So You Want to Have Impact?

The field of “impact” has greatly expanded over the past few years.  “Impact” is generally defined as an emphasis on environmental, social, and governance (ESG) factors in addition to financial returns by both corporations and investors.  Initially (and often still) viewed as an extension of philanthropy, impact first rose in prominence through the corporate social responsibility (CSR) departments of large corporations and the philosophies of a new breed investors who heralded the importance of double, triple, or quadruple bottom line returns by focusing on employees, the community, and the natural environment in addition to financial returns.

With the growing recognition of the significant and positive impact that ESG factors can have on profitability, impact has now spread to mainstream companies and capital markets.  In addition to the growing number of “impact first” investors and social enterprises, there has also been an expansion in focus on impact by traditional corporations and investors that emphasize financial returns.

If you are managing a company that has been established to bring new technology, goods, and services to market (outside of the clean technology/renewable energy sector), you may want to consider impact for the following reasons:

  • Gain an edge over your competitors
  • Attract and retain employees and create a more creative workplace
  • Generate more positive relations with the community in which you operate
  • Shift toward carbon-neutral (or carbon-negative) policies and operations
  • Attract more investment and increase confidence from your shareholder base

If selected and implemented carefully, the adoption of one or more of the solutions below may increase your valuation and generate greater returns through a sale or IPO.  Further, you will be better prepared to respond to investors in both private and public companies who are asking more questions about ESG and requiring ever more robust reporting.

Examine Your Corporate Form

New corporate forms (see below) are gaining mainstream acceptance and companies using new forms have filed for a public offering and become attractive acquisition candidates.  Nonetheless, should you prefer your existing corporate form, you can incorporate impact into your company’s DNA.

  • Corporation.  Retain your existing corporate form and include mission in protective provisions, voting rights, governance, information rights, and/or shareholders agreement.
  • LLC.  Draft mission into your operating agreement as part of the purpose and require manager and/or common member approval for change.  Other provisions can be added to prioritize mission as part of distributions, allocations, and governance.
  • Public Benefit Corporation (DE)/Social Purpose Corporation (CA).  Consider converting into a new form that creates an affirmative fiduciary duty on the parts of board and management to shareholder-agreed social or environmental goals in addition to shareholder returns and provides protection from liability similar to the business judgement rule.
  • Other Benefit Corporations.  In states other than CA and DE, closely examine the widely disparate benefit corporation forms prior to conversion.
  • L3C.  Consider the Low-profit Liability Company if you wish to attract “impact first” investors and foundations making PRI investments.
Explore the Establishment of an Affiliated Non-profit or .Org

Establishment of an affiliated .org (501(c)(3) public charity) can provide a company with numerous advantages including:

  • Generation of good-will with customers, employees, and the public
  • Access to donations (or non-dilutive capital) for .org charitable programs
  • Development of programs and services that can be provided to the .com and its customers provided that they are not exclusive and within the scope of the exempt purpose
  • Expansion of customer base to include non-profits, NGOs, and government agencies who prefer to contract with the .org, with revenues returning to .com via market license royalties

The .org can be established as a 501(c)(3) foundation or public charity, in the latter case only if there is significant funding from outside of the affiliated company.  However, public charities have considerably more flexibility to — and are really the only tax-exempt entities that can — provide the benefits above.  Also, note that both the establishment and the operation of a hybrid are complex.  The flow of funds, intellectual property, services, and resources between the two entities must be documented by agreement and carefully managed to avoid loss of tax-exempt status and excise taxes.  Further, good governance requires disinterested members for both the non-profit and boards to provide regular oversight over the relations between the two affiliates.

Implement Integrated Reporting or “B-Corp” Certification

A company that wishes to accentuate ESG factors should consider how it wants to measure, verify, and report on such impact.  For public companies, there is increased focus on “integrated reporting,” with standards being set by groups like the Sustainable Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI), which is identifying the ESG factors by industry that are material to operations and should therefore be included in a 10-K or 10-Q.  Many private companies chose to report pursuant to the GRI or to become certified “B-Corps.”  A B-Corp is not a new corporate form; a company becomes a B-Corp by completing an audit prepared by B Labs, submitting the same to B Labs, and paying a license fee for the mark.  Most B-Corps do not convert their corporate form but B Labs usually requires conversion into a new “benefit corporation” form in the license agreement. 

Management and investors that wish to measure carbon emissions should consider including metrics and a verification process that will allow reporting pursuant to COP21.

Consider Use of Licenses to Preserve Impact

Founders who wish to protect against mission creep in normal operations or change of control can consider isolating a valuable part of the company’s intellectual property (important to operations but not critical to valuation).  Such intellectual property can be either retained by a founder or held by a for-profit or non-profit affiliate and licensed to the company pursuant to an exclusive royalty-free license with an affirmative covenant to maintain the agreed mission focus. If and to the extent that there is a material change to the mission of the company without the consent of the licensor, the license can either terminate or the company can pay penalty royalty payments.

Include “Impact” in Compensation Plans

Many companies that are serious about impact wish to ensure that they meet standards set by the board, management, or outside investors.  Such companies can expand evaluation criteria for salaries, bonuses, and promotion to include ESG.  The key is identifying factors that are clear and easy to measure and report.

Embed Mission in Terms of Traditional Debt or Equity Instruments

Investors who want to ensure impact in their portfolio companies, for either mission or profit-driven reasons, should consider the following:

  • Preferred Equity.  Inclusion of mission in protective provisions (class vote), information rights, governance and board seats, redemption rights on material deviation from mission
  • Simple Agreements for Future Equity (SAFEs).  Inclusion of mission in affirmative covenants; approval of new form prior to conversion to equity
  • Convertible Debt.  Inclusion of affirmative or negative covenants, reporting on impact, default interest rate for mission shift, default if material deviation from mission
Consider Issuance of Green Bonds

Investor appetite for green bonds is expanding exponentially.  Green Bonds were created to fund projects that have positive social, environmental, and/or climate benefits.  The majority of the green bonds issued are green “use of proceeds” or asset-linked bonds.  Proceeds from these bonds are earmarked for projects that are focused on environmental and social returns but are backed by the issuer’s entire balance sheet.  For those instruments focused on carbon mitigation, it will be critical that the reporting to investors in these bonds is consistent with the verification and reporting required under COP21.