Legal structures to optimize the impact strategy of private investors – Company law / commercial law
United States: Legal structures to optimize the impact strategy of private investors
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How can legal structures help investors maximize the impact of their investments? Below, learn more about key ESG concepts and best practices that stakeholders and investors should consider moving forward.
- 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 shift more of their endowments to impact investing, while for-profit funds create impact-focused affiliates.
- “Form follows function.” There is no single “right” answer when it comes to structuring investment vehicles, businesses or transactions. It is essential to clearly articulate the objectives and roles of the parties in order to design an appropriate structure.
Best practice structures for impact capital aggregation
Investors have a number of options when selecting a legal structure to aggregate impact capital.
- Investors use capital risk, growth and capital investment funds. Investors can include impact terms in a cover letter if a fund’s governing documents do not already contain such terms.
- Investors also create Donor Advised Fund Accounts (DAF) with sponsors committed to impact investing. Investors get a tax deduction when 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-oriented side cars to seize opportunities that are not eligible for traditional funds.
Best practice structures for impact capital deployment
Foundations, businesses and individuals use a combination of financial instruments and investment vehicles to effectively deploy impact capital.
- Private foundations and public charities provide traditional grants or revocable grants as part of independent deployments of impact capital or as part of larger impact investments. Foundations can make mission-related investments from their endowments in pursuit of their exempt purpose.
- Alternatively, foundations are increasingly doing program investments (PRI) in various forms, including equity investments and loan guarantees, to for-profit and non-US entities.
- Likewise, for the deployment of capital, donors are also increasingly using DAFs, which can provide grants, revocable grants and PRI.
- Start-ups use the Simple Agreement for Future Equity (SAFE), a financing instrument that converts to equity in specific circumstances.
- Founders and impact investors can lock in the mission of a social enterprise by using preferred stock.
- Businesses and lenders can use convertible debt to have an additional impact by negotiating provisions such as engagement covenants and reporting requirements.
- Investors can use pass-through entity structures, such as LPs and LLCs, as investment vehicles to have additional impact. These entities offer a flexible economic structure that allows impact measurements without increasing the tax burden for investors.
- For high net worth individuals, combining a trust with periodic distributions to investment vehicles and donor entities can maximize long-term flexibility for the deployment of capital.
Best practice structures for impact capital beneficiaries
The beneficiaries of the impact capital structure themselves to best attract capital and anchor the mission.
- Traditional “C” companies offer several mechanisms to anchor the mission, including mission-aligned investor protections and impact-related charter provisions.
- Hybrid or tandem structures consist of close relationships between non-profit and for-profit entities through participation, funding or contracts.
- Holders of shares of an LLC can emphasize the mission in the operating agreement of the company.
- New forms of business establish fiduciary obligations that equate public benefits with profits. The Delaware utility corporation calls on directors to balance the public interest stated in its charter with shareholder value, while the California social purpose corporation requires boards of directors to pursue ESG goals agreed upon by shareholders.
Previously presented by Suz Mac Cormac at CREO Union, an organization of family offices.
Due to the generality of this update, the information provided in this document may not be applicable in all situations and should not be implemented without specific legal advice based on particular situations.
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