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Kickstarter Went B Corp – Why Your Company Should Not

Kickstarter B Corp

So, Kickstarter Went B Corporation

Kickstarter got some well deserved publicity for electing to become a Delaware B Corporation (more formally referred to as a public benefit corporation) rather than continuing its status an elective B corp.  That is commendable and I applaud their decision but it must be said that, well, your company probably isn’t Kickstarter.  I have written in the past about why social enterprises should think long and hard before making this legal status binding.   Rather than restating those points, let me point out why it may well work for Kickstarter (and its existing apparently very happy investors) but it would not be wise for most social enterprises (or regular businesses that aspire to have some social benefit beyond simply making money for shareholders).

Kickstarter is Not Raising Money and Does Not Need to Do So

According to current investor Chris Sacca, “[Kickstarter] is a fast-growing, highly profitable enterprise.”  Highly profitable enterprises do not need to worry very much about what future investors think about their corporate structure.  If your company does not need investment now or in the future, you may not care either.  However, most private companies do not have that luxury. Some potential investors will not like the public transparency.  Some might not like the causes the company elects to support. As I have said before, many investors (especially institutional investors) simply run from anything “new” like the plague. The reality is that until issues like fiduciary obligations of B Corp directors, derivative lawsuit claims, enforceability of investor protections and a host of other issues are addressed by Delaware courts through fact specific litigation, expect most sophisticated investors such as venture capital managers to be leery at best. Their cautious lawyers will be all the more suspicious. Don’t need the money? Then have at it. Not sure? Being a bit more measured is probably prudent.

Kickstarter is Apparently Not Planning on Selling . . . Ever

Ok, here is where Kickstarter gets to really rarefied air. According to the New York Times, Kickstarter CEO Yancey Strickler stated that, “We don’t ever want to sell or go public.” Well, that might come as a bit of a surprise to the limited partners of the venture funds that already invested. Suffice it to say that the B corporation is going to complicate either a sale or an IPO. It probably won’t make it impossible, but it will be an issue–especially early on in the life of this relatively new statute. As a lawyer that has long advised companies in sales and IPOs, added complication isn’t exactly a welcome visitor to the sale or IPO. If you are amongst the business owners that intends to never sell or IPO your company, I guess you don’t care. I don’t know too many of those business owners. In fact, those owners probably don’t care enough to be reading this blog either so I am assuming that if you read this far, you’re probably not like Kickstarter in this regard.

The Tax Man Doesn’t Care About Your Social Purpose

Kickstarter had no choice but to be tax inefficient. You probably do have that choice and making a decision to be a B corp may well kill it. Part of Kickstarter’s adopted social charter is apparently to remain as tax inefficient as possible (or at least to avoid dirty loopholes). Good for them! However, Kickstarter was a C corporation for tax purposes before it elected B corp status and it will simply continue to be a C corporation afterwards. C corporations are generally tax inefficient. Kickstarter had no choice but to be a C corporation because of the tax requirements of its own venture capital investors. Is that the case for your private company? It may sound stupid to state the obvious but Delaware B corporations are, well, corporations under Delaware’s General corporation law. As such, they will either be S corporations (if eligible and properly elected) or C corporations. In either case, the tax efficiency and structural benefits of a limited liability company taxed as a partnership are off the table.

The Social Purpose Can Be Achieved Without B Corp Status

As I have said before, I really like social enterprises and I am glad that the option to be a public benefit corporation is now out there in many states. However, keep in mind that Kickstarter already did many of these things before electing formal B corp status and your company can likely do so without making a decisions that will be potentially limiting and potentially difficult or costly to unwind. That is the real bottom line: you can achieve all the same goals without making a decision to organize as a B corporation. It’s sort of the present day version of “Come on sweetheart, do we really need a certificate from the state to prove we are committed?” Only in this case, your mother probably does not really care if you get the state certificate. If you can achieve the result without the risk, why would you? Maybe you are like Kickstarter . . . but the reality is that your business probably isn’t.

