Social Enterprise Law: Trust, Public Benefit and Capital Markets

Dana Brakman Reiser & Steven A. Dean

216 pages, Oxford University Press, 2017

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Too often, law has been painted as a villain frustrating the efforts of social entrepreneurs to build ventures dedicated to pursuing profits for owners and benefits for society. This book argues that law should instead be seen as a powerful tool to align the incentives of social entrepreneurs and investors and enhance dual mission ventures’ access to capital.

The book develops a range of legal technologies to help social enterprises grow and scale, including hybrid financial instruments, a tax credit to fuel crowdfunding for social enterprises, and exit planning strategies. The excerpt below argues governance, too, could serve this purpose, but only if early efforts like the benefit corporation are bolstered by social mission prioritization and effective enforcement. While existing specialized legal forms empower adopting entities and their fiduciaries to serve dual goals of generating profit and social good, their permissive “do both” approach provides little guidance to managers and no assurances to social entrepreneurs and investors. Below, we propose a mission-protected hybrid (MPH) form that could impose a prioritization mandate and offer a range of enforcement mechanisms – placing a kind of speed limit on profit.—Dana Brakman Reiser

Legislation creating the mission-protected hybrid (MPH) form will first address prioritization in a provision on proper purposes. Adopting entities will be explicitly permitted to earn and distribute profits, but will also be unambiguously required to prioritize their pursuit of social good. In simple, straightforward language the statute would say: “Corporations organized under this chapter will pursue both social good and profit for owners, but pursuit of social good will be prioritized.” Requiring social mission to be prioritized, rather than pursued exclusively and at all costs, leaves room for adopting entities to take many profit-maximizing actions. Imposing the mandate as a purpose requirement makes clear that every decision need not demonstrably prioritize social good over profit. Rather, the mandate demands only that a social enterprise organized as an MPH be able to show that it prioritizes social good in the aggregate.

This nonexclusivity echoes the charitable purpose requirements found in nonprofit corporate law. After all, a museum organized as a charitable nonprofit formed to pursue educational goals can certainly choose to discontinue a lecture series when its attendance falls below the number sufficient to justify the costs of hiring the speakers. It may do so even if this decision reduces the education remaining attendees might have received, and even if it increases the entity’s revenues, profits, or both. Likewise, an MPH organized to manufacture and distribute low-cost lanterns in the developing world in an effort to combat poverty need not violate the prioritization mandate by choosing a supplier that produces the metal sheeting it needs at the lowest price point. It may do so even if patronizing higher priced suppliers would result in higher pay for some low-income manufacturing workers. As long as the entity’s broader constellation of actions prioritizes its antipoverty mission, individual decisions will not run afoul of the relevant purpose requirements.

On its own, the purpose requirement will not adequately protect an MPH’s mission. The prioritization mandate must also be incorporated into its fiduciary standards. As in other corporate contexts, MPH fiduciaries will be required to discharge their duties carefully, and in a manner they reasonably believe to be in the best interests of the MPH. But MPH legislation will define the best interests of the MPH as prioritization of social good. The prioritization mandate will not only constrain, but will also provide helpful guidance to fiduciaries. When faced with the inevitable trade-offs between enhancing profit for owners and generating greater social good, directors and officers can ask themselves, “If I opt for greater profit in this decision, can I still reasonably argue that the organization prioritizes social mission?” Courts evaluating fiduciary decision-making will also be able to employ this lens. Of course, reviewing courts can be expected to offer some deference to organizational leaders. Still, the potential for prioritization to be reviewed should impel fiduciaries to make an implicit or explicit assessment of the trade-offs between profit and social good as they run their enterprises, and to resolve close cases in favor of social mission. With prioritization elements plainly provided by the MPH statute, all stakeholders will be put on notice of this important organizational bias.

Anticipating Critiques

If social ends can be well served by an organization engaged in both social good production and profit generation, the legal form developed to house them cannot amputate one.

Critics of the prioritization standard might decry it as vague, noting in particular its failure to define “social good.” But the absence of a definition is a feature of MPH legislation, not a bug. The term, like the legal concept of charity, cannot help but be capacious. Social good under an MPH statute will include the broad range of traditionally charitable activity, as well as pursuing the interests of the great variety of organizational stakeholders by benefiting employees, improving the local economy, conserving environmental resources, and any other lawful vision of creating good for society. MPH status would offer founders no significant legal benefits beyond its branding value and a more aptly structured organizational form with access to limited liability. As limited liability is already widely available under a range of existing legal forms, MPH legislation can afford to be generous. MPH legislation will create a recognizable brand not by circumscribing the type of social good adopting entities can pursue, but by requiring them to prioritize their chosen social goals over profit for investors.

To some, prioritization’s emphasis on cumulative social good will also seem nebulous. More clarity for adopting entities and their leaders could come from stripping away one of the two competing goals: profit or purpose. But narrowing the obligations of MPHs and their leaders to a single goal would betray the core of the double bottom line. After all, the uncertainty as to how much social good and how much profit an MPH must produce flows from the dual nature of the social enterprise concept itself. If social ends can be well served by an organization engaged in both social good production and profit generation, the legal form developed to house them cannot amputate one. Moreover, the result would merely replicate the single-purpose nonprofit or for-profit forms already available.

Legislatures might attempt to provide guidance by requiring adopting entities to show that a certain percentage of their efforts pursue social good. The right percentage might be a bare majority, or perhaps something greater, and effort would need to be reduced to some measure, such as expenditures or revenues. Despite the appeal of such a reductive approach, we advocate the more open-ended legislative standard. Access to an organizational form is policed lightly at the outset. State officials receiving a request for MPH status could not effectively test the prospective claims applicants would make about meeting these percentage requirements. Instead, as discussed below, MPH legislation would utilize a rough preponderance-of-expenditures rule to anchor a mandatory annual review process to safeguard the statutory prioritization mandate.

The Need for Enforcement

A prioritization mandate will be a paper tiger unless MPH legislation also provides some means of enforcement. Building the mutual trust necessary to solve the stag hunt problem preventing social enterprise founders and would-be investors from capitalizing their ventures requires more than aspiration. For adoption of a legal form to function as a strong brand, there must be quality control. People buy Coke because they trust they will be getting a very particular type of fizzy, sweet brown liquid in each can. If consumers learned (the hard way) that some cans instead contained motor oil—or even iced tea—the strength of the brand would dissolve. Likewise, for a legal form to work as a brand, its prioritization requirement must be reliably enforced. The branding work of a legal form begins by recognizing the responsibility adopting entities have to prioritize social good. For the brand to convince investors and entrepreneurs to risk their money and their dreams on each other, however, the form must provide protection rather mere acceptance.

Unfortunately, this task requires far more manpower than formulating and enacting new legal standards for entities and their fiduciaries. The work of enforcement mechanisms will not be done when a legislature approves a statute and a governor signs it. They must be designed not for the showroom, but for the road. They will succeed only when they can be relied upon to use the MPH form to motivate, if not force, entities to be truly different from standard for-profits.

The MPH form will incorporate an array of enforcement mechanisms, aimed at creating confidence in the strength of its brand. Some operate at formation, limiting access to MPH status at the outset. The more potent enforcement tools subject adopting entities to continuing review for compliance with the prioritization mandate, especially at the moment when entities seek to exit the form. This arsenal of overlapping enforcement techniques also draws on a deep pool of enforcers, including government officials, private certifying bodies, investors and other stakeholders, and even potential competitors. Many are adapted from methods used in policing for-profit and nonprofit entities and their leaders, but each is carefully adjusted to take account of the social enterprise context.