In recent years there has been a surge of restructuring of traditional corporations (C corporations) into the public benefit corporations (PBCs). As an investor or entrepreneur, the task is not just check the box. We at Rimon have a long history of working with companies in different stages with different missions. We witness how in recent years entrepreneurs pivot to more socially impactful missions in their corporate strategies. We are well poised to help investors and entrepreneurs understand the benefits of PBC as an innovative corporate type.
A family office may get involved in a public benefit corporation (PBC) as a minority investor. PBC is a unique corporate structure. The principals of a family office need to evaluate the extent to which a PBC’s board of directors may be beholden to its unique interests in its decision-making process.
What is a PBC?
A Public Benefit Corporation (PBC) is distinguished from a C corporation where a PBC is a “new kind of socially conscious for-profit corporation intended to operate in a responsible and sustainable manner”[1]. A PBC’s corporate charter must identify one or more specific public benefits. Such benefits can be of an artistic, charitable, cultural, economic, educational, environmental or other meaningful nature.
Some well-known examples of PBCs include Patagonia, Allbirds, Ben & Jerry’s, Coursera and Vital Farms. Reportedly, OpenAI is restructuring into a PBC.
What are the interests of a Family Office Investor in investment in a portfolio company?
- A family office investor (as others) has a paramount interest in preventing harm to the share value. The harm could be done by any of the following malfeasances of the directors or controlling stockholders: reckless management, lack of a process to make an informed decision, self-interest or fraud.
- A family office investor may have an interest in preserving the status quo of a healthy portfolio company. This may have to do with the long-term mandate of the family office to preserve the value of the portfolio for such investor’s next generations. Harm can be done through reckless or self-interested transactions.
- A family office investor may have an interest in revenue growth.
- A family office investor may expect that the portfolio company should prioritize such investor’s exit schedule over other shareholders’ exits.
- A family office investor may have a mandate that the portfolio company should not just pursue IRR, but rather should foster some socially impactful purposes.
What are the standards of review of the directors’ decisions in a C Corporation?
In a C corporation, the actions of the directors are subject to a complex (near-intractable to some) review system. The review process is fact-intensive. The pillars of the system may be summarized as: (a) standards; (b) conducts; and (c) defenses.
The review standard moves in a spectrum, from the most deferential, which is business judgment rule, to enhanced scrutiny, then to the least deferential, known as the “entire fairness standard”.
The “tainting” conducts that could elevate the review standard to the less deferential include bad faith, conflicted board, interested stockholders, non-ratable benefits, coercion, etc. Compounding the analysis are transaction-based review standards, including the Revlon standard and the Unocal standard, which are precedents that require application of heightened scrutiny on the directors’ conducts in mergers and acquisitions or hostile takeovers.
In a C corporation, on the defense end of the spectrum, there are elements the court reviews to determine either if an exculpatory clause in the charter is available to the director or if the review standard should be lowered to the more deferential one, based on absence of the “tainting” conducts illustrated above.
How are decisions of the directors in a PBC reviewed?
In Delaware, the PBC statute includes Section 361 through Section 368 of the Delaware General Corporation Law (DGCL). Depends on how they are read, either these rules may seem like a new quandary for a PBC’s directors to grapple with, or they are perceived as sanctifying a simpler review process.
“Morality is not properly the doctrine of how we may make ourselves happy, but how we may make ourselves worthy of happiness” – Immanuel Kant.
Here, the “worthiness” of the directors’ decisions in a PBC is not just the happiness of its stockholders, but the happiness of a wider class of protected interests.
The directors in a PBC shall balance the following interests:
- the pecuniary interests of the stockholders,
- the best interests of those materially affected by the corporation’s conduct; and
- the specific public benefit or public benefits identified in its charter (the latter groups known as “stakeholders” versus stockholders).
Where does a Family Office Investor fit in?
In a C Corporation, a family office investor is part of the “corporate enterprise” (understood as stockholders overall) to which the directors owe fiduciary duties. In a C Corporation, parties in a business relationship do not have a fiduciary relationship. In a PBC, a “formal” fiduciary relationship between the directors and some non-stockholders (e.g. customers, employees, community) is preordained. Hence, the interests of a family office investor will be measured for their congruence with the interests of a wider myriad of groups as the concept of the “fiduciary relationship” is being redefined.
Due to the scarcity of case law, in PBCs, the fairness of a transaction as in relation to the controlling stockholders versus the minority stockholders has not been illuminated. The notion of fairness is being reconstructed.
Evaluate the interests of a family office investor in a PBC’s decision-making process
- Where a family office investor has an interest in preserving the status quo of a portfolio company, the balance-of-interest test would embolden the PBC’s directors to prevent or defend a hostile takeover.
An M&A which otherwise sustains the Revlon review standard may not survive scrutiny in PBC if the interests of a specified community are susceptible to being impaired. Where the Unocal review would otherwise apply, a directors’ adoption of a defensive measure in a hostile takeover – even otherwise not reasonable or proportionate – might be upheld as fair in light of the overall interests of employees or environment.
- A family office investor may find itself sharing a common interest with employees of a PBC to challenge the directors’ decision to divest a “crown jewel” asset.
- A family office investor may “anchor” the restructuring of a C corporation into a PBC if the investor is aligned with the entrepreneurs in instilling more social benefit elements in the company’s growth strategies.
What is the exposure of the board representative?
“The only people who achieve much are those who want knowledge” – C.S. Lewis.
Here, the PBC statute implies that to cleanse a transaction the court may put more weight on the cleansing factor of lack of a conflicted board than an informed board.
Apropos of the director’s exposure, although the fiduciary duties of the directors remain unchanged, the defense dynamics may change. Sections 365(b) and (c) insulate a director to the extent such director’s decision is “both informed and disinterested” and “not such that no person of ordinary, sound judgment would approve”. Also, “in the absence of a conflict of interest, no failure to satisfy that balancing requirement shall constitute an act or omission not in good faith, or a breach of the duty of loyalty, unless the certificate of incorporation so provides.”
This presupposes a review standard interlocking between the business judgment rule and a heightened review standard. The charter may also opt to provide a higher standard. The conflicted board element seems carry more weight than the other elements.
The “reasonable person in the boardroom test” also becomes operative.
Is PBC a better entity for socially impactful investors?
PBC straddles between a C corporation and a non-profit organization. By design, a PBC provides greater certainty for advancing socially impactful investment mandates. It is a more palatable investment target for some family office investors with such investment mandates. It also fosters the function of a family office in preparing next generations for greater social responsibility.
