"A Double-Edged Sword": Regulatory Compliance for Social Enterprises
- Alysse Danyi
- Nov 5, 2024
- 5 min read
A social enterprise is any legal entity that exists to make some widespread social or environmental improvement.[1] Social enterprises vary widely in their business models and in the causes they support, ranging from combating sanitation crises by franchising affordable public toilets, to developing pesticide-reducing robots.[2] One thing that all of the ten million social enterprises around the world have in common, however, is that they adhere to the principle of “purpose before profit.”[3]
Although social enterprises have gained prominence in recent decades, generating approximately $2 trillion in revenue each year and creating over 200 million jobs, regulatory compliance law has struggled to keep up.[4] As one commenter describes it, regulatory compliance is a “double-edged sword” for social enterprises: on one end