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Starting a California Business with a Cause: Comparing the California Social Purpose Corporation with the Delaware Public Benefit Corporation

Hayley Hodson, a rising third-year student at UCLA School of Law and an M&R 2021 Summer Associate assisted in the writing of this article.

As home to the Silicon Valley, Hollywood, and a host of some of the world’s finest academic institutions, California is a haven for entrepreneurs, innovators, and investors alike. Many of these are socially conscious and mission-driven individuals and entities, operating at the intersection of purpose and profit. For them, laws on both coasts providing for unique corporate forms that allow directors to balance a company’s profit-maximizing goals with its society-benefitting ones should be of great interest.

California offers the Social Purpose Corporation (SPC) as an alternative entity form to the C Corporation, non-profit corporation, or LLC. For those headquartered in the Golden State but wanting to incorporate in Delaware, that state has the Public Benefit Corporation (PBC), which functions similarly to the SPC. Both of these corporate forms are tailor-made for organizations that place profit and purpose (read: environmental sustainability and social justice, etc.) on equal footing.

For businesses adamant on incorporating in Delaware, the PBC is the clear choice. But for businesses with a cause and California roots, the SPC offers unique flexibility and protections that may constitute compelling reasons not to incorporate back east. The SPC (California) may be especially appealing for small businesses looking to keep costs down as they grow.

What follows is a close look at the differences between the SPC (California) and PBC (Delaware). Note that either entity type can be certified as a B corporation (B-Corp), though a B-Corp is a certification rather than a legal entity form that can be attached to entities in any state that meet the certification requirements.

What Is a California Social Purpose Corporation (SPC)?

The SPC is one of two special corporation types in California that provide alternative forms for entrepreneurs who want to build businesses that pursue both profitability and broader social or environmental goals (the other is California’s Benefit Corporation). A modified form of a C-corporation, the SPC requires incorporators to state in the Articles of Incorporation a specific purpose that a nonprofit corporation is allowed to pursue under California law, or a specific purpose to promote the short- or long-term beneficial effects of the SPC’s activities on its employees, suppliers, customers, creditors, the community, society or the environment.

Created in 2015 by an amendment to California’s Corporations Code, SPCs allow their directors to consider the social impact of their businesses along with shareholder interests when making decisions. Indeed, the directors of SPCs are afforded tremendous discretion to choose how to balance and prioritize purpose and profit. Consequently, SPC directors in California can allocate resources and capital in pursuit of their company’s special purpose with less risk of exposure to shareholder derivative suits. As otherwise stated, directors of SPCs are not in breach of their fiduciary duties when they act in furtherance of their socially driven mission at the expense of some profit generation.

While an SPC must produce reports documenting progress toward its specific purpose, it does not have to measure that progress against third-party standards. This gives directors of an SPC more freedom (and subjects them to less liability) when choosing how the company pursues its socially conscious goals that help make the world a better place, all the while also generating profits. By way of example, some California SPCs include Imperfect Foods, SPC, and Dayspring Technologies, Inc. SPC.

What Is a Delaware Public Benefit Corporation (PBC)?

Delaware enacted the PBC by statute in 2013, which was modified in 2020. As defined by law in Delaware, a PBC is a for-profit corporation “that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner.”

PBCs must be managed in a manner that balances “the stockholders' pecuniary interests, the best interests of those materially affected by the corporation's conduct, and the public benefit or public benefits identified in its certificate of incorporation.” The Delaware statutory definition of a “public benefit” is a positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in that capacity), including but not limited to “effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.”

Essentially, a PBC formed under Delaware law operates as a for-profit business that also serves broader societal interests. Every two years, a PBC must report to its shareholders the status of its public benefit purpose, which report requires detail and transparency. And while directors are obligated to manage a PBC in the best interests of its shareholders, they must balance shareholder interests with the public benefit purpose and the interests of those materially affected by the PBC’s conduct. This latter element constitutes a heightened fiduciary duty for directors of PBCs (Delaware) directors as compared to SPCs (California).

Given that most public corporations are formed in Delaware for its tax benefits and legal system amenable to business, the PBC is something to consider for companies planning to go public. As of 2020, there were three publicly traded PBCs: Laureate Education, Inc., Lemonade Inc., and Vital Farms, Inc.

