Social 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:
- 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.
- 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.
- 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.
- 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.