BY ADAM COHEN
Consensus is rapidly forming around the evident impact of climate change, the dislocations caused by deep societal fissures, and the critical need for resilient business leadership to confront them. Following suit, companies in all sectors are facing more pressure than ever from regulators and investors, big and small alike, to become “sustainable businesses” by addressing the environmental, social and governance impact of their operations.
This growing perspective recognizes and promotes the idea that addressing these seemingly non-financial ”ESG” factors will establish the foundations for long-term business success and stability. Although these matters may seem non-financial now, a company’s role in confronting these challenges head on will indeed improve your individual bottom line, as well as the bottom lines seen across your industry sector.
Cutting-edge Research suggests that those companies truly embracing sustainable business principles are outperforming their competition, and that purpose-driven companies experience higher rates of employee retention at all levels and report higher levels of worker satisfaction and productivity. Consumers around the world are increasingly willing to use their purchasing power to support those businesses that align with their values. Focus on ESG among funders is no longer the provenance of “impact investors” alone, but becoming so widespread that the Securities and Exchange Commission (SEC) is considering requiring public companies to make impact commitments and disclosures to the public. This all equates to better financial outcomes for those who try to “do well by doing good.”
The Startup Advantage
One of the key determinants of successful adoption of sustainability is the company’s sense of mission. This allows a company to move beyond platitudes and small peripheral investments in change onto the necessary work of turning an interest in impact into a strategic edge over the competition. Nowhere is the sense of purpose needed to succeed more present than among today’s entrepreneurs. Innovation has always been about disrupting the status quo and turning problem-solving into a strategic advantage. Even if a company’s business is not primarily “about” impact, contemporary founders are still more likely to use sustainability to enhance operations and culture within the workplace.
Startups are also at an advantage as new or relatively new businesses. Without the burdens of a large workforce with deeply entrenched practices, startups are beginning from scratch and lack the reservoirs of skepticism and outdated habits that older companies need to shed before sustainability can be fully embraced. A new founder can commit to sustainability and plan strategically to create a culture motivated by mission from the very beginning of the enterprise. And startups are more likely to realize the virtuous cycle of sustainability, too. Today’s newest companies are more likely to require young, highly skilled workers and the loyalty of consumers with the greatest demands for corporate responsibility. Commitment to sustainability allows startups to best attract and retain those workers and earn and keep the support of an engaged consumer base.
Public Benefit Companies: The “G” in ESG
Public benefit companies, or “PBCs” are statutory organizations, like c-corporations or limited liability companies, committed not only to financial success but to striving towards greater sustainability generally and to pursuing a chosen specific public benefit. This is a clear signal from the company’s founders that they intend for the business to be mission-driven and to leverage a commitment to positive impact for a strategic edge and for the long haul. If this speaks to you, you may want to consider becoming a public benefit company.
To become one, a company simply need to include that pledge in its foundational documents. If the company is already in operation, this can be added through an amendment to those documents.
Shareholder Primacy vs. Stakeholder Primacy
PBCs are designed to address negative outcomes created by the pervasiveness of “shareholder primacy”, first espoused by Milton Friedman, the well-known 1970s economist associated with the “Chicago School” which espouses thatfree markets best allocate resources in an economy and that minimal, or even no, government intervention is best for economic prosperity. Shareholder primacy is the belief that all companies should be driven to maximize shareholder value at all costs. While there is no statutory requirement to operate in this manner, influential judicial rulings such as the decision in Dodge v. Ford Motor Company (1919) created a debatable presumption that fiduciary duties are dictated by shareholder primacy.
PBCs address shareholder primacy by explicitly stating that their decisions will be are driven by “stakeholder capitalism,” the antithesis of shareholder primacy. This is expressed through a mandate to balance financial gains and the pecuniary interests of shareholders against the needs of a more holistic set of stakeholders: the company itself, shareholders, employees, local communities, and the environment. This redefinition of fiduciary duties empowers directors and officers to pursue sustainable business strategies in their business judgment with less concern that shareholders will bring derivative lawsuits against them.
Investors and the Sustainability Edge
Conventional wisdom, driven by shareholder primacy, holds that investors are skeptical of funding purpose-driven companies such as PBCs. Yet recent evidence reveals that investors are embracing ESG metrics at an exponential rate, to the tune of 85% of all investors in 2019 deploying an aggregate $1.7 trillion in committed capital. Investors, it seems, see a greater risk to their bottom lines in ignoring the negative externalities of business than in embracing them.
This perceptual shift should comfort founders once concerned that their funding efforts would suffer if they committed to a mission-driven model. Moreover, they may now find themselves at a considerable advantage over their peers.
Leveraging purpose to drive outside financing may come with additional benefits. Some investors will begin to distinguish their expertise in this area. As ESG measures become more precise and streamlined, angel investors and venture capital funds are becoming more effective and experienced in identifying ways for their portfolio companies to improve their impact efforts. Just as some investors are sought after trusted experts on other areas of business value, others will now be pursued as strategically chosen mission-driven partners.
PBCs are required to publish progress reports on at least a biannual basis. These reports must be based on a third-party standard to ensure objectivity, and companies may double-down on that by allowing a third party to conduct their impact assessments. A strong disclosure can create an effective tool for enforcing workforce morale and attracting top talent, as well as approaching the growing number of investors factoring ESG metrics into their evaluation of potential portfolio companies.
Until the SEC or another authoritative body lays out definitive guidelines for how impact data should be collected and disclosed, PBCs will have considerable leeway in determining how to prepare their progress reports and may refer to a number of resources for inspiration. The Sustainability Accounting Standards Board (SASB) developed a model that identifies “material” areas for evaluation and disclosure for companies based on their industries and geographies. The B Impact Assessment provided by B Labs may be especially useful for companies hoping to become B Corps. The United Nations’ Sustainable Development Goals (SDGs) is yet another. These are just a sample of third-party standards to consider, and it would not be surprising if more popped up as the practice evolves.
While there are reputational concerns for publishing a lackluster report (more on that below), the risk of facing legal action from shareholders is currently low. The business judgment rule that protects directors and officers that exercise reasonable care in making decisions for the good of the company also applies to the way in which they balance the competing interests of their various stakeholders.
The main legal vulnerability to companies in the future may be related to the accuracy of these reports and allegations of “purpose-washing,” the practice of marketing a company as sustainable even as it continues to operate in a non-sustainable way. As the law in this area develops, PBCs should be careful about the data they report to avoid any inaccurate or potentially misleading statements.
Greenwashing concerns extend beyond the legal realm and reflect the importance of committing to the sustainability path once embarked upon. Just as companies can “do well by doing good,” the rising costs of ignoring sustainability suggest that failing to do good leads to doing poorly – or worse.
It should come as no surprise that the benefits cited above only materialize for those companies that embrace their missions with sincerity and determination. Companies that simply proclaim themselves to be doing good without following through will see their stakeholders, from workers to consumers to investors, lose trust and profits will stagnate or fall. Your reputation proceeds you; at least it should.
Allies For Impact
The call to sustainability is a true opportunity for those willing to take on the challenge, its risks and rewards alike. The rewards are becoming increasingly palpable for those driven by their conviction to make positive impact; so too are the risks of forgoing the competitive advantages mission-driven companies enjoy.
As founders, and some at the beginning of your journeys, you are positioned to build a company with a commitment to “doing well by doing good” from the ground floor up. For those of you who are interested, please know that you are not alone. Jayaram represents several PBCs and other purpose-driven companies as well as investors taking sustainability initiatives seriously. We are ready and able to support you in connecting your mission with the means to achieve it, as you grow and scale your operations, profits and contributions to society.