Legal Structures To Optimize Private Investor Impact Strategy

Morrison & Foerster LLP

Morrison & Foerster LLP

How can legal structures help investors maximize the impact of their investments? Below, read more about key ESG concepts and best practices for stakeholders and investors to consider moving forward.

Key Concepts

  • Over the past decade, private investors have increasingly sought social impact alongside profits. Impact investors focus on environmental, social, and governance (ESG) factors in addition to financial returns.
  • Foundations are moving larger portions of their endowments to impact investments, while for-profit funds are establishing affiliated entities focused on impact.
  • “Form follows function.” There is no single “right” answer when it comes to structuring investment vehicles, businesses, or transactions. It is critical to clearly articulate the goals and roles of the parties in order to design a suitable structure.

Best Practice Structures for Aggregating Impact Capital

Investors have a number of options when selecting a legal structure to aggregate impact capital.

  • Investors make use of venture capital, growth, and private equity funds. Investors may introduce impact-related terms through a side letter if a fund’s governing documents do not already contain such terms.
  • Investors also create donor-advised fund (DAF) accounts with sponsors committed to impact investing. Investors receive a tax deduction upon donating to the account and have advisory powers over the use of these funds, which are controlled by the sponsor.
  • Private investment funds may have impact-focused side cars to pursue opportunities that do not qualify for the mainstream funds.

Best Practice Structures for Deploying Impact Capital

Foundations, companies, and individuals use a combination of financial instruments and investment vehicles to efficiently deploy impact capital.

  • Private foundations and public charities make traditional grants or revocable grants as independent deployments of impact capital or as part of larger impact investments. Foundations may make mission-related investments from their endowments in furtherance of their exempt purpose.
    • Alternatively, foundations are increasingly making program-related investments (PRIs) in a variety of forms, including equity investments and loan guarantees, to for-profit and non-U.S. entities.
    • Similarly, for capital deployment, donors also increasingly use DAFs, which can make grants, revocable grants, and PRIs.
  • Early-stage companies make use of the Simple Agreement for Future Equity (SAFE), a financing instrument that converts into equity under specific circumstances.
  • Founders and impact investors may lock in the mission of a social enterprise using preferred equity.
  • Companies and lenders can use convertible debt to further impact by negotiating provisions like mission-related covenants and reporting requirements.
  • Investors may use pass-through entity structures, like LPs and LLCs, as investment vehicles to further impact. These entities provide a flexible economic structure that allows for impact measures without increasing the tax burden on investors.
  • For high net-worth individuals, combining a trust with periodic distributions to investment vehicles and donor entities can maximize long-term flexibility for capital deployment.

Best Practice Structures for Recipients of Impact Capital

Recipients of impact capital structure themselves to best attract capital and anchor mission.

  • Traditional “C” corporations offer several mechanisms to anchor mission, including protective measures for mission-aligned investors and impact-related charter provisions.
  • Hybrid or tandem structures consist of close relationships between nonprofit and for-profit entities through equity ownership, funding, or contract.
  • Equity holders of an LLC can emphasize mission in the company’s operating agreement.
  • New corporate forms establish fiduciary duties that make public benefits co-equal with profits. The Delaware public benefit corporation requires directors to balance the public benefit set forth in its charter with shareholder value, while the California social purpose corporation requires boards to pursue shareholder-agreed upon ESG goals.

Previously presented by Suz Mac Cormac to CREO Syndicate, an organization of family offices.

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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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