By Cliff Ennico
This coming week Connecticut will be joining about 27 other states that are adding a new type of business entity – the benefit corporation or “B Corp.” – to the traditional list of corporations, partnerships, and limited liability companies (LLCs).
Under current law, corporations and other business entities can be “for profit” or “not for profit,” but not both at the same time. If a group of people wish to form a company with a social purpose, they are required to organize as a “not for profit” entity. This means:
there can be no owners or shareholders – any profits must be plowed back into the company in order to further its charitable purpose;
if the company’s goal is a “charitable” or public good, the entity must register with the IRS as an “exempt organization” under Section 501(c)(3) of the federal Internal Revenue Code (a process which takes almost two years on average right now); and
the company must pay income tax on any profit-making activity not “directly related” to the company’s charitable purpose.
While “for profit” companies are not barred from engaging in charitable activity – many corporations such as Ben & Jerry’s® and Newman’s Own® require a specific percentage of annual profits to be donated to charity – they are discouraged legally from engaging in such activities to the detriment of their shareholders. Since 1919, U.S. law has said that the sole purpose of a for-profit business is to generate a return for its shareholders . . . period.
The B Corp. is designed to change all that, by requiring that directors and officers take the needs of society, the needs of employees, and the needs of owners all into account when making business decisions. Under the model statute that serves as a guide for state legislatures wishing to allow benefit corporations, a B Corp.:
MUST be formed for a “general public benefit” (defined as a “material positive benefit on society and the environment, as measured by a third party standard”); and
MAY also be formed for a “specific public benefit” (defined by the company as a specific intent of the company, similar to the charitable purpose of a not-for-profit entity).
The statute does not define “positive,” nor does it give guidance as to what a “third party standard” may be, although clearly this refers to criteria such as LEED for green buildings, Fair Trade for coffee, or USDA “organic” status for milk. Where there is no “third party standard” (for example, a martial arts studio that wants to teach kids coping strategies for dealing with schoolyard bullies), the B Corp. option may not be available.
Also, a B Corp. must benefit both society AND the environment. Many socially worthy causes that benefit one but not the other would not qualify for B Corp. status (although two states – Delaware and Colorado – have amended this requirement so that a B Corp.’s purpose can benefit either society or the environment).
While LLCs and other business entities can convert into a B Corp., a B Corp. is a corporation and must be taxed as either a regular or “S” corporation. An LLC does not qualify for B Corp. status, although a similar entity, the “low profit limited liability company” or “L3LLC,” has been adopted in a handful of states to facilitate socially-conscious LLCs. Any B Corp. that wishes to accept tax-deductible donations or equity investments will have to qualify as a 501(c)(3) “exempt organization”.
The directors of benefit corporations are required to consider (or, in some states, balance) the interests of shareholders, employees, and society when making business decisions. Since there may be an inherent conflict of interest between these goals, the model B Corp. statute exonerates B Corp. directors and officers from personal liability for actions that they take. Director-and-officer liability insurance (so-called “D&O coverage”) may also be available to B Corp. management. Still, that may not deter plaintiffs’ lawyers from suing B Corps.: for example, if a B Corp. reduces staff to lower its costs, that will invariably hurt “at will” employees, who may be tempted to bring a class action against the B Corp. that would go nowhere against a traditional “for profit” corporation that has no legal duty to them.
Don’t get me wrong: I’m not against corporations doing good. We can all think of examples of corporations that are so focused on the bottom line that they pollute the environment, release defective or dangerous products, or devastate the middle class. But the B Corp., at least in its current form, is not the answer.
B Corps. are most likely to appeal to nonprofit startups with zero profit motive that want to avoid the arduous process of obtaining 501(c)(3) status from the IRS. If you are “for profit” and want to do good, amend your charter to require that x% of your profits each year be donated to “such bona fide charities as the directors may determine in their sole discretion.”
Cliff Ennico (www.succeedinginyourbusiness.com), a leading expert on small business law and taxes, is the author of “Small Business Survival Guide,” “The eBay Seller’s Tax and Legal Answer Book” and 15 other books.