Morrison & Foerster Discusses Publicly Traded Public Benefit Corporations

In 2013, Delaware passed legislation adopting a new corporate form, the public benefit corporation (PBC), with a view to allowing directors of for-profit corporations to take actions not just in pursuit of stockholder returns, but also with the “[intent] to produce a public benefit or benefits and to operate in a responsible and sustainable manner.” [1] Over the past few years, thousands of social ventures, as well as more traditional companies, have incorporated as PBCs, with one study reporting 295 venture-backed PBCs as having raised a combined $2.5 billion from 2013 to 2019. This is in part due to decisions made by the non-profit B Lab, which required that Delaware corporations paying for the license to use its “B Corporation” mark adopt the PBC or other benefit corporation form to maintain their status. It is also due to a rise in “impact” investing in the private markets and an emphasis by prominent institutional investors such as BlackRock on sustainable, long-term investment and growth and environmental, social and governance (ESG) factors. Until recently, however, only one PBC had gone public and listed on a national securities exchange.

This is not particularly surprising: institutional stockholders tend to be wary of novel structuring and dramatic changes to corporate governance practices. With so much at stake in a company’s initial public offering (IPO), issuers and underwriters are often wary of adding factors to the mix that might spook the market. The PBC’s shift in fiduciary duties to include a chosen public benefit has been no exception. Indeed, even B Corporations that had already gone public with a stated focus on values, like Etsy, the e-commerce site for handmade and vintage crafts and other items, elected for a variety of reasons not to convert into a PBC and to allow B Lab’s certification to lapse.

Times have changed. In July 2020, two companies successfully went public that were both PBCs and certified B Corporations. We are optimistic that in addition to immediately tripling the number of such listed companies, this will normalize the PBC form among capital markets investors and make it easier for more companies to IPO as PBCs and certified B Corporations in the future—particularly as institutional investors become more familiar with the form and as retail investors and consumers increasingly demand that companies they invest in and buy from commit themselves to ethical and sustainable behavior.

The Publicly Traded PBCs

In some ways, the three publicly traded PBCs have very little in common:

  • Laureate Education, Inc., an owner and operator of higher education institutions in various countries teaching design, hospitality, culinary and business courses, completed its IPO on February 2, 2017, listing on Nasdaq. Operating pre-IPO with the primary financial backing of private equity investor KKR, Canadian pension fund CDPQ and various family offices, the Maryland-based company converted into a PBC in 2015, two years before its IPO, after over 20 years of existence as both a public and private company. After raising $490 million in its IPO, Laureate saw its stock price drop initially before slowly climbing to a peak in early 2020 of 150% its IPO price, after which the economic shock due to COVID-19 eliminated such gains, with the stock trading just below the original IPO price by August 2020.
  • Lemonade Inc., a property and casualty insurance company, completed its IPO on July 2, 2020, listing on the New York Stock Exchange (NYSE). Operating pre-IPO with the primary financial backing of SoftBank and a group of venture capital investors, including Sequoia Capital and Aleph LP, the New York-based company converted into a PBC in 2016, four years before its IPO and just one year after its original incorporation. Raising $319 million in its IPO, Lemonade’s stock price soared to double the IPO price on the first day of trading, where it remained steady for the subsequent two months.
  • Vital Farms, Inc., a provider of eggs and dairy from humanely- and pasture-raised animals, completed its IPO on July 31, 2020, listing on Nasdaq. Operating preIPO with the primary financial backing of the corporate venture capital arm of

Whole Foods Market and various venture capital and growth equity investors, the Texas-based company converted into a PBC in 2017, three years before its IPO, after existing privately as a standard Delaware corporation for about four years. After raising $204 million in its IPO, Vital Farms saw its stock price jump 60%, also remaining steady for the subsequent month.

Lessons from PBC IPOs

That these three companies are so different is itself important: they prove that the PBC form is not just for “social ventures” or some limited subset of industry verticals.

What they have in common, however, will be instructive for companies considering going public as a PBC (or for existing public companies considering conversion to a PBC).

Focus on Mission

First and foremost, these companies have sold their focus on a carefully crafted mission as a key component of the investment thesis. While the model “benefit corporation” statute adopted by many states specifies the public benefits a company must pursue, the board and shareholders of each Delaware PBC adopt a specifically chosen mission set forth in their certificate of incorporation. Each company portrays its mission as a way of differentiating itself, most significantly to consumers, and likely with a particular eye to industry competitors and reputation. Laureate, a company in the for-profit higher education space, in its investor letter described itself as having the “head” of a business with the “heart” of a non-profit. Given Laureate’s substantial presence outside the U.S., the company likely also viewed a focus on mission as a meaningful branding tool in a field that, in such countries, has traditionally been the province of the public sector. Lemonade made explicit in its prospectus its goal to decouple its financial incentives from variability in claims, by generally donating excess premiums to nonprofits selected by Lemonade customers. Both Laureate and Lemonade operate in industries that have faced criticism for the inherent tension between profit-maximizing incentives and customer outcomes, and the PBC form is a meaningful way to communicate to customers a real intention to address that tension. In addition, the target market for Laureate and Lemonade skews towards younger consumers, where the branding impact of being cutting edge and socially conscious may be particularly meaningful. Vital Foods’ mission is inherently more intrinsic to its business model, and the detailed public benefits included in its charter and relatively lengthy discussion in its IPO prospectus reflect the many aspects of mission relevant to its operations, including not only the customer and the product but also employees, farms and suppliers, animals and the environment.

