The Benefit Fund

(Photo by iStock/oatawa)

With the creation of the first private investment funds that were intended to pursue social goods in addition to financial returns—commonly referred to as “impact funds”—impact-oriented investors were able to pool their resources and enlist the assistance of professional fund managers in carrying out their aims. While impact funds were a great step forward, they are still held back by a variety of factors: a lack of clarity as to what an impact fund is, a lack of trust due to real or alleged “greenwashing,” and a lack of appropriately balanced incentives for fund managers.

We believe that the next step in the evolution of impact investing is the Delaware statutory public benefit limited partnership, or “benefit fund,” an investment fund structure that has been used by Samaritan Partners Fund I, LP—a benefit fund the authors have had the privilege of advising. Like its corporate analog, the “benefit corporation,” a benefit fund provides certainty around how public benefit will be pursued alongside financial returns, while otherwise maintaining the flexibility that makes the limited partnership the standard form for nearly all US investment funds. We hope that this article will raise awareness of the benefit fund model and begin a conversation about how it can be best improved and utilized going forward. As it currently exists, the benefit fund already solves several key issues plaguing impact investing, which we will explain. However, there is also still progress to be made: We believe that updates to Delaware’s benefit fund statutes, certifications like those that exist for benefit corporations, and standardized documents that reflect best practices for benefit funds would make the benefit fund the gold standard and maximize the capital invested in companies pursing social goods.

What is a benefit fund and how does it differ from other funds?

Traditional venture capital funds and private equity funds pool capital and make investments in order to maximize financial returns for investors, and impact funds expand their objectives to include social impact as well. But, like traditional funds, impact funds are nearly always formed as Delaware limited partnerships, which provides substantial flexibility in determining how the fund will operate, permitting impact funds to seek social impact alongside, or even ahead of, financial returns. However, this flexibility creates ambiguity and has its downsides: Different impact funds can have substantially different terms, raising costs and increasing the burden on investors seeking to determine whether an impact fund will strike a balance between social good and financial return that aligns with their expectations and values.

The flexibility of the Delaware limited partnership stands in contrast to the rigidity of Delaware law for corporations. This rigidity provides clarity for investors and directors, but was insufficient to allow Delaware corporations to seek social good without justifying it in terms of increasing value for stockholders, preventing traditional Delaware corporations from pursuing social good for its own sake or on equal footing with financial returns. As a result, in 2013 Delaware created a new type of entity, the Delaware public benefit corporation, to provide the flexibility needed for corporations to expressly pursue social impact alongside financial returns (commonly referred to as a “benefit corporation,” though distinct from the “B Corporation” certification provided by B Lab).

The benefit fund draws from both: maintaining the flexibility of the Delaware limited partnership while adopting the rigidity of the benefit corporation. The three key features that define a benefit fund are:

1. An obligation to balance pursuit of a specified public benefit, impact on stakeholders, and investors’ financial interests (the three “benefit considerations”)
2. A special reporting obligation on the benefit fund’s investment activities and impact, and
3. A statutory enforcement mechanism through which investors can hold the fund’s manager accountable.

The result is certainty for both investors and fund managers. Investors know that, without exception, each benefit fund in which they invest will have these elements, while fund managers are provided with a roadmap for operating the benefit fund towards its social and financial aims.

How does the benefit fund solve key issues plaguing impact investing?

The benefit fund can potentially solve three issues that have so far prevented the impact investing community from realizing its potential.

1. Definition: There is no clear definition of what makes a fund an “impact fund” or how it must operate. One impact fund might contain a legal obligation to pursue social impact in its partnership agreement while another might only have a non-binding commitment to invest in companies who have programs to promote diversity, equity, and inclusion. As a result, impact-focused investors are forced to spend time and resources determining whether a particular impact fund aligns with their values and contains enforceable terms regarding the fund’s efforts to pursue social goods or whether they are comfortable relying on the good faith of the fund’s manager to carry out their intentions. The benefit fund model ensures that the fund’s manager always has an enforceable legal obligation to balance the benefit considerations and is required to provide investors with reporting on the fund’s impact, thus streamlining the due diligence process.
2. Trust: Accusations of “greenwashing” can erode trust in the impact investing movement, and social impact sometimes takes a back seat to financial returns, serving only as an exercise in “checking the box” before an investment is made. The benefit fund model helps protect against both greenwashing itself and allegations of greenwashing by providing an enforceable standard against which a fund’s activities can be measured, thereby giving investors tools to hold the fund’s manager accountable.
3. Manager Incentives: By modeling impact funds on traditional funds, the economic incentives and protections for fund managers have largely tilted impact funds’ emphasis away from pursuing social impact, to the extent it does not align with the possibility of large financial returns. Traditional private funds provide strong legal protections for fund managers, often requiring the manager commit fraud or other intentional actions that have a material negative effect on the fund before the investors can bring a legal claim. When those protections are combined with performance-based compensation, fund managers have a strong incentive to seek substantial financial returns while doing the bare minimum with respect to social impact. The benefit fund addresses this issue through mandatory legal obligations and a stringent enforcement mechanism which can be used to ensure fund managers strike an appropriate balance between social and financial returns.