 

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Mergers and Acquisitions: Avoid Unnecessary Legal Fees

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When we formed Corridor Legal, we did it with the intention of changing many of the big firm practices that drive unnecessary costs and, worse yet, create inherent conflicts with clients.  For instance, conflicts are created when firms train junior lawyers by having them learn the practice by charging clients for their time and then using seasoned lawyers to review that work.  The client is charged for both the junior lawyer’s time (which is much more time than it would take a qualified lawyer) and then also charged for the review by the seasoned lawyer (which often takes more time than simply having the senior lawyer do it themselves).  The fair thing to do is to write off the junior lawyer’s time.  Some do, many do not.  When I was buying a significant amount of legal services as general counsel of a public company, I would not allow first or second year lawyers to work on our files.  If the work was complex, I expected partners to be doing it themselves.

Law Firm Revenue Tricks in M&A

Another area of conflict with law firms involves lawyers that attempt to sell clients documents that they do not yet need (and may never need) in advance of a contemplated sale of a business. I recently had the opportunity to hear two large law firms pitch for representation of a venture-backed company that is considering beginning a sale process. Both law firms recommended that the company prepare a full advance set of transaction documents for the sale of the company at the very beginning of the process. Conveniently, if the company agrees, the law firm gets paid to do the work in advance regardless of the outcome. This is almost always a bad move for the client and often results in paying attorney’s fees for the same deal twice.

The reason is because preparing documents for mergers and acquisitions requires one to actually know the form of the merger or acquisition. Is it going to be a stock sale, asset sale, merger, reverse-merger? In most cases, the seller has only a preference at the beginning of the process. The seller may have a strong preference, but until a buyer agrees it is only a preference. The form of the deal is mostly determined by the identity of the buyer and by pure negotiation and leverage. Do not let the lawyer tell you that preparing documents in advance will materially impact anything that a sophisticated buyer will do. Everything is negotiable.  At the right price, a seller that wants to do a stock sale is probably willing to do an asset sale. If a buyer wants to do an asset sale but critical assets cannot be assigned without the consent of an unwilling third party, it is not going to be an asset sale. That is how mergers and acquisitions deals get done. Doing a full set of documents for a stock sale that turns out to be an asset sale is a complete waste of time. Guess who pays for that wasted time (and guess who gets paid)?

What if the client decides not to sell the company after all or is not actually successful in finding a buyer? If the law firm does the documents in advance, the law firm still gets paid.  Do not think for a minute that this is coincidental. As an aside, we also see this trick used in financing documents. If you are going to try to raise money for your company, do not let a law firm sell you investment documents for the round before you know that you likely have a round and what the form of that round and investor rights will be. We have represented venture funds that receive template stock purchase documents from a naive company. Those documents go straight into the circular file (I have literally seen companies charged in excess of $30k for documents that were never even read by the investor).

Even assuming an actual M&A deal gets done in the very same manner predicted at the time the company does the advance documents. The documents prepared in advance will often be so one-sided that no sophisticated buyer will accept the terms without substantial revisions and rounds of negotiations. Again, this is not accidental. The law firm that drafts the advance documents often takes totally non-market positions because the process of revising documents after the buyer refuses to accept the terms drives additional attorney time (read: costs) for the seller. Are you seeing a trend here?

Stick With a Term Sheet

We are continuing to see a mergers and acquisitions marketplace where sellers have unprecedented leverage in the sale. Some sellers are likely to be so sought after that they may be able to get competing bidders to agree to almost anything–including the terms of definitive transaction documents. However, on a percentage basis, this is still seldom the case and, even where it is, there is plenty of time for the documents to be prepared once an agreement in principle is reached. There is no good reason to take the risk of incurring that expense at the beginning of the process. Company’s should always prepare a document that fairly represents the deal they want to do (whether in a sale process or in a capital raise) but that should be done through a short and simple term sheet that is very inexpensive to produce and involves very little attorney time. That term sheet can be easily modified in negotiations and the deal described is non-binding on the parties until full documents are competed and signed. Once the general deal terms have been agreed, it is then prudent to spend the money on producing full deal documents.  Before that time, you are probably wasting your money (and enriching your lawyer).

