good.”[xix] Anyone can use this tool to analyze one’s practices (it’s free).
However, it is only companies that get enough points on the assessment that can submit it for review to qualify for certification. During review, staff will verify the responses with data requests. Once verified, the company can sign a contract committing to B-Lab’s high standards. Only then can the company market itself as part of this growing network of gold-star social entrepreneurs. Payment is required each year, recertification happens every two years, and the assessment keeps getting harder as the bar continues to rise.
If your client will form its company as a benefit corporation, it will need to select a third-party assessment, which could be the Certified B Corporation. Note that a benefit corporation is not legally required to achieve certification, but it must use a standard to assess its performance.
If your client will form as an LLC or other non-corporate for-profit entity, and it wants to formally commit to social and environmental benefits, becoming a Certified B Corporation is a bold move. It’s not easy, and it takes a lot of work to make it through the assessment and remain certified every year. But it’s the best option to publicly declare a commitment and stay accountable for showing results. I am not paid to advertise for B-Lab, so I will keep my cheerleading to a minimum. But I do encourage companies to at least take the assessment and see what it illuminates.
Any entity can use the B Impact Assessment to examine how it can improve its triple bottom line.
Other entities must prioritize goals
If your client does not want to form a benefit corporation or earn a Certified B Corporation designation, what then? I suggest having meaningful conversations about goals, intentions, and strategies. Clients must determine what they are willing and able to commit to. They can insert self-created standards into their operating agreements or implement policies or programs to act on their values. Many companies already do this (e.g., worker wellness programs, volunteer days, nonprofit sponsorships, flexible work hours, etc.). In these situations, the company won’t earn the accolades or benefit from the marketing opportunities of the certification, but it can still do good work.
Deciding how to operate one’s business is complex. As legal counselors, we have the opportunity to get to know our clients and help them analyze the costs and benefits of their options. Some businesses are willing to opt in-to extra rules to prove their commitment to social and environmental benefits, and some are not. This article should help your clients identify where on the spectrum they feel most comfortable.
Kelsey J. Nunez’s boutique practice is dedicated to social entrepreneurs and collaborative culture. She is available to consult with fellow attorneys who have clients interested in integrating these new tools and models. In addition to lawyering, Kelsey owns The Vervain Collective, a plant-based apothecary with a natural health treatment room in Garden City.
[i] See State by State Status of Legislation, BenefitCorporation.net,https://benefitcorp.net/policymakers/state-by-state-status (last visited August 30, 2019). Most states have deviated from the model legislation (especially Delaware), so readers should review the statute of the desired state of incorporation.
[ii] Idaho Code § 30-2001(4).
[iii] I have addressed this topic in previous issues of The Advocate. See Kelsey Jae Nunez & Mark Buchanan, New Corporate Form Provides More Options for Social Entrepreneurs, 60 The Advocate 42 (Aug. 2017); Kelsey Jae Nunez, Enforcing the Benefit Part of Benefit Corporations, The Advocate (Aug. 2019). For a well-rounded analysis of case law, legislative history, and academic literature that inspired the creation of the benefit corporation, see generally Frederick H. Alexander, Benefit Corporation Law and Governance: Pursuing Profit with Purpose (2018) (especially Part 1: Shareholder Primacy and Its Discontents). See also FAQs, BenefitCorporation.net, https://benefitcorp.net/faq (last visited August 30, 2019).
[iv] Many authors have argued that existing corporate law was sufficient and a new entity was not required. For example, see Janet E. Kerr, Sustainability Meets Profitability: The Convenient Truth of How the Business Judgment Rule Protects a Board’s Decision to Engage in Social Entrepreneurship, 29 Cardozo L. Rev 623 (2007) (I was a student research assistant on this article). The argument still has merit, although the benefit corporation provides clearer protection than the Business Judgment Rule.
[v] Chapter 9 of Benefit Corporation Law and Governance: Pursuing Profit with Purpose, analyzes constituency statutes and case law governing their applications in various fact patterns.
[vi] Idaho Code §§ 30-1602, -1702.
[vii] Id. §§ 30-2006(1), -2002(5).
[viii] Id. § 30-2002(9).
[ix] Id. § 30-2002(11).
[xi] B Lab, bcorporation.net, https://bcorporation.net/about-b-lab (last visited August 30, 2019).
[xii] Idaho Code §§ 30-29-830(a)-(b), -842(a).
[xiii] Id. §§ 30-2007, -2009. Other factors may also be considered, and none of the factors have to be prioritized over the others. Id.
[xiv] Several authors have written about the real and perceived downsides of benefit corporations. See Ronald J. Columbo, Critiques of the Benefit Corporation, Law of Corp. Offs. & Dirs.: Rts., Duties & Liabs. § 22:20 (2018); Sarah Dunn, What is the Benefit of Benefit Corporations? 9 Hous. L.R. 82 (2019); Kennan Khatib, The Harms of a Benefit Corporation, 65 Am. U. L. Rev. 151 (2015).
[xv] Idaho Code §§ 30-2012, -2013.
[xvi] Id. § 30-2011.
[xvii] Kelsey Jae Nunez, Enforcing the Benefit Part of Benefit Corporations, The Advocate (Aug. 2019). This article also discusses various methods used to measure return on investments into social and environmental impacts.
[xviii] See Certified B Corporation, https://bcorporation.net/ (last visited August 30, 2019).
[xix] See B Impact Assessment, https://bimpactassessment.net/ (last visited August 30, 2019).. “Using business as a force for good” is a trademarked phrase of B-Lab. B Lab, bcorporation.net, https://bcorporation.net/about-b-lab (last visited August 30, 2019).