What's the difference between a nonprofit and a for-profit corporation? Actually, it's becoming less clear. As the interest in impact investing explodes and social entrepreneurs want to access different types of capital, more nonprofits are creating hybrid structures with for-profit subsidiaries. Corporations, on the other hand, are embracing sustainability as a way to reduce costs and risks, and to boost the value of their brand.
Despite their doggedly charitable missions, however, cutting edge social entrepreneurs who create low-profit "businesses" can be too innovative to fit into the boxes permitting nonprofit status by the IRS. And while risk-averse corporate directors retain the legal right to determine what's in the best long-term interest of a corporation, they may not actually have the power to favor environmental or social factors over profit-especially when control of a company is in play.
Two very different proposals to establish new corporate forms in the California legislature seek to address these issues by broadening the fiduciary duties of directors. One new corporate structure is designed to unleash capital for impact investing and the other creates more accountability for corporate social responsibility. Neither proposal would apply to all companies; both are aimed only at those that specifically choose to adopt the respective corporate form-by a two-thirds super-majority vote.
The story begins in 2008 when California governor Arnold Schwarzenegger vetoed a "constituency statute" similar to those already passed in 31 other states in the wake of the takeover battles of the 1980s. Corporate directors often felt compelled to maximize profits at the expense of employees and communities, and the idea was to allow them to take the interests of these other stakeholders into account. Acknowledging that the bill included many "intriguing concepts," Schwarzenegger argued that it could produce unknown ramifications. "Corporate governance is a serious matter and changes should not be entered into without deliberate study and evaluation," he wrote.
Thus was born a working group of ten lawyers representing as diverse interests as possible-impact investors, nonprofits, the Chamber of Commerce, the state bar, academics, corporate counsel, etc. Setting out to invent a new corporate form from scratch, they spent 18 months hashing out the legal issues around marrying money and mission.
The result: The Flexible Purpose Corporation [Flexible Corp.], a type of company that can make profits and also pursue at least one special do-good purpose that is comparable to the charitable missions pursued by nonprofits.
A veritable for-profit/nonprofit hybrid, the Flexible Corp. is designed to accommodate any kind of company that wants to practice doing good (Google: Are you listening?)-public as well as private, slow growth or high growth, big or small, even nonprofits that choose to convert. The early adopters, however, are expected to be the social enterprises opting to create businesses to solve the world's social and environmental problems that are at the heart of the impact investing movement. Think microfinance or community development, say, or businesses that sell clean energy or deliver access to water in the developing world.
"We wanted to help social entrepreneurs access capital from the mainstream markets," says Todd Johnson, partner at Jones Day, who co-chaired the working group. Neither nonprofits nor their for-profit subsidiaries, he says, are currently set up to do this.
Here's the twist: Although the Flexible Corp. allows directors to make decisions that forgo profits in favor of a special purpose like the environment, it also requires a "drastic" level of transparency, Johnson says: a management discussion in the annual report describing the company's special purpose, its strategy for pursuing it, the metrics it's using to measure success, a report on its progress, etc.
"Without transparency in this area, the risk for investors exists that directors waste corporate assets without accountability," he says.