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At the Green Startup Legal Discussion on Day 2 of the San Jose Green Business Academy, the attorney panelists covered important legal issues for social entrepreneurs. Topics included approaches to legal structure, options for incorporation, and funding.

Green dollar bill

Attorneys from Starter Law, a law practice focused on helping entrepreneurs launch and grow their businesses, outlined a few common ways investors fund start-ups. Below are overviews of the funding methods along with notes from the panelists.
3 Ways Investors Fund Social Entrepreneur Startups

1. Convertible notes.  Also known as convertible debt, this is money an early-stage start-up raises in the form of a loan. It usually “converts” to equity (i.e. shares) sometime in the future with a discount (so that the angel investor often pays 15-30% less than the sticker price on each share). Depending on the provisions of the convertible note, the debt may automatically convert to equity when the start-up receives its next round of funding. This arrangement may feature a maximum price per share the angel investor will be required to pay if the convertible debt automatically converts to equity.

Notes from the panel: Convertible notes are inexpensive to set up and do not generally require very complex agreements. They are fairly flexible. Notably, investors are not equity-holders, they are creditors (which only convert to equity by provisions of the note).

2. Preferred Stock Financing. As the name suggests, preferred stocks enjoy preferential treatment over common stock. Startup companies issue preferred stocks to investors, giving the company needed financing and giving the investor valuable stake in the company. Preferred stocks are generally valued higher than common stocks, in scenarios of liquidation or acquisition preferred stocks are paid out first, and preferred stocks often include voting and anti-dilution provisions.

 Notes from the panel: This method of funding gives investors equity in the company, a seat on the board of directors, and all the bells and whistles that come with preferred stock. One type of preferred stock financing is Series A.*

3. Series Seed Financing. Similar to preferred stock financing, investors receive preferred stock in exchange for investing in the startup. Series seed financing generally refers to simplified version of preferred stock financing, which streamlines & expedites the purchase of preferred stock by seed capital investors. This mode of financing may not include some of the protective provisions valuable to social entrepreneurs and impact investors.

Notes from the panel: This financing model is not as complex as Series A and gives some, but not all, of the rights as Series A.

*This post has been edited to accurately capture the points made by panelists. 

Meet Attorney Donald Simon

Attorney Donald Simon explains a few terms related to California’s benefit corporation legislation (AB 361) in the interview below. Simon is a Partner at Wendel Rosen Black & Dean LLP and co-author of AB 361–legislation that would create a new for-profit corporate form in the state for companies wishing to earn a profit while also creating a positive impact on the environment and community.

Watch the Interview

(quick tip, turn the sound all the way up.)

Terms to Know

You can see Innov8Social’s previous interview with Donald Simon–to learn the general features of AB 361 and why social entrepreneurs may choose it as a business structure.  In this interview, he addresses constituency statutes and how they relate to the benefit corporation legislation.
He also explains what the third-party standard is, and the role it will play in assessing a company’s impact on the community and environment. Finally, Simon lays out the supermajority shareholder requirement of AB 361.Simon also offers a few tips and suggestions to social entrepreneurs who are considering incorporating or reincorporating as a benefit corporation.

Shift in Business As UsualWhether you think of the move towards a greener economy as quick turn to consider more than a singular bottom line, or you view it as part of the gradual evolution of the way business is done–you will have noted a shift in business as usual.Former President Bill Clinton recently discussed the changing economy, and interconnected role of private and public sectors in an interview about jobs and the green economy.

And notably, California is not first on the scene of the benefit corporation party. In fact the first state to pass benefit corporation legislation was Maryland, followed by Vermont, Virginia, New Jersey, and Hawaii. Similar bills are proceeding through the legislative process in New York, Pennsylvania, North Carolina, Colorado, and of course, California.

The Update on AB 361

  
Despite the interview’s consideration of terms that will come into effect ‘once’ the bill is passed, in reality, there is no guarantee that AB 361 will become new law. It is currently awaiting Governor Jerry Brown’s review. You can read a full update on AB 361 here, and also learn how to support these efforts to enact legislation supporting social entrepreneurship.Related Posts:

California Benefit Corporation Law, From a Legal Lens

How can new entrepreneurs, founders, social enterprises be ready for benefit corporation legislation? Why might new businesses opt to incorporate as a benefit corporation? What makes benefit corporation compelling—from a legal standpoint?

Meet Donald Simon, Attorney and Co-Author of AB 361

These are a few of the questions we asked Donald Simon, Attorney and Partner at Wendel Rosen Black & Dean and Co-Chair of the Legal Working Group. Simon is an environmental activist-turned attorney who has remained steadfast in his passion for conservation causes —having founded two 2 environmental non-profit organizations. He has been a lead attorney in drafting and advocating for AB 361.

We caught up with him after the California State Senate Judiciary Committee hearing on California’s benefit corporation legislation, AB 361.

Watch the Interview

Ask any law school graduate, and they will probably tell you that Michigan Supreme Court in Dodge v. Ford Motor Co. 170 N.W. 668 (Mich.1919) did.