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Its Getting Frothy: Transactional Legal Services as a Barometer of the Economy

Transactional lawyers can often provide some significant insight into the business climate. It is not based on economic prognostication skills, it is simply based on type and volume of work being done. By that measure, this economy is hitting on all cylinders. Many clients call their lawyers when they are hiring employees, and when they are letting them go. For some time now, it is well chronicled that companies are mostly hiring.

But it isn’t just jobs–deals are increasing at an astounding rate. In late March and early April, we closed five meaningful investment transactions in a seven day period. That was partially coincidence, but several of those transactions had been in the works for some period of time. In bad economies, even good deals often do not get funded. In good economies, investors and acquirers fight over deals. We are getting to the point where competition among buyers and investors is increasing. I am getting those calls again where funders are trying to find deals. While moderating a recent panel of professional investors, one thirty-year venture capital veteran quipped that “2015 will be the best year to sell a business since 1998.” I don’t think that is an overstatement–but it may actually be eclipsed by 2016.
If you are interested in raising capital into your business or selling, the pendulum has finally swung back in your direction and it appears to be staying there for a spell.

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Show Me the Money – Panel Discussion at Full Sail’s Pitch Day

Many thanks to Professor Ron Cook and the team at Full Sail University for inviting me to participate in their panel discussion on capital fundraising for small companies.  It was a great time and, as always with any event hosted by Full Sail, as professionally produced as any production you can find anywhere.  I also enjoyed the comments of my co-panelists and the interaction with the crowd–both during and after the event.  An additional thank you to Nathan Chitty of Central Capital Group of Florida, who was kind enough to send links to my personal comments.  I am listing these links below but consider watching the entire panel discussion.  Feedback appreciated.

6 12:50 http://bit.ly/fss21250 Mark Mohler Tell about yourself and how your got to where you are today.
14 20:45 http://bit.ly/fs-s2-t-2045 Mark Mohler Q: Mark, Tell us about the clients you have had successes and failures.
16 22:57 http://bit.ly/fs-s2-t-2257 Mark Mohler Q: Mark, Tell us about Crowdfunding
23 32:00 http://bit.ly/fs-s2-t-3200 Mark Mohler Q: Funding has changed in the last 10 years how?
28 41:15 http://bit.ly/fs-s2-t-4115 Mark Mohler Q: What do you look for in a pitch, best and worst pitches
34 52:47 http://bit.ly/fs-s2-t-5247 Mark Mohler Q:What are 1 or 2 critical advice in giving a funding pitch?

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Florida B Corp: Social Entrepreneurs Probably Should Not Be Early Adopters

O7A9fAvYSXC7NTdz8gLQ_IMGP1039Social entrepreneurs looking to form or operate their business through a Florida business entity now have two dedicated types of for-profit corporations from which to choose: the social purpose corporation and the benefit corporation.  In this post, I will refer to both social purpose corporations and benefit corporations as “B Corps” because the differences between the two options are not material to the issues addressed.  As of July 1, Florida has officially joined the states who have created special laws to accommodate social enterprises.  However, this post will offer a few reasons why social entrepreneurs should think long and hard before they rush in to either of these new options.

First, let me make clear that we are strong proponents of both social enterprises, in general, as well as impact investment.  We have long seen these not as trends, but as permanent changes to the social contract through which for-profit entities will increasingly be judged by investors, employees and customers.  Those that know us are aware that we have not only acted as counsel to these companies—particularly through our longstanding emphasis on representing cleantech companies, we have also founded and operated several successful social enterprises ourselves over the last ten years.  To that point, it is important to know that social enterprises have existed long before the creation of various B Corp laws and are not dependent upon special laws such as the new Florida laws for their existence.  In fact, at least at this stage, forming your social enterprise as a B Corp is not a “no brainer” and caution is prudent. Always evaluate the pros and cons before selecting any form of entity for your business.  Your social enterprise is no different.

