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California Creates Two New Classes of Corporation to Empower Social Entrepreneurs

  • by
  • October 12, 2011
  • 11:57 pm
California Creates Two New Classes of Corporation to Empower Social Entrepreneurs
Even as Wall Street is being occupied and corporations are reviled, there is a revolution quietly raging across the country that empowers corporations to be a strong force for good. This week, California joined that revolution when Governor Jerry Brown created two new classes of corporations for businesses that seek to pursue both profit and purpose: Benefit Corporations and Flexible Purpose Corporations. 

These new legal structures are revolutionary in two ways. First, they broaden the duty of a company beyond maximizing shareholder value to include maximizing stakeholder value, such as operating the business in an environmental and social responsible manner. Second, they increase transparency and accountability.

Though it is the first state to pass the Flexible Purpose Corporation type, California is the sixth state to approve the Benefit Corporation classification. Here is a look at exactly what Benefit Corporations and Flexible Purpose Corporations are, and what they could mean for your company.

What’s the problem with the existing system?

Under current corporate law, a company’s sole mandate is to maximize shareholder value — make as much profit as possible – for its shareholders. If a corporation’s board of directors makes decisions based maximizing stakeholder value – which include shareholders, the environment, community, employees and suppliers – and those decisions adversely affects the profits of the corporation, the shareholders may file a lawsuit against the directors of the corporation for failing to maximize shareholder value. This tension between maximizing shareholder value and maximizing stakeholder value is most likely to cause a shareholder lawsuit when the company is being acquired.

This, obviously, this poses a huge problem for socially and environmentally responsible corporations since their mission driven decisions can end up in a shareholder law suit.

What is a Benefit Corporation?

The Benefit Corporation is a new class of corporation that allows companies to pursue profit as well as a strong social and environmental mission.

The new Benefit Corporation structure addresses this problem in two primary ways.

  • First it mandates that, in addition to shareholders, the board of directors take the environment, community, employees and suppliers into account when they make decisions. This is known as the shift from maximizing shareholder value to maximizing stakeholder value.
  • Secondly, it mandates a high level of transparency and accountability. Within 120 days after the end of each fiscal year, a Benefit Corporation is required to publish a Benefit Report, which states how the Benefit Corporation performed that year on a social and environmental axis. The Benefit Corporation is held to a third party’s independent assessment that measures social and environmental impact. The most prominent is currently B Labs Assement. The Benefit Corporation has to then share this assessment of its performance publicly, which increases transparency and accountability.

What is a Flexible Purpose Corporation?

Benefit Corporations and Flexible Purpose Corporations are, by and large, similar legal structures. However there is one primary difference between these two pieces of legislation: The Flexible Purpose Corporation (FPC) allows a corporation to select a specific mission, in addition to profits, that it will pursue. 

Just like the Benefit Corporation, a Flexible Purpose Corporation broadens the duties of its board of directors, from solely maximizing shareholder value to also pursuing an additional purpose that is clearly stated in the FPC’s organizing documents.

The Flexible Purpose Corporation allows the directors to choose a their own “special purpose,” such as employing people from an underprivileged community. The FPC must clearly state its specific purpose, outline goals to achieve that purpose, and publish an annual report disclosing how well it has achieved that purpose. The premise is that clearly stating the positive purpose of the company and being transparent in an annual report will create better business.
The special purpose chosen by a FPC can be anything that generally benefits society, but can include the following:
  • One or more charitable or public purpose activities that could be carried out by a California nonprofit public benefit corporation.
  • The purpose of promoting positive short-term or long-term effects of the Flexible Purpose Corporation’s activities upon stakeholders, the community and society, or the environment.
  • The purpose of minimizing adverse short-term or long-term effects of the corporation’s activities upon stakeholders, the community and society, or the environment.

What are the advantages of these structures?

The benefits of these new structures for a company are, first, that it has the ability to make decisions that are in the best interest of all stakeholders without risking a shareholder suit. Second, it allows a company to differentiate itself from any competing companies that are green washing.

The benefits for shareholders are that they can now invest in companies that are serious about running in a sustainable manner.
By mandating that corporations only focus on profits, the current system almost assures a negative outcome for society. By mandating stakeholder primacy and increasing transparency and accountability, directors are freed up to use the market as a force for good without risking suit from their shareholders.

Is it right for your company?

You should use either of these new forms if you are serious about operating a sustainable business, and if you are comfortable enough to allow the public to see how well you are performing. If you just want to greenwash your business, or want to look socially conscious without actually changing your core business model, then these new classes of corporations will just make you look ridiculous.

I think the best analogy is, if you’re going to be naked, you’d better be buff.

Kyle is a Cordes Fellow. He lectures at Harvard Law School and Stanford Law School. He launched Socentlaw – a blog about the legal side of social enterprise. Kyle has been featured by We Are NY Tech and Dowser; and writes for Huffington Post, Venture Beat, GOOD, and Social Earth. He is Chairman of the Board for both the Excel Charter School in Brooklyn and The Adventure Project – a nonprofit that seeks to add venture capital to social entrepreneurs in the developing world. Twitter – @kylewestaway & @socentlaw

 

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83 comments

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2:26PM PDT on Oct 24, 2011

Great idea!
Anything to see profit contingent on higher priorities being met - environmental and social responsibilities being the two key ones!

4:42PM PDT on Oct 21, 2011

California could do something that makes a helluva lot more economic sense than this new subsidy to "social" enterprise (aren't there already TOO many such plans in California?) and that would be to lower taxes, cut government size, sharply reduce regulation, and reduce their pension outlays.

Shuffling about the shrinking amount of money taken from the shrinking pool of businesses and actual California taxpayers does nothing to solve the state's fiscal problems. Picking and choosing reasons for supporting entities in the state is just another problem any business insane enough to locate there will have to deal with.

But the actions the state could do that MIGHT just slow or reverse the numbers of job creator shrinkage looks like it will be bypassed to play more governmental favorites. A single party state that fails like California is doing probably needs a miracle now though so maybe its just too late.

7:17AM PDT on Oct 20, 2011

Great idea I hope this gets done everywhere.

8:04PM PDT on Oct 18, 2011

Lillith M, I too have wondered about that shareholder responsibility. Maybe it's because many shareholders are middle and upper class, and they don't want to face that much of their profit is because lots of people way down the line in the production trenches are paid poorly so more profit can be had.And that making stuff requires natural resources,and polution is a by product.And if the profit is made thru speculating or intrest income, then they're even further removed from the source [Earth, working class].

12:16AM PDT on Oct 18, 2011

Thank you, this sounds good.

8:14PM PDT on Oct 17, 2011

I'm all for less greed and more benefit!

4:45PM PDT on Oct 15, 2011

California is again on the cutting edge of social reform. Kudos to them.

11:20AM PDT on Oct 15, 2011

A big step in the right direction

3:37AM PDT on Oct 15, 2011

interesting

9:24PM PDT on Oct 14, 2011

This is excellent - may these models be a force for change in the corporate structure.

Which alarms me that shareholders are in these cases the ones who should be held responsible for what many corporations do. In a sense, this is the way voting with ones dollars is what moves the wheels of commerce and corporations - it's all of those people who are investing through the stock market who can be the force for change - and that is a lot of people, who may be completely unaware of what their investment is being used for. It's not just the guys at the top - it's the shareholders as well, and the CEO's will be the first to say "we have to do it for the shareholders". How come nobody ever discusses how to mobilize shareholders for the energy to cause change in the corporations? This seems an interesting place no one has ever quite gone.

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