Ford Overdrive

Dodge v. Ford: A Swashbuckling Tale for Maximizing Shareholder Profit

 

The historic case Dodge v. Ford tells a page-turning tale of astonishing innovation, mind-blowing wealth, deep rumination, distrust, and defection. There are larger-than-life personalities all-around, unafraid to use (legal) sword and shield to pursue and protect their interests.Less clear, however, is who is the hero and who is the villain. That can only be judged by the lens through which you see the story.

 

Ford Motor Co. Circa 1919: The Unstoppable Model T

 

In his enlightening law review article, “Everything Old is New Again: Lessons from Dodge v. Ford Motor Company” (December 2007) University of Chicago Law School Professor M. Todd Henderson sets the scene of the automobile industry in the early 1900’s.After two unsuccessful ventures, Henry Ford’s Ford Motor Company began expanding in a big way in the early 1900’s. With efficient mass production of cars, a growing market, and increased demand—the Ford Motor Co. was virtually unstoppable. The advent of assembly-line manufacturing led production of Ford’s original “Model T” to increase from less than 2000 cars per year in 1905 to over 2 million per year by 1923—growing over 700% in the span of 2 years.

 

An OMG Reaction to ROI

 

As reported by Henderson, financial life was not bad for the handful of Ford shareholders. Investments snowballed in their rate of returns. For example the brothers Dodge—who were shareholders at the time—made an initial investment of $10,000 and would yield over $35M over the next 13 years.

 

Restless Shareholders and Distrust

 

In his article, Henderson also paints broad brush strokes in describing the personalities of Ford and the Dodges. Henry Ford is described as suspicious and to some degree–unimpressed–that shareholders were so richly rewarded for investment of only money and no effort in creating the triumphant Model T.In the same vein, the Dodges were perhaps growing restless in the shadow of their overwhelmingly successful investment. And were ready to strike on their own. They knew of Ford’s plan to withhold dividends and build a factory—which would further lower the cost of manufacturing an automobile. And, incidentally, make it harder for them compete.

Legal Swords and Shields


Dodge v. Ford was not the first time Henry Ford stepped into a courtroom. He was well-acquainted with litigation and had filed cases to defend his name and reputation.

The Dodges decided to take action to prevent the building of the new factory by flexing their shareholder muscle. They first sent a letter to Dodge questioning the propriety of denying dividends and investing those funds in a large, expensive factory.

After their inquiry went unanswered, they filed a complaint demanding that the Ford Motor Co. establish a dividend policy that distributed all earnings except certain emergency funds and that an injunction be issued to prevent construction of the factory.

The Weight of Wealth


It is not clear whether Ford was always benevolent, strategically benevolent, or whether a sense of benevolence developed as he amassed great wealth. According to Henderson’s article, it may have been a complex hybrid.

Said Ford, “I believe it is better for the nation, and far better for humanity, that between 20,000 and 30,000 people should be contented and well fed than that a few millionaires should be made.”

It probably didn’t hurt the Ford Motor Co.’s prospects that the proposed actions (i.e. withholding dividend and reducing the cost of a car by ramping up production) would not only endear Ford to Americans but would also undercut future competition.

 

The Michigan Supreme Court Issues a Decision


While the lower court called for a special dividend to be issued and an injunction. The Michigan Supreme Court took a more subtle approach. It tried to keep courts at bay from making business decisions by declaring that courts must defer to the rational business judgment of a company. But allowed itself a loophole, by saying that Ford did not follow a rational business objective in denying dividends.

At the end, the Michigan Supreme Court gave Dodges their special dividend and Ford–the go-ahead for building his new factory.

 

Just a Load of Dicta?


In case law speak, judicial commentary articulating an opinion and not decisive to the case is known as “dicta” and is not binding in the court of law. The comments that have made Dodge v. Ford the single-most known case for defining a corporation’s duty to maximize shareholder wealth…comes in, well, dicta.

That has led some, such as UCLA Law Professor Lynn A. Stout to argue that Dodge v. Ford is not actually good law. She does so in her law review article “Why We Should Stop Teaching Dodge v. Ford“.

 

Why I am Fascinated by Dodge v. Ford


While I love learning the details of all of the law school cases I studied (note: this may be an overstatement :), I have truly been fascinated by the far-reaching implications of this case since the day I learned about it in a Corporation Law course. Whether or not the case has been misconstrued or is wrongly emphasized as an articulation of the maximize shareholder wealth principle, it is taught by law professors and learned by law students in that context.

And, in that context, the concept that the legal framework supports a single financial bottom line pursuit by corporations, I think, may impact the incentives and methodologies business chooses.

While, as Henderson argues, the Michigan Supreme Court may have found an ‘elegant’ solution to a complex situation of competing interests, the long-range result of emphasizing shareholder wealth above other measures suggests that other costs and outcomes are de-emphasized.

 

Triple Bottom Line and Shareholder Redefinition

Perhaps, to some degree, and according to the long-living dicta of Dodge v. Ford, businesses are not always incentivized to consider externalities such a corporation’s relationship to the environment, employee well-being, community involvement, and social justice.

If there was a way to work in such externalities to the ‘bottom line’ of rational business judgment outlined by Dodge v. Ford or expanding our definition of ‘shareholders’ to include non-monetary contributors it could literally change the way business is done by rewarding a company for its business acumen as well as its social innovation.