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.

Unlike the case with financials where there are accountants to verify the books, no standards exist for the variety of do-good purposes that nonprofits engage in or that social entrepreneurs or companies may conjure up. "We want to rely on best practices, which are evolving and a company can choose," Johnson says. "We don't want to legislate morality.  We think it's best to let the market and shareholders decide."

On February 8,  California state senator Mark DeSaulnier sponsored legislation, SB 201, proposing the Flexible Corp. in California.

Then, on February 28, California assemblyman Jared Huffman suddenly sponsored "spot" bill AB 361-in effect a blind or empty legislative shell. The final bill, proposing a Benefit Corporation, was posted in mid-March.

Like the Flexible Corp. the Benefit Corp. allows a company to engage in a special do-good purpose for which there must be transparency. But its distinguishing characteristic is a holistic "material" beneficial impact upon society (workers, products, consumers, supply chain, community, governance) and the environment-something that must be measured by an independent third-party standard.  The Benefit Corp. is designed for small private companies with a sustainability focus or social conscience. Think Ben & Jerry's.  

"The Benefit Corp. is focused on companies that want to be held to a higher [corporate social responsibility] standard," says Andrew Kassoy, co-founder of B Lab, the Berwyn, Pa.-based nonprofit that is promoting Benefit Corps (and special tax treatment for them) in several states. (Maryland, Vermont and New Jersey already have adopted various iterations.) "The Benefit Corp. will actually be fairly prescriptive in what needs to happen in order to qualify and how you need to maintain the status," Huffman adds. "It's going to be rigorous and specific. [Folks in my district] are looking for the gold standard in social responsibility."

Problem: when it comes to standards for corporate social responsibility, there is only game in town: the "B Corporation" certification developed by B Lab, the same group promoting Benefit Corps. Huffman concedes that questions have been raised about a potential conflict of interest for B Lab --one akin to that of the rating agencies who were paid by the issuers of the mortgage-backed securities and derivatives that blew up the financial system in 200--especially if a standard is legislated. "That's not going to happen," he says.

But an attorney that is helping to write the Benefit Corp. legislation in California compares the situation to that for LEED, the green building standard that can be downloaded for free. "Benefit Corps have to apply a third-party standard," says Donald Simon, a partner at Wendel, Rosen, Black & Dean.  "But they don't have to pay for it unless they want to be certified."

Of course, most companies, if they choose to bother with the standard at all, would no doubt choose to be certified-for marketing purposes. Even so, as highly regarded as B Corporation certification is, it is self-reported and only occasionally audited. This may be current best practice for corporate social responsibility, but it hardly qualifies as a gold standard.

In fact, the impetus for the two types of new corporations was entirely different and is reflected in their respective forms-and how they deal with fiduciary duty.

Ultimately, the purpose of the Benefit Corp. is to hold directors accountable to the high level of corporate social responsibility they promise. As such, the legislation includes a right of action, which allows certain shareholders the right to sue companies and directors if they do not meet their socially beneficial obligations.

Is this a veiled attempt to allow an entrepreneur to maintain control, possibly even from the grave, with respect to a company's social DNA-especially in a hostile situation? After all, stakeholders like employees do not have the right to sit on the Board (as they do in Germany) or to sue. Nor does that right apply to all shareholders---only to those who own-gulp!-more than 5% of the company's shares.

According to Simon, the answer is no because a company's shareholders or a new owner can "opt out" of being a Benefit Corp. at any time. "The idea is trust but verify," he says. "If you have requirements and obligations but there's no enforcement mechanism, it could easily come to pass, especially if there is new leadership or circumstances arise, that suddenly these things aren't addressed anymore. This is a way to make sure that if a company opts into being a Benefit Corp., they are going to live by it.

"Obligations mean nothing unless there's a means by which you can hold people accountable," he says.

Translation: The Benefit Corp. broadens the fiduciary duty of directors by increasing their potential liability in the sense that they are accountable for a company's social and environmental commitments as well as financial performance.

The logic behind broadening the protections for directors when exercising their fiduciary duty in the Flexible Corp. is the exact opposite-the carrot as opposed to the stick.  Here, the idea is to encourage directors to engage in socially beneficial decision-making including, potentially, at the expense of maximizing profits by helping them to avoid litigation. "Boards of directors, especially in public companies, are incredibly risk-averse," Johnson explains. "As a practical matter, directors always become consumed with the concern that if they don't maximize profits, they are going to get sued."

"[Both types of new corporations] change fiduciary duty," he adds. "But in the [sense of reducing risk for directors], we are doing a better job of protecting that change."

Of course, the different approach reflects a different raison d'etre for the Flexible Corp., which is to help social entrepreneurs access capital-both from mainstream profit-driven capital markets and mission-constricted foundations. Nonprofits, if they are wealthy and can afford expensive lawyers, have been creating hybrid structures by establishing for-profit subsidiaries. But since it's best for the for-profit in this structure  to be mission-driven so that the parent non-profit does not risk the loss of its tax-exempt status, they are often structured as LLCs, a corporate form that institutional investors in the mainstream capital markets generally avoid.

As part of California's general corporation code, the Flexible Corp. is designed to resolve that dilemma by allowing the hybrid social enterprise to simplify its structure and thereby eliminate the attendant hybrid conflicts by converting to for-profit status while satisfying the requirements of institutional shareholders for a standardized corporate entity. "The Special Purpose is designed to put shareholders and potential shareholders on notice that the corporation will pursue interests that may or may not align with profit maximization," Johnson says. "The idea is to make all kinds of social innovation a whole lot easier by unleashing the capital that will allow it to happen."

When activists or even corporate intra-preneurs want to change a "system," they look for a strategic lever, something like a tiller on a sailboat. The idea is this: You move the tiller just a tad, and you can shift the direction of the entire boat. In this metaphor, of course, the tiller represents fiduciary duty and the boat represents our entire economic system-or, in this case, the behavior of two new classes of companies.

To put it another way:  the importance of redefining fiduciary responsibility cannot be overemphasized-or belittled.

"Marketing yourself as having positive social benefit is very valuable," one lawyer says. "But when I think about making [impact investments] and the related challenges, the idea of actually changing the fiduciary duty of a set of directors for a company so that it allows them to take into account any other factor besides maximizing shareholder profit, that is a significant, material legal structural change."

It's a change, he adds, that is "small but profound."

-- Ellie Winninghoff writes a blog at DoGoodCapitalist.com. She can be reached at: ellie.winninghoff @gmail.com.