New California hybrid corporate form could bring mainstream capital to social enterprises

The Flexible Purpose Corp. is being pushed in the Senate

A bill in the California legislature, SB 201, sponsored by state senator Mark DeSaulnier, proposes a new corporate form that marries money and mission. The idea is to allow social enterprises, which are often organized as either non-profits or for-profit/non-profit hybrids, to access capital from mainstream investors. As a Flexible Purpose Corporation (Flexible Corp.), a company could make profits while pursuing at least one do-good purpose akin to the charitable missions traditionally pursued by nonprofits, or promote the interests of employees, suppliers, customers, creditors, community or public interests like the environment. Although early adopters are expected to be social enterprises engaged in activities like microfinance, this for-profit/nonprofit hybrid corporate form could accommodate any kind of company—public or private, big or small, high-growth or slow-growth. While directors of these companies may forego maximizing long-term profits in favor of a special purpose, the Flexible Corp. would also require a high level of transparency regarding the company’s special purpose. “Without transparency in this area,” Todd Johnson, partner at Jones Day told Responsible Investor, “there is a risk for investors that directors will waste corporate assets without accountability.” Johnson co-chaired the working group of ten lawyers representing diverse interests (impact investors, nonprofits, the Chamber of Commerce, the state bar, corporations, etc.) who hashed out the legal issues around marrying money and mission for 18 months in an effort to invent a new corporate form. According to Johnson, California is home to more companies seeking to mix money and mission than any other state. Despite their doggedly charitable missions, though, cutting edge social entrepreneurs who create low profit “businesses” can be too innovative to fit into the boxes permitting nonprofit status by the IRS. Other nonprofits are creating for-profit subsidiaries as a way to access more capital. But there are limits to the types of capital even a non-profit’s for-profitsubsidiary can attract. It’s best if the for-profit is mission-driven so that the parent non-profit does not lose its tax-exempt status. But this is not something usually permitted by the rules for corporations, which, as products of trust law, are generally determined by either statute or the courts as a part of a director’s fiduciary duty. Limited liability corporations (LLCS), in contrast, are products of contract law, which means that trade-offs between money and mission can be written into their operating agreements. As a result, most for-profit subsidiaries are structured as LLCs, a corporate form that institutional investors generally avoid due mostly to tax laws. The Flexible Corp. would resolve these dilemmas by allowing hybrid social enterprises to simplify their structures and convert entirely to for-profit status. The Special Purpose puts shareholders on notice that the corporation will pursue interests that may not align with profit maximization. In this way, Johnson says, the Flexible Corp. broadens the protections for directors when they exercise their fiduciary duty, encouraging them to engage in socially beneficial decision-making including, potentially, at the expense of maximizing profits by helping them to avoid litigation. “Boards of directors are incredibly risk-averse,” Johnson says. “As a practical matter, they become consumed with the concern that if they don’t maximize profits, they are going to get sued.” This protection only applies to directors of companies that have chosen by a two-thirds supermajority shareholder vote to become Flexible Corps. Another provision provides dissenters’ rights whereby dissenting shareholders can be cashed out, particularly where a company is private and there is no liquidity. “This acknowledges that the proposal changes the rules of the game in a substantial manner,” Johnson says. “Dissenting shareholders should not be dragged into a new form against their will.”