This article was written by guest author Alicia Plerhoples. Ms. Plerhoples is a Visiting Assistant Professor at University of California at Hastings College of the Law and will be an Associate Professor of Law, Georgetown University Law Center, starting Fall 2012. This post is based on her article Can an Old Dog Learn New Tricks?: Applying Traditional Corporate Law Principles to New Social Enterprise Legislation, 13 Tenn. J. Bus. L. [_] (forthcoming 2012).
Theoretically, the organizational spectrum has two extremes. On one end of the spectrum are organizations that pursue social and environmental missions and eschew profit motives, such as non-profit organizations. On the other end of the spectrum are organizations that focus solely on profit-maximization and disregard social and environmental missions—these might be called profit-maximizing businesses.[1] Somewhere between these two extremes lie social enterprises that blend profit motives and social missions.
For many social enterprises, how the business operates is just as important as what the business produces. Rather than seek out the cheapest raw materials and labor, social enterprises are likely to establish their supply chains to source sustainable materials and engage in fair trade practices, while paying fair wages and providing fair benefits to their employees. The social enterprise movement attempts to move beyond corporate social responsibility or “greenwashing.” Social enterprises truly “serve two masters”[2]—they have a profit motive, but their social and environmental missions are at the core of their business models.
As the market for products and services produced by social enterprises grows, traditional profit-maximizing corporations—which may have given limited attention to their social or environmental outputs in the past—will want a piece of this market share and will be able to make a rapid market entrance by acquiring an established social enterprise. On one hand, a social enterprise may face a change in control transaction because it chooses to forgo profits to achieve a social or environmental mission. For example, TOMS Shoes has given away over one million pairs of shoes.[3] The management of TOMS Shoes made a strategic decision to start manufacturing operations in Ethiopia and Argentina as part of its social objective to create jobs in the areas where it donates shoes.[4] Some would argue that choosing to provide jobs where it provides charity rather than ship shoes from China, where it also has manufacturing operations, could come at the expense of company earnings if the labor and raw materials are more cheaply available in China. The social enterprise’s earnings affect its stock price and entice a buyer, either hostile or friendly, in an attempt to achieve greater earnings and higher stock prices for the company.
On the other hand, many would argue that the financial success of a social enterprise may be because of—and not in spite of—its social and environmental mission, since many consumers prefer socially responsible and environmentally sustainable products and services. Profit-maximizing businesses will expand into that market by acquiring an established participant rather than starting their own brands. Such an acquisition leads to an immediate immersion in the market, marked by the legitimacy of the target social enterprise. Such was the case of Tom’s of Maine, Inc. (purchased by Colgate-Palmolive Company), Burt’s Bees, Inc. (purchased by The Clorox Company), and Ben & Jerry’s (purchased by Unilever). As one mergers and acquisitions lawyer notes, “it might just be cheaper to buy than build.”[5]
The shareholder wealth maximization norm and shareholder primacy are fundamental corporate law principles that impact a social enterprise engaging in succession planning. Shareholder wealth maximization requires board directors to make decisions based solely on the maximization of shareholder value. Shareholder primacy requires board directors to advance and prioritize shareholder interests over non-shareholder interests. Under certain circumstances, once a social enterprise offers itself for sale, the shareholder wealth maximization norm and shareholder primacy work together to dictate heightened judicial scrutiny of the directors’ decision-making process. Notably, Delaware’s Revlon rule[6] would impose heightened judicial scrutiny of the sale transaction and would inquire as to whether the directors sought to obtain the best value reasonably attainable for the corporation. Questions surround whether a social enterprise formed as a traditional profit-maximizing corporation could consider the social enterprise’s social and environmental value during the sale of corporate control.
Legislatures are beginning to provide social entrepreneurs with off-the-shelf corporate forms to employ for social enterprise—ones that eschew the shareholder wealth maximization rule but wholly embrace shareholder primacy, such as the flexible purpose corporation and the benefit corporation. Shareholder primacy in the context of social enterprises has a different meaning than it does for profit-maximizing corporations. Shareholders of social enterprises—namely impact and social investors—may not want shareholder value prioritized over social and environmental considerations. For example, the California flexible purpose corporation law explicitly rejects the shareholder wealth maximization norm and allows adoption of charitable purposes or consideration of other constituencies (including the community, society, and the environment) as “special purposes” of the corporation.[7] Thus, for a flexible purpose corporation, shareholders invest with both economic and non-economic interests in mind. Importantly, under both the flexible purpose corporation and benefit corporation statutes, only a shareholder—and no other constituent—has a private right of action to enforce the board of directors’ fiduciary duties to the corporation.
A social enterprise organized as either a flexible purpose corporation or a benefit corporation presumably would be free to pursue social and environmental objectives along with shareholders’ economic interests, even when engaging in a sale or change of control transaction. Moreover, conversions and mergers with other corporations require a supermajority vote of the shareholders. Presumably, the social enterprise formed as a flexible purpose corporation or a benefit corporation will thus be able to better preserve its social and environmental mission.
However, these new corporate forms are untested. It remains unclear as to how traditional corporate law principles will be applied to the flexible purpose corporation or the benefit corporation. The lack of corporate law precedent is a true barrier to the proliferation of these new corporate forms, although perhaps social entrepreneurs, by virtue of their careers as entrepreneurs and not lawyers, are willing to take that risk.
[1] “Profit-maximizing business,” or “PMB,” is a term used by Muhammad Yunus to describe companies that seek profits, even if the company also has social or environmental missions. See Yunus, Building Social Business, supra note 44, at 1.
[2] Matthew 6:24.
[3] One for One, TOMS Shoes, http://www.toms.com/our-movement/movement-one-for-one (last visited Mar. 10, 2012) [hereinafter TOMS Shoes].
[4] See TOMS Shoes, Shoe Digest (July 5, 2011), http://www.shoedigest.com/donate-shoes/toms-shoes.
[5] Dennis J. Block, Public Company M&A: Directors’ Fiduciary Duties And Recent Developments In Corporate Transactions, at 20, in Contests for Corporate Control 2009: Current Offensive & Defensive Strategies in M&A Transactions (2009).
[6] I do not wish to overstate the significance of Revlon. Subsequent Delaware cases have narrowed the scope of the Revlon rule and some scholars have eschewed its import. Nevertheless, as it stands, the Revlon rule is the most proscriptive use of the shareholder wealth maximization norm in corporate law. And to some extent, corporate managers and their general counsel heed its directive. As such, the Revlon rule presents a useful lens through which to examine the shareholder wealth maximization norm and shareholder primacy.
[7] Cal. Corp. Code § 2602(b)(2)(B) (Deering 2012).