Social Businesses Come in Many Legal Forms

I asked an entrepreneur recently why she wanted to incorporate her business as a benefit corporation.  Her response:  “Because it’s awesome.”  After more prodding, she went on to explain that although she did not know any of the details about the benefit corporation, she knew that it reflected her values in terms of how businesses should be operated.

It is undeniably awesome that entrepreneurs have a choice of not one, but now three different forms of entities that allow for alternative governance structures.  It is important, though, to think critically about the different options, and to understand that the best choice for a particular social business may be none of the new forms.  The details matter, and it does not help anyone if a structure reflects a business’ values but impedes its ability to execute on critical components of its financial plan.

So, I’m glad that the recently adopted California laws creating the Flexible Purpose Corporation and the Benefit Corporation do not take effect until January 1, 2012.  The delayed effectiveness will, hopefully, allow for some of the hype to die down and misinformation to be corrected, so that entrepreneurs make well informed decisions about the form of entity that is appropriate for their particular business.

On the hype:  it is important to remember that there a number of factors that must be considered before choosing a particular corporate form.   It would be a big mistake to think that just because you operate or plan to start a business with social objectives that you must (or should) migrate to one of these new corporate forms.   In a later post, I will provide more details on some of the considerations that go into this decision, but here’s a short starter list:

• Is a corporation the right form for tax purposes?  Keep in mind that limited liability companies and cooperatives have potential tax benefits that are unique to those forms.
• How will prospective investors respond?  This question is particularly important for companies that may want to attract capital from more mainstream sources.
• What are the increased costs associated with the reporting and other requirements of these new forms?
• What will be the demands on managements’ time to comply with these new governance standards and procedures?

On the misinformation:  a much tweeted New York Times article that references the Flexible Purpose Corporation contains so many inaccuracies and misleading statements that I may cancel my subscription.  Todd Johnson points out a few of the mistakes in his blog.  I wish I had the time to address the others.

The most misunderstood aspect of this conversation is the potential liability for directors of traditional corporations with social objectives.   In my opinion, the liability concern is overstated – or at least over simplified – by almost everyone who writes on the topic.   For a comprehensive discussion of director fiduciary duties in the context of a business with social objectives, see this law review article.  It is interesting to note that the law professor authors conclude that corporate law did not compel the Ben & Jerry’s founders to sell their company.  The sale of Ben & Jerry’s to Unilever, of course, is the most often cited example of why entrepreneurs with social objectives need to seek out alternative corporate forms.

Before any of these new corporate forms existed, I would sometimes have a client come into my office (I know, old school) and tell me that they wanted me to form a particular kind of entity for them based on advice from their accountant, or a friend or the research they did on the Internet.  Not once did I agree to form an entity without first understanding – and often challenging – the client’s assumptions around why they had decided on that particular form.   Often after such a conversation we agreed that the client’s initial decision was a good one, but a good amount of the time we concluded that a different approach made more sense.

In my opinion, we as social enterprise lawyers have a responsibility to engage in the same kind of rigorous analysis of a client’s decision to use one of the new corporate forms, especially given all of the hype and misinformation that is currently rampant in social and traditional media.  At the end of the day, legal form is just a tool, and what matters most is how the tool is used.  A social business should be defined by its positive impact on society, not by the corporate identifier that comes after its name.