There is also room to improve the benefit fund model itself. Specifically, drawing on learnings from the benefit corporation movement, the benefit fund may be enhanced through alterations in the benefit fund’s statutory framework, the creation and adoption of standards (e.g., a “B Fund” certification), and the development of best practices (e.g., a set of model documents for benefit funds, like those created for traditional funds by the Institutional Limited Partners Association). This process can accelerate the virtuous cycle through which benefit funds allocate capital to companies with a positive social impact and those companies return profits to the funds, each in turn expanding the pool of capital used to further social aims while continuing to generate financial returns for their respective investors.

Why aren’t impact funds already using the benefit fund structure?

Delaware was the first, and as of now is the only, state to permit the formation of a benefit fund, having adopted the benefit fund statutes on August 1, 2019. Yet, as far as we are aware, Samaritan Partners Fund I, LP is the only institutional-grade fund structured as a benefit fund.

Why have others not opted to use this structure? We have three hypotheses.

1. Some may view the model as extraneous. After all, the flexibility of the traditional limited partnership permits an impact fund to create the key features of a benefit fund by contract. However, as noted above, this flexibility also results in the expenditure of substantial resources in connection with investors’ due diligence of impact funds, potentially significant costs in the drafting and negotiation of those legal documents, as well as opening the door to greenwashing, whether actual or alleged. In other words, the benefit fund can reduce costs and provide certainty by combining the best elements of the benefit corporation’s clarity and rigidity with the flexibility of the traditional limited partnership.
2. The benefit fund model may not be right for all impact funds, particularly in its current state. But as noted above, we anticipate that significant improvements can be made to the model and, even after those improvements are implemented, it may not be the right structure for those who have alternative approaches to seeking social impact and financial returns. In short, the benefit fund structure is not going to be right for everyone in the impact investing community, but it provides a clear roadmap for investors and fund managers who want to embed social impact in the DNA of their investment activities.
3. The impact investing community, including fund managers, legal advisors, and investors, may not have been aware of the option. Some may also have thought that using the benefit fund was not necessary given the ability to implement the desired terms on a fund-by-fund basis. However, we believe that shifting the conversation from a fund-by-fund approach to one about the common standards and practices for impact-oriented funds, rooted in the benefit fund model, has the potential to accelerate the work already being done by making it easier and more efficient to form impact-oriented funds that will direct capital to companies pursuing social aims.

What about management companies that are structured as benefit entities?

Some impact funds have, to demonstrate their commitment to balancing financial returns with social impact, set up a fund as traditional limited partnership but formed at least one of the fund’s management companies as a Delaware statutory public benefit limited liability company (the LLC-equivalent to the benefit fund and benefit corporation). With this structure, the management company is required to manage the fund in a manner consistent with the benefit considerations, even if the fund does not have a stated public benefit it aims to promote.

This is a well-intentioned effort to provide a statutory basis to pursue financial returns and social impact while mitigating the potential risks associated with giving investors the enforcement mechanism discussed above. However, we also believe that because it shifts the enforcement right from investors in the fund to the owners of the management company, it significantly reduces, if not outright eliminates, the investors’ ability to ensure the fund’s manager stays true to its obligation to seek social impact alongside financial returns.

To us, the decision to form a management company as a “benefit LLC” rather than forming the fund as a benefit fund highlights the need for additional developments in the statutory basis and supporting social infrastructure for the benefit fund. As more benefit funds are formed and standards and best practices are established, the right balance can be struck between the flexibility of the traditional limited partnership and the rigidity and clarity of the benefit corporation.

What next?

The benefit fund model, by enhancing the traditional impact fund with features that have helped drive the success of the benefit corporation, provides the clarity, transparency, and enforcement mechanism necessary to address the issues currently holding impact funds back. However, for benefit funds to reach their full potential, the development of best practices, model documents, and certifications is essential. As the benefit fund ecosystem develops, benefit funds can increase the speed and efficiency with which impact-oriented investors ultimately put capital in the hands of those seeking to do well by doing good.

Read more stories by Frank J. Martin & Brandon Leppke.