How Do SPCs and PBCs Compare?

SPCs and PBCs are comparable in terms of purpose and general structure; however, the PBC is governed under Delaware corporate law, which is historically preferred by investors. Still, the SPC (California) should not be ruled out, as incorporating as an SPC may provide access to investors whose interests are aligned with a California-based company’s social purposes. That being said, because the SPC is a relatively new type of entity, it is not yet entirely clear what, if any, impact the adoption of the SPC form will have on financing and fundraising.

There are other reasons to consider SPC formation as well. While Delaware law generally gives corporate directors more protection with regards to liability, directors of SPCs in California have more freedom than the directors of PBCs in Delaware when it comes to deciding how they balance their corporation’s social purpose with profit generation. In addition, incorporating as a PBC requires registering as a foreign entity in California which, while not expensive, does include some extra fees and obligations, including having to comply with California’s gender quota requirement for directors (which is not a bad thing, but may impose a heightened burden on a young company with few resources).

In terms of a director’s fiduciary duties, those construed under Delaware law are typically less strict than in California, at least for a C corporation. But that assumption does not take into consideration the unique benefits the SPC affords directors. For an SPC in California, the evaluation and analysis of the corporation’s impact on its social purpose does not need to be evaluated by a third-party (as it does in Delaware), thus reducing potential liability and duties owed to shareholders. Additionally, shareholders do not have any specific enforcement rights pertaining to the social purpose of an SPC in California, whereas shareholders of a Delaware PBC can bring a derivative action for breach of duties owed by a board of directors to better balance the pecuniary interests of stockholders with the specific public benefits identified in the company’s certificate of incorporation filed in Delaware.

Overall, if you want to incorporate your California-based business but do not want to be solely dedicated to profit-maximizing activities and wish to also pursue a goal that helps the world in some positive way, it is worth looking at both the SPC in California and PBC. Which entity type is right for your business will, of course, depend on a variety of factors that legal counsel can no doubt help decipher.

Table Comparing SPCs and PBCs

 

Delaware PBC

California SPC

Key Advantage

Subject to Delaware corporate law which many investors prefer and are more familiar with

More flexibility for directors in assigning different weights to profit and purpose as they deem appropriate

Corporate Purpose

Requires enterprise to provide a general AND specific public benefit; 2/3 vote required to change general or specific purpose

Must serve one or more of the following specific purposes:

-       Charitable activities that a non-profit can carry out;

-       Benefiting the corporation’s employees, suppliers, customers, and creditors;

-       Benefiting the community and society; or

-       Benefiting the environment.

Factors the Corp. Directors Are Required to Consider

PBC shall be managed in a manner that balances:

(1) the stockholders’ pecuniary interests,

(2) the best interests of those materially affected by the corporation’s conduct, and

(3) the public benefit or public benefits identified in its certificate of incorporation

SPC directors must consider:

(1) interests of the corporation,

(2) its shareholders, and

(3) any specific purposes laid out in its Articles of Incorporation.

[Note the absence of a requirement to consider the best interests of third parties]

Is a Third-Party Evaluation Required?

Maybe; a PBC’s board of directors create objectives for promoting the company’s public benefits and standards for measuring the company’s progress in promoting the public benefits. Internal assessment is permitted (but biennial statement must specify the standards/criteria used for assessment); the enterprise may require a third-party standard by specifying the requirement in certificate of incorporation

No; evaluation of the corporation’s impact on its special purpose is based on management’s discussion and analysis. The analysis must identify the company’s special objective, discuss actions taken, and reveal expenses incurred

Is Reporting on Social or Environmental Impact Required?

Biennial statement to shareholders is required; enterprise formation documents may require more frequent assessments

A not too stringent annual report is required to discuss the special purpose of the SPC based on management’s discussion and analysis; report must be given to shareholders annually and posted on the public website

Mechanisms to Enforce Corporate Purpose

Shareholders who individually or collectively hold 2% of the outstanding shares may bring a derivative action for breach of duties owed by board of directors to “balance 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 certificate of incorporation”

Traditional enforcement proceedings only, such as derivative lawsuits by shareholders, but with no special ability to enforce certain progress towards the social purpose nor to interfere with the board’s balancing of the SPC’s financial and social interests.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.