Just over 10 years ago, benefit corporations emerged as legal entities intended to permit for-profit social enterprises to pursue public-interest missions. While increasingly popular among states and businesses, these new entities have received unending criticism from commentators on all sides. To some, benefit corporations are unnecessary, because traditional corporations already can and do pursue social missions. To others, they are insufficient, because benefit corporation directors must merely consider those missions but need not prioritize them.
In the latter camp, many legal scholars have proposed legislation to improve benefit corporations or to create new types of entities to better accommodate social enterprises, but state lawmakers show no signs of adopting any of these proposals. Dissatisfied with the options offered by public law, some creative social entrepreneurs are resorting to private ordering, developing elaborate corporate structures to pursue their public-interest missions over the long term.
My forthcoming article, Golden Shares and Social Enterprise, illuminates a nascent structure of this kind in the United States, called the golden share model (GSM). This is one manifestation of a broader global movement known as steward ownership, which aims to commit companies to pursue unique purposes and to keep corporate control with managers and employees rather than outside investors. To achieve these goals, the GSM borrows and combines several features from very different areas of corporate law, resulting in a novel and complex structure intended to maintain both mission and management over the long term.
This model begins with the popular Delaware public benefit corporation (PBC), which must state in its charter a specific public benefit that its directors must then balance against the interests of stockholders and other stakeholders. The corporation employs a dual-class stock structure, typically associated with “unicorn” tech companies that sell shares with minimal voting rights in their IPOs so that their celebrity founders retain majority voting control even with a minority equity stake. Adapting this structure to an entirely different context, the GSM adds a twist: Insiders (including approved successors to the founders) receive stock with all the voting rights but no economic rights and strict transfer restrictions, and investors receive stock with no voting rights or transfer restrictions but all the economic rights. Those economic rights may consist of dividends and share redemptions, up to an aggregate cap on receipts in each case. Finally, the GSM’s eponymous feature comes from the private debt financing context, where a single “golden” share can empower a creditor to prevent a debtor from declaring bankruptcy. The GSM similarly creates a single share, but its veto rights are different, entitling the holder to block any sale or liquidation of the company, any transformation from a PBC to a traditional corporation, and any change to its charter’s specific public benefit or other fundamental provisions. That golden share is issued to a nonprofit organization that is required by its charter to veto any such proposal without consideration, a function currently served exclusively by the Purpose Foundation in Switzerland.
Together, these arrangements have interesting implications for the relationships among managers, investors, the golden shareholder, and the corporation itself. As a threshold matter, though legally untested, most of the GSM’s various features comply with Delaware law, except that its strict transfer restrictions may require some feasible modifications to withstand judicial scrutiny. Once legally compliant, the GSM provides several advantages to social enterprises over the standard PBC.
Most important, this model should prevent the company from surrendering its mission through some of a social entrepreneur’s worst nightmares, like a sale to a profiteering acquirer or an IPO that leads to short-term earnings pressure. In a standard PBC, founders often worry that they will lose to investors the voting control needed to block these transactions. In contrast, the GSM’s intricacies would prevent them no matter how much capital is raised.
Moreover, a business’ choice of such a restrictive structure, which denies managers several profitable exit options and other avenues toward enrichment, could promote alignment with its investors through both signaling and screening. Impact investors, who frequently express concerns about mission drift and “greenwashing,” may worry less when founders have sacrificed opportunities for personal gain. At the same time, the exploitative venture capitalists that social entrepreneurs hope to avoid would likely take one look at the capped financial returns of a golden share company’s nonvoting stock and tear up the term sheet.
Despite these potential benefits to social enterprises, the GSM has significant limitations. In general, this model would appear to eliminate most of managers’ typical reasons for mistrusting investors, but from investors’ perspective, many concerns may remain.
Most critical, although the GSM may indelibly enshrine a particular mission in a charter, it does nothing beyond the standard PBC form to make managers pursue that mission. A company’s achievement of social goals depends largely on day-to-day business decisions, not on the M&A transactions and charter amendments that are subject to the golden shareholder’s veto or even a stockholder vote. Directors can easily satisfy the PBC legislation’s mandate to consider the company’s mission in their decision-making process, whether or not their ultimate decisions advance that mission. Even if they fail to meet this low bar, the main enforcement mechanism is a stockholder derivative lawsuit with limited remedies, which would be so expensive and unlikely to succeed that nobody would bother bringing one.
Moreover, by depriving investors of voting rights, the GSM enables various managerial abuses. First, like all dual-class stock structures, it can entrench founders, who often turn out not to be the best people to run a company as it grows. Second, although insiders cannot make money through stock-related transactions like dividends, they can easily extract private benefits by increasing their salaries and pursuing pet projects. Under a normal capital structure, investors could vote out derelict directors, but they have no votes under the GSM. When these risks of managerial abuse are combined with precisely limited financial returns, nonvoting stock in a golden share company can be a hard sell, as founders of these businesses have already experienced in fraught fundraising efforts.
Other potential problems with the GSM arise from its dependence on an independent foundation as the golden shareholder. Presently, only one, relatively new organization meets the criteria to provide this critical service, and a company must rely on it to exercise its veto rights predictably and indefinitely. If that organization stops performing this duty or even existing, and if no other organizations arise to replace it, then the whole model will disintegrate.
Despite these serious shortcomings, businesses could make various improvements to create incentives for investors to accept the limited financial returns and lack of control that the GSM offers.
First, because the model does not ensure that a certain mission stays a priority, a company could employ impact metrics to assure investors of its commitment to its specified social objectives. These metrics, notably the IRIS+ system, are ubiquitous in impact investment deals, typically as triggers for rights and obligations in loan agreements. Because the GSM contemplates equity investments in which all stockholders of the same class receive the same rights, a contractual approach with each investor is not ideal. Instead, these companies could implement impact metrics in a completely novel way by integrating them into their organizational documents. For example, upon a failure to satisfy a set of metrics over a given period, the charter could enable investors to force the company to redeem their shares at a certain price, or the bylaws could temporarily enfranchise them to nominate and vote for candidates in the next board election. Facing the prospect of financial strain or defenestration, directors would have a real incentive to achieve their social missions rather than just discuss them in board meetings, which is all that the standard PBC and GSM require.
Advocates of steward ownership may object that this proposal falls short of their ideals of managerial independence by granting too much control to outside financiers. But social entrepreneurs who want broader access to capital may need to sacrifice some of the absolute control inherent in the default GSM. The proposed reliance on metrics would provide that access by elevating purpose, not profits, while relinquishing managerial authority only when the company falls short of its social mission, not its financial one.
Beyond this primary proposal, the GSM could also improve in other ways. To limit management from extracting private benefits, the charter could add “protective provisions” to grant investors consent rights regarding compensation decisions. To avoid overreliance on a single, unknown, overseas foundation, the founders could instead confer the golden share’s voting rights through a voting trust to any person or entity, which would be contractually obligated to exercise those rights according to the company’s instructions.
To social entrepreneurs disappointed by the standard benefit corporation’s marginal advances beyond the traditional corporation, the GSM’s fusion of exotic arrangements could be tantalizing. Unfortunately, the existing model does too little to prioritize missions and too much to neutralize investors. With my proposed improvements, however, an updated model could assuage all stakeholders’ concerns, providing a more solid foundation for building social enterprises to last.
This post comes to us from Naveen Thomas, director of the Business Transactions Clinic at New York University School of Law. It is based on his recent article, “Golden Shares and Social Enterprise,” available here.