The three companies also have in common an ability to maintain the missions agreed to by their respective pre-IPO shareholders, even as public companies, through voting control at the board or stockholder level. Changing a PBC’s public benefit statement, eliminating PBC status entirely, or converting from a regular Delaware corporation into a PBC all are effected by an amendment to a corporation’s certificate of incorporation, which requires approval of a Delaware corporation’s board of directors and the affirmative vote of at least a majority of the corporation’s outstanding voting power. In the case of Laureate, the pre-IPO stockholders held “Class B” shares with ten times the voting rights of the public investors’ shares, making it impossible to eliminate that company’s PBC status or change its mission without support of the pre-IPO investors that enacted those provisions in the first place. Lemonade and Vital Health do not have dual-class stock, but pre-IPO investors retain significant stakes in those companies, and through their classified board structures, it would be difficult for investors not aligned with the companies’ missions to quickly effect any change. As for PBCs contemplating going public without a controlling voting block, in addition to using classified boards to lock in mission and defended against activist investors, the company’s certificate of incorporation can set a supermajority approval threshold to amend or eliminate the chosen public benefit. That said, given this stickiness of a public PBC’s mission, post-IPO investors are likely to buy into the public benefit investment thesis, and may themselves be less likely to vote to eliminate it.

Emphasis on Returns

The three IPOs also each show that being a PBC can be good, and big, business. The IPOs were each in the nine-figure range, with the largest coming in at nearly half a billion dollars. These are not “small potatoes.” Further, the most recent two IPOs clearly out-performed the underwriters’ expectations of the market’s valuations for those companies.

The prospect of achieving significant economic returns for investors while balancing mission has been a key concern for PBCs since their inception. It therefore may not be surprising that each of the three IPO prospectuses included a letter to stockholders from the companies’ founders discussing the companies’ beliefs and values while highlighting growth strategy. This once-rare practice has become increasingly common in IPOs, where even for non-PBC companies, a primary purpose of the letter is to link these two potentially competing concepts and manage investor expectations.

Disclosures, Reporting and Accountability

As one would expect, the prospectuses for each IPO also include risk factors regarding the potential risks associated with PBC status. All three include disclosure regarding the potential for lower return due to their PBC status, providing protection for the company in the event that notwithstanding the theses behind the investor letters, a focus on public benefit nevertheless detracts from the bottom line. The most recent two prospectuses also included risk factors related to the potential for stockholder derivative litigation to enforce mission, likely spurred by recent legislation to amend the Delaware code to provide more clarity around such procedures. [2] Interestingly, Lemonade’s prospectus also included language noting that failure to achieve that company’s public benefit might itself “have a material adverse effect on reputation,” and therefore returns, reflecting the idea that Lemonade’s PBC and certified B Corporation status is an important component of the company’s marketing efforts and therefore a driver for growth.

As required by SEC rules, the prospectuses also summarize certain material elements of the Delaware code applicable to PBCs, including the requirement to at least biennially make available to stockholders a report on public benefit performance and an assessment of the company’s success in achieving its stated public benefits. Each of the three companies note that they have elected, as optionally provided under Delaware law, to have B Lab provide its B Corporation certification as evidence of social and environmental performance, accountability and transparency.

Final Thoughts

Having two PBCs IPO within such a short amount of time, and after such a hiatus, is itself noteworthy. Investors and consumers, activists and advocates, regulators and other stakeholders have for years been discussing the need for increased disclosures and board consideration of ESG factors in public companies. Indeed, many public companies have been voluntarily reporting on ESG already, and as a result of this investor pressure, the SEC recently approved final rules requiring additional disclosure around human capital measures that touch on various aspects of ESG and will likely enhance communications and efforts around diversity and inclusion as well.

Ultimately, though, an obligation to report on ESG considerations and risks is not the same as an obligation to pursue a public benefit potentially to the detriment of short-term stockholder value. Adopting a PBC form allows boards of directors and management to balance these considerations and make the choices they think are right, while having a defense from activist stockholders that may be off-put by a quarter or year of lower-than-hoped results. Because of this, PBCs have been touted as a potential solution both to the problem of short-termism in issuer and investor behaviors and to companies seeking to maximize profits for stockholders and passing associated negative externalities to the public at large. It would seem the market is ready to put its money where its mouth is, so to speak, by investing in companies that are required by law to pursue and report on a public benefit.

ENDNOTES

[1] Del. C. §362. The PBC is substantially different from the model “benefitcorporation” form adopted in many states, providing more protection to boards of directors and management and looking much more similar to the social purpose corporation form adopted in California. Importantly, the certificate of incorporation of a PBC specifies a chosen public benefit or benefits approved by stockholders, rather than an array of public benefits mandated by the statute.

[2] See Morrison & Foerster’s blog post.

This post comes to us from Morrison & Foerster LLP. It is based on the firm’s memorandum, “Capital Markets Embrace a Novel Corporate Form,” dated September 3, 2020, and available here.

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