Alternative Entities

Benefit Corporations

Unlike traditional corporate structures, in the US, a benefit corporation obligates the board to consider the interests of all stakeholders in its decision making, not just shareholders. The company must pursue a public benefit purpose, and must report on its impact performance to shareholders and potentially to the general public (depending on the state). The definition of public benefit varies by state, but it is most often expressed as a purpose of creating a positive impact on society and the environment as a whole, or of operating in a responsible and sustainable manner. The statutes also allow (or in some states require) the company to specify one or more specific public benefit purposes that it will pursue, each of which must fall within statutory definitions. For example, Delaware requires the specific public benefit purpose to be stated in the certificate of incorporation, and allows it to include positive effects of “an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.”

Some states, including New York, also allow the company to specify which purposes have priority. Practitioners should keep in mind that provisions prioritizing one purpose over others run the risk of limiting the board’s discretion.

Benefit corporations are often conflated with certified B Corporations (or B Lab certifications or B Corp certifications). Benefit corporation is a legal status conferred by state law in the US; whereas B Lab certification is issued by a private organization and has no legislative framework. B Lab certification is not needed to obtain benefit corporation status.
Non-profit B Lab, which issues B Corporation Certifications to organizations that commit to a set of impact “best practices”, also advocates for the adoption and improvement of benefit corporation.

Term sheet language specific to benefit corporations may be useful in the following situations:

  • the corporation will be formed at the time of the investment, and so the specific public benefit has not yet been defined;
  • the investors want to modify the definition of the specific public benefit in connection with the investment;
  • the investors or entrepreneurs want to require that the benefit report be distributed more often than is statutorily required;
  • the investors or entrepreneurs want to require the company to publicly share its benefit report;
  • the investors or entrepreneurs want to require the enterprise to assess its performance with respect to its specified public benefit against an independent third party standard;
  • the investors want a voice in any future changes to the benefit purpose and related concepts; and
  • if the company has multiple specific benefit purposes, the investors or entrepreneurs may want to specify that the company prioritize one or more purposes over others.

With some of the sample language, we identify a state or states for which the language is designed. Adjustments may be required to this language for corporations formed in other states.

  • Agreeing on a company’s specific public benefit purpose:

Sample language: The [Certificate][Articles] of Incorporation of the Company shall identify as the Company’s specific public benefit purpose(s) [definition of specific public benefit purpose(s)].

  • Requiring more frequent benefit reporting:

Sample language: The Company shall provide to its shareholders its benefit report [insert time period, which is more frequent than statutorily required].

  • Requiring public dissemination of benefit reports:

Sample language: The Company’s benefit report shall be posted on the Company’s website. The Company may omit from the posted reports any financial or proprietary information included in the reports.

  • Requiring assessment of social performance with reference to third party standards:

Sample language: The Company’s benefit report shall include an assessment of the overall social and environmental performance of the Company against a credible, independent third party standard].

  • Requiring investor approval of specific benefit purpose and related items:

(Sample language – Delaware Debt): During the term of the Loan, the consent of the Investor shall be required to (1) change the Company’s specific public benefit purpose(s), (2) adopt or change the objectives the Board is required to establish to promote its public benefit purpose(s) and the interests of those materially affected by the Company’s conduct, or (3) adopt or change the standards the Board is required to adopt to measure progress in promoting such public benefit purpose(s) and interests.

Sample language (Delaware equity): As long as the Investors hold at least [X percent] of the Shares purchased, [the vote of at least X percent of the Shares, voting as a separate class] OR [the approval of the Board, including the approval of the Series X Director(s)], shall be required to (1) change the Company’s specific public benefit purpose(s), (2) adopt or change the objectives the Board is required to establish to promote its public benefit purpose(s) and the interests of those materially affected by the Company’s conduct, or (3) adopt or change the standards the Board is required to adopt to measure progress in promoting such public benefit purpose(s) and interests.

Sample language – NY/CA debt): During the term of the Loan, the consent of the Investor shall be required to (1) change the Company’s specific public benefit purpose(s), or (2) adopt or change the third-party standard used to assess the Company’s social and environmental performance.

Sample language (NY/CA equity): As long as the Investors hold at least X percent of the Shares purchased, [the vote of at least X percentage of the Shares, voting as a separate class] OR [the approval of the Board, including the approval of the Series X Director(s)], shall be required to (1) change the Company’s specific public benefit purpose(s), or (2) adopt or change the third-party standard used to assess the Company’s social and environmental performance.

