California Creates Two New Classes of Corporation to Empower Social Entrepreneurs
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?
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 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