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Choice of Social Enterprise Business Entity Types

In recent years, a wave of mission-driven start-ups have emerged that are seeking to combine goals of social responsibility, sustainability and profitability. Start-ups that want to commit to doing good while maintaining a for-profit business model have several options for how to structure their business entity.

C-Corporation

One option is to form a traditional C-Corporation. The usual considerations such as choice of state for incorporation will apply. With a regular C-Corporation, rather than integrating the company’s social purpose will not be built into its legal structure, but the company can still orient toward sustainable practices and socially conscious business decisions. Any for-profit entity can also be certified as a “B-Corporation” by the nonprofit organization B Lab if the company applies and meets the B Lab’s requirements (to be clear a “B-corporation” or “B-corp” is a third party certification and not a legal entity or legal status).

Corporate Governance

Although a fundamental principle of corporate law is that directors of a corporation have a duty to maximize shareholder value, many company decisions that skew toward social responsibility or sustainability would be difficult to challenge, since directors also have wide latitude under another corporate law concept known as “the business judgment rule” which is very deferential in toward director business decisions. Still, in general directors do have to think about the bottom line, and there may be some instances where a decision that clearly detracts from shareholder value that could be challenged. In the event of a company being sold, maximizing shareholder value has elevated importance -- a legal doctrine known as “Revlon duties” (arising a 1980’s case Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.) requires directors to take reasonable steps to sell the company at the highest price.

California or Delaware LLC

The usual considerations in deciding between an LLC vs C-Corp will apply to social enterprises. The LLC operating agreement is flexible and highly customizable, so a social purpose can be written into the company’s operating agreement and considerations of social purpose can be built into other parts of the operations of the company, such as by giving favorable treatment to mission-aligned investors. In Delaware, LLCs can explicitly contract through the operating to elevate social and environmental objectives over fiduciary duties. In California, however, LLCs still have to prioritize fiduciary duties.

California Social Purpose Corporation (SPC)

(previously known as a California “Flexible Purpose Corporation”)

An SPC is a spin on the traditional C-Corp for company. The name of the company must include the words “social purpose corporation” or “SPC,” and the Articles of Incorporation must set out a social purpose. The social purpose can be to positively impact employees, suppliers, customers, the broader community, the environment or some combination of these.

Corporate Governance

In making decisions, directors are supposed to consider the SPC’s overall prospects, shareholder interests, and the social purposes of the SPC set forth in its articles. Directors have flexibility to weigh each factor as they see fit.

Reporting and Transparency

The SPC is required to produce an annual report that includes financial statements and a discussion of how the company fared with regard to its social purpose objectives. Directors are also required to notify shareholders within 45 days of any significant expenditures or decisions to withhold an expenditure for furthering the SPC’s social purpose. The reports are also to be made available on the company’s website and at shareholders’ requests.

California Benefit Corporation

A Benefit Corporation is another spin on the C-Corp. A California Benefit Corporation must state in its articles that it is a Benefit Corporation and set out a purpose of creating a general public benefit and may also include other specific public benefit purposes.

Fiduciary Duties

In making decisions, directors must consider multiple factors and stakeholders including employees, customers, the local community, the environment, short and long term interests of the corporation, and the the ability of the corporation to accomplish its public benefit purposes. Directors have discretion as to how to weigh each factor.

Reporting and Transparency

CA Benefit Corporations are required to provide an annual report assessing their social and environmental performance, but unlike SPCs, Benefit Corporations have to use a third party standard that meets certain requirements. The assessment must be made available online on the company’s website.

Accountability.

In addition, enforcement proceedings can be brought against directors or officers for violating their duties to work toward the company’s public benefit purposes. Only injunctive relief is available (no monetary damages). This kind of proceeding can be brought by the company itself, by a group of shareholders holding an aggregate of at least 5% equity, or derivatively by a shareholder or director.

Delaware Public Benefit Corporation (PBC)

A Delaware PBC is similar to a California Benefit Corporation with a few notable differences. The name may include the words “Public Benefit Corporation” or “PBC” but it is not required. The purpose of the PBC must be set forth in the Certificate of Incorporation and must include a purpose “to operate in a responsible and sustainable manner” AND identify one or more public benefit purposes

Corporate Governance

Directors are required to balance financial interests of shareholders with interests of others materially affected by the company’s conduct and consider the company’s public benefit purposes.

Reporting and Transparency

PBC’s are required to provide biennial reports to shareholders assessing the company’s performance in relation to its public benefit purposes. Using a third party standard for reporting purposes is optional and public posting of reports is also optional.

Accountability

Shareholders holding individually or in aggregate at least 2% equity have a private right of action to enforce PBC purposes.

For companies that wish to commit to a social purpose and stay true to their mission, establishing a social purpose corporation or benefit corporation can help the company avoid mission drift over time.