Best in Law: Hybrid corporations combine profit and good will

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Press-Enterprise - October 2, 2014

These new entities give directors and officers the flexibility to pursue both profit and social objectives without the risk of liability associated with doing so in a traditional corporation.

In 2012, California created two new subtypes of stock corporations – a “Flexible Purpose Corporation” and a “Benefit Corporation” (also known as a “B corporation”).

These new subtypes enable entrepreneurs to form hybrid corporations, operating with both economic and social objectives. California is one of at least six states to acknowledge entities that pursue profit as well as aim to create a positive impact on society.

These stock corporation subtypes differ from both traditional, for-profit corporations that are organized to pursue profit and nonprofit corporations that must be used solely to promote social benefits.

Traditionally, directors and officers who pursued activity outside of the scope of the purpose of a corporation could be held liable to shareholders. These new entities give directors and officers the flexibility to pursue both profit and social objectives without the risk of liability associated with doing so in a traditional corporation.

Although these hybrid corporations provide greater flexibility to those who run them, they are rather new in California and have little, if any legal, precedent to support them. The precedent that does exists is from other states, which California is not required to follow.

A lack of precedent creates uncertainty as to what directors and officers can and cannot do within the bounds of the law. This should be considered when deciding whether or not to form a Flexible Purpose Corporation or a Benefit Corporation.

Some owners are enticed by the marketing prospects of claiming that their corporation provides a social benefit, and therefore are interested in converting their traditional for-profit corporations into a Flexible Purpose Corporation or Benefit Corporation. However, this can actually have a devaluing effect on the corporation. In a hybrid corporation, management can redirect assets to activities that often do not result in profit, which ultimately could result in a lower share price.

For those corporations that are primarily profit driven, a hybrid corporation probably is not a good choice since the shareholders or future investors may be resistant to trade profit for good will.

On the other hand, organizations that are primarily driven by a passion for doing good could benefit from forming a hybrid corporation rather than a traditional for-profit or nonprofit corporation. A hybrid corporation can receive investment from like-minded people without running the risk of being sued by profit-minded shareholders.

In addition, the hybrid corporation can take profits for its shareholders without having to worry about the restrictive tax rules that govern nonprofit corporations.

Ultimately, the decision to use a hybrid corporation should be based on the founders’ true motives balanced with their tolerance for risk and willingness to follow the applicable rules.

*This article first appeared in The Press-Enterprise on Oct. 2 , 2014. Republished with permission.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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