Investors widen focus to business models in assessing ESG impact

Most impact investors seek to make positive change by targeting start-ups or companies based on the social, or environmental, impact of their products — from affordable homes to solar power systems. But some are starting to base their investment decisions on the enterprise’s business model or leadership — in other words, the machinery driving the mission. 

Start-ups focused on creating positive social impact are, by definition, more likely to have business models designed to promote a diverse workforce and look after those employees.

But, as those companies grow, go public or are sold to larger enterprises, what happens to the mission? The risk increases that the original purpose — to have a positive impact — gets lost.

One way of mitigating that risk is for impact investors to back founders who have incorporated their business as an entity that embeds ethical and sustainability commitments into its charter documents.

In many US states, these are likely to be “public benefit corporations”, or in some jurisdictions similar entities known as “benefit corporations”.

A PBC’s articles of incorporation require it to balance shareholders’ financial interests with the interests of employees, customers, the environment and other stakeholders while pursuing the social or environmental purpose set out in its corporate charter.

In addition — unlike traditional publicly listed companies which, when being acquired, must sell to the highest bidder — PBCs and similar entities can turn down a prospective buyer that fails to meet its social, environmental or ethical values, irrespective of the size of the bid.

While the US led the way, other countries, including Colombia, Ecuador, Italy, Peru, France, Rwanda and the Canadian province of British Columbia, have also introduced the PBC or similar models.

Even so, these new alternative corporate forms can be hard for investors to navigate. In the US, models vary from state. In Delaware, for example, a PBC is a for-profit company while, in California, it is a non-profit.

The terminology can be bewildering, too. PBCs and benefit corporations are often confused with B Corps, which are not alternative legal entities but businesses certified by the non-profit organisation B Lab, based on their social and environmental performance.

And incorporating as a PBC does not guarantee “mission lock”, warns Susan Mac Cormac, a corporate lawyer at Morrison Foerster who teaches the topic at Berkeley’s law school. “With all the new corporate forms, a majority of investors can vote to turn it back into a normal corporation,” she points out.

One way to prevent such a conversion is by establishing a purpose trust with oversight that ensures a company’s operations remain true to its impact objectives.

For example, outdoor clothing brand Patagonia, which registered as a benefit corporation in California in 2012, recently transferred all voting rights to a purpose trust.

“Having some equity held by a purpose trust — a public charity or an entity that has approval rights over conversion out, over changing the mission, or over the budget and how it relates to the mission — is really critical,” says Mac Cormac.

However, impact investors have not, so far, made widespread use of a company’s business model to assess potential investment opportunities, says Mac Cormac. She suggests this is partly because alternative corporate forms can be hard to navigate.

But Lyel Resner, visiting faculty and head of the Public Interest Technology Studio at Cornell Tech says: “Investors are increasingly open to it.”

There is also an increasing focus on assessing the type of leadership or ownership of a company. For example, investors seeking to reduce inequality might fund employee-owned companies, since workers get a say in how the business is run and can build equity in the enterprise. Or they might advance gender equality by investing in companies with female management teams.

“A lot of investors are thinking about addressing gender equality and advancing racial equity, and one strategy is looking at better representation in the leadership of firms,” says Amit Bouri, chief executive of the Global Impact Investing Network.

While it is early days, Resner believes more entrepreneurs want to ensure their values remain at the heart of their businesses — expanding the opportunities for this type of impact investing. “With the next generation of founders, it’s overwhelmingly clear that they prefer these types of models,” he says.