  • Establishing priority of multiple public benefit purposes

Sample language: The [Certificate][Articles] of Incorporation of the Company shall identify as the Company’s specific public benefit purpose(s) [definition of the specific public benefit purpose], and shall state the Company’s intention to give priority to [definition of the priority purpose].

Low Profit Limited Liability Companies (L3Cs)

The Low-Profit Limited Liability Company, or L3C, is an alternative form of LLC that builds key program-related investment (PRI) requirements into the form’s charter documents. L3C statutes require, for example, that it must be organized to further a charitable or educational purpose articulated in its operating agreement. Financial returns cannot be a significant purpose of L3Cs, and they are prohibited from pursuing political or legislative purposes.

Given these restrictions, the promoters of the form hoped that investments in L3Cs would automatically qualify as PRIs, but the IRS has not issued any guidance to that effect. But even without automatic qualification, users of the form argue that it makes it easier for private foundations to conduct the due diligence necessary to complete PRIs and to comply with expenditure responsibility rules.

Term sheet language specific to L3Cs may be useful in the following situations:

  • the L3C will be formed at the time of the investment, and so the charitable or educational purpose has not yet been defined;
  • the investors want to modify the charitable or educational purpose in connection with the investment; or
  • the investors want a voice in any future changes to the charitable or educational purpose.
  • Identifying purpose with a L3C

Sample language: The [L3C state formation document] of the Company shall identify the Company’s purpose as [charitable or educational purpose definition].

  • Changing purpose with a L3C

Sample language: As long as the Investors hold at least X percent of the outstanding membership interests of the Company, [the vote of at least X percent of the preferred membership interests, voting as a separate class] OR [the approval of the Board, including the approval of the Series X Manager(s)], shall be required to change the Company’s [educational or charitable] purpose(s).

Alternative Entities

Investments in entities designed to protect mission may require different terms than investments in traditional entities. Entrepreneurs and investors may also want to establish a mechanism to convert a traditional entity into one of these alternative entities in the future. Once such mechanism is so-called “drag along rights.”

Agreeing on company’s social purpose

The social purpose corporation is a new corporate form that requires directors to pursue a social purpose in addition to shareholder return. State statutes require or allow social purpose corporations to commit to one or more specific social or environmental purposes that fall within statutory guidelines, and obligate the company to publicly report on its performance relative to those purposes.

Types of Alternative Entities

Term sheet language specific to social purpose corporations may be useful in the following situations:

  • the corporation will be formed at the time of the investment, and so the social purpose has not yet been defined;
  • the investors want to modify the definition of social purpose in connection with the investment;
  • the investors or entrepreneurs want to require the enterprise to benchmark its performance with respect to its specified social purpose against independent third parties; or
  • the investors want a voice in any future changes to the social purpose and related concepts.

For our sample language, we’ve used language designed for California social purpose corporations because California was the first and most populated state to adopt the social purpose corporation. Adjustments may be required to this language for social purpose corporations formed in other states.

  • Agreeing on a company’s social purpose:

Sample language: The Articles of Incorporation of the Company shall identify the Company’s special purpose as [special purpose definition].

  • Third party reference for assessment of social performance:

Sample language: The Company’s annual [social purpose report] OR [special purpose MD&A and any special purpose current reports] shall include an assessment of the overall social and environmental performance of the Company against a credible, independent third party standard.

  • Requirement of investor approval for change in social purpose and related items (equity):

Sample language: As long as the Investors hold at least X percent of the Shares purchased, [the vote of at least X percent of the Shares, voting as a separate class] OR [the approval of the Board, including the approval of the Series X Director(s)], shall be required to (1) change the Company’s special purpose(s), (2) adopt or change the overall objectives of the Company relating to its special purpose(s), or (3) adopt or change the financial, operating, and other measures used by the Company for evaluating its performance in achieving such special purpose(s).

  • Requirement of investor approval for change in social purpose and related items (debt):

Sample language: During the term of the Loan, the consent of the Investor shall be required to (1) change the Company’s special purpose(s), (2) adopt or change the overall objectives of the Company relating to its special purpose(s), or (3) adopt or change the financial, operating, and other measures used by the Company for evaluating its performance in achieving such special purpose(s).