A Few Reasons to Hold off on B Corps

It is easy to find plenty of blog posts out there on what the new Florida B Corp laws allow and require.  These are mostly technical recitations of the statutes themselves.  We try to focus our posts on perspectives that address practical business issues for business owners beyond mere legal issues.  But given the amount of questions we have already received about the new Florida B Corp laws, we may do a white paper that goes into more detail.  For now, here are some reasons not to choose to form your new social enterprise as a B Corp or convert your existing social enterprise to a Florida B Corp:

  1.   Tax Classification.Keep in mind that B Corp status is not a tax classification and there is no current state or federal tax benefit to operating as a B Corp.  This is one of the regrettable consequences of the B Corp nickname itself as both “C Corp” and “S Corp” are mere tax classifications.  Do not consider the B Corp as an alternative to S corps or C corps.  Because both new B Corp entities are merely corporations under Florida state law, owners will still need to classify their B Corps as either C corporations or S corporations for tax purposes.  C corporations are inherently tax inefficient and S corporations are unnecessarily inflexible for most startups that seek any sophisticated capital.  If you want to maintain the most flexibility and tax efficiency for your social enterprise, the LLC, and not the B Corp, will likely continue to be your best option.
  2. Investor Uncertainty. In many cases, you will have selected a for-profit entity to form your social enterprise because you anticipate the potential need for investment capital–as opposed to donations received by non-profit entities.  “Investors” are indeed a broad category.  There is a very good chance that certain family offices and impact investors will embrace B Corps and welcome the associated legal protections and required transparency.  However, many institutional investors run from anything “new” like the plague.  Until issues like fiduciary obligations of B Corp directors, derivative lawsuit claims, enforceability of investor protections and a host of other issues are addressed by Florida courts through fact specific litigation, expect most institutional investors such as venture capital managers to be leery at best.  If you have decided that a for-profit entity is necessary because of the likely need for investment capital, don’t make an early decision that will likely eliminate a large category of potential investors before you even get started.
  3. Converting Later is Probably Easier.Flexibility is a powerful asset for startups.  We preach over and over that the successful path of mosts startups requires many pivots that are not predictable at the inception.  Maintain any option you have to stay flexible.  If you have investors that want your company to be governed by the B Corp provisions, you can always elect that status or convert your entity immediately prior to that investment.  All you need is the required vote. Undoing a B Corp status not only requires the minimum 2/3 vote of each class of stock, it also triggers appraisal rights under the relevant termination provisions for both social purpose corporations as well as benefit corporations.  Few things create more heartburn for founders than creating appraisal rights for dissenting shareholders.  Few things are less acceptable to venture capital investors than cashing out shareholders with their investment capital.  Don’t put yourself in this position.
  4. D&O Insurance Issues.Insurers typically do not like “new” either.  I am really not sure how directors and officers insurance underwriters will weigh the risks and exposure of insuring directors and officers of B Corps.  However, at a time when D&O insurance has gotten very expensive, I would not be excited about being the test cases.  It is true that one of the perceived benefits to social enterprises under the benefit corporation statutes is to make it clear that directors should not be liable to shareholders for pursuing agreed social benefits over mere profit maximization.  However, I’m not willing to make the assumption that insurers are going to treat the obligations of directors under these statutes more like directors of non-profits than their for-profit brethren. I would be interested to hear an insurance perspective on this.

The gist is this: while additional options for social entrepreneurs are always good, the intention of this post is to evaluate whether the B Corp is actually a wise option for your social enterprise under these brand new laws.  In some case, it will be.  Before the Florida law became effective in July, we have advised companies that have formed new B Corps under Delaware law.  In some cases, the marketing benefit alone is probably worth the potential negative characteristics mentioned in this post.  However, most LLC statutes are predicated upon freedom of contract and it is possible to have governing documents that clearly provide for business purposes and actions that address social issues and in addition to profit goals.  In some respects, the B Corp laws are something of a solution in search of a problem.  Do not assume that you need these new entities to achieve your social goals.  The costs may greatly exceed the perceived benefits.

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