Thursday, January 21, 2016

Why Companies Are Choosing to B Good: A Closer Look at Delaware Public Benefit Corporations

As of August 1, 2013, the Delaware Legislature added Subchapter XV to its Delaware General Corporation Law (“DGCL”) providing for the formation of a Public Benefit Corporation (“PBC”). As of now, 31 states (including the District of Columbia) have enacted similar statutes, with Maryland and Vermont leading the way by becoming the first states to do so in 2010.  You can check the status of benefit corporations in each state here. This blog, however, will focus only on Delaware PBCs. Delaware is home to over 1,000,000 corporations.  Approving a PBC entity structure in Delaware is an endorsement of corporate culture that aims to conduct business in a responsible and sustainable manner.

Similar to a regular corporation, a PBC is a for-profit corporation that, in addition to maximizing shareholder value, is committed to pursing a purpose that would create a public benefit. There are however key differences that set these two types of entities apart. This blog will discuss differences between the two entity structures and why this new corporate structure is so enticing to socially conscious entrepreneurs.

Formation and Purpose

In its certificate of incorporation, a PBC must identity itself as a public benefit corporation (that means that it is going to have “P.B.C.” or “PBC” at the end of the name rather than an "Inc.") and must list at least one public benefit that it intends to pursue.

Section 362 (b) of DGCL defines a public benefit as a “positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.”

Responsibility and Reporting Requirements

Unlike in a traditional corporation, directors in a PBC must provide a biennial (once every two years) report to the shareholders describing the corporation’s promotion of the public benefit identified in its certificate of incorporation. The report has to include the objectives established by the board to promote the public benefit; the standards adopted by the board to measure the corporation's progress in promoting such public benefit; objective factual information based on those standards regarding the corporation's success in meeting its objectives; and finally an assessment of the corporation's success in meeting its objectives.

This requires taking additional corporate governance steps, including the development of clearly defined objectives and standards that can be measured and quantified in order to assess the corporation's success in meeting its public benefit goals.  

Fiduciary Duties

Directors owe fiduciary duties of care and loyalty to both the company and the shareholders. The duty of care requires directors to act in the same manner as a reasonably prudent person in their position would. The business judgment rule offers directors some protection in this category from any losses incurred under their watch as long as the decisions were made in good faith and with reasonable skill and prudence. The duty of loyalty is an affirmative duty to protect the interests of the corporation, and also an obligation to refrain from conduct which would injure the corporation and its shareholders such as self-dealing. 

A PBC's board duties are pretty much the same.  However, when making decisions, the directors are required to balance the "pecuniary interests of the stockholders, the best interests of those materially affected by the corporation's conduct, and the specific public benefit or public benefits identified in its certificate of incorporation." DGCL 365(a).

In a change of control situation, the business judgment rule standard of review applied to a regular corporation's board of directors is changed to that of enhanced scrutiny standard (remember the Unocal and Revlon decisions?) (Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985); Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. 506 A.2d 173 (Del. 1986)). At the time of a company sale or a takeover, directors are required to maximize the shareholders' value by seeking the highest price available. However, in a Delaware PBC, the board's duty to consider other constituencies and society as a whole does not go away in the context of a merger or a takeover. A Delaware PBC board cannot simply sell to the highest bidder. It needs to consider and which acquirer would be most suitable to continue furthering the corporation's public benefit purpose.

Benefit Corporation vs. B Corp Certification

Often used interchangeably, a PBC and a B corp should not be confused with one another. A PBC is a legal entity form (like an LLC or a corporation or a partnership), while a B Corp is a certification awarded by B Lab, a non-profit organization that serves the global movement of people using business as a force for good. In order to obtain the certification, the company must first become a benefit corporation in its home state. There is a strict process to become certified. Additionally, B Lab charges annual fees which are assessed on a sliding scale, starting at $500 for companies with revenues of less than $1 million to $50,000 for companies with revenues over $1 billion.  Etsy, Patagonia, Warby Parker, Plum Organics are all examples of companies that received certification as B corp companies.

Thinking of Converting?

A traditional corporation can easily be concerted to a PBC by filing an amendment to its certificate of incorporation with the DE Department of State. The amendment would require an approval of 90% of the outstanding shares of each class of stock (whether voting or nonvoting) of the corporation.  A merger or a consolidation with a domestic or foreign PBC also requires the same 90% vote.

Perhaps one of the largest recent converts from a traditional C corporation to a PBC (2015) is Kickstarter, PBC (formerly, Kickstarter, Inc.) Kickstarter, a crowdfunding platform, proudly lists their conversion on their website along with their mission statement “to help bring creative projects to life.”  Since its conversion, Kickstarter has received a lot of publicity regarding their new status and has been branded as one of the many companies that want to be apart of movement demonstrating they are not all about maximizing profits. Articles discussing their recent conversion to a benefit corporation can be found here and here.

Going Back

A two-thirds vote of the outstanding shares of each class of the PBC, whether voting or non-voting, is required to terminate the PBC status.  This makes it difficult for just one group within the corporation to decide to revert to a regular corporation status, unless supermajority of the corporation's shareholders also agree.

Is There Really a Downside?

This new entity type allows companies to legally use their resources to advance a public purpose that they believe in, while working towards increasing company revenue. How can there be a downside? Some say that small companies and start-ups choosing to register as benefit corporations may have harder time securing investors because benefit corporations may not always have the same returns as regular corporations.  However, this is changing. According to B Lab, many lead VC funds have invested into benefit corporations.  

Here is the list: Abundance Partners, Andreessen Horowitz, Baseline Ventures, Benchmark, Betaworks, Brand Foundry, Bullet Time Ventures, Capital, Freshtracks Capital, Claremont Creek Ventures, Collaborative Fund, CommonAngels Ventures, DBL Investors, Emerson Collective, First Round Capital, Forerunner Ventures, Formation|8, Founders Fund, Foundry Group, Generation Equity Investors, Good Capital, Greycroft Partners, Hallett Capital, Harrison Metal, Impact America Fund, Kapor Capital, Kortschak Investments, Learn Capital,Lighter Capital, Matrix Partners, New Enterprise Associates, New School Ventures, Omidyar Network, Pacific Community Ventures, Peterson Ventures, Prelude Ventures, Reach: New Schools Capital,Red Swan Ventures, Renewal Funds, Serious Change, SherpaVentures, Tekton Ventures,The Westly Group, Thrive Capital and Union Square Ventures.

Another disadvantage that a PBC must endure is their reporting requirement to the shareholders regarding whether or not the company is successfully working towards and fulfilling their public purpose. The good news here is that in Delaware, the reporting requirement is not as onerous as in several other states. Delaware PBCs are not required to (i) appoint a benefit director or officer; (ii) disclose the benefit report to the secretary of state; (iii) use a third party standard or assessment in connection with the report; (iv) prepare the report annually; or (v) consider the impact of every single corporate decision on a variety of stakeholders (shareholders, employees, customers, etc.).

So, being a benefit corporation may not be such a disadvantage after all.

Delaware PBC Act is flexible, and combined with the authority and weight of DGCL in general, may make a big shift in the US corporate culture towards a greater use of benefit corporations to conduct business. It just might pay to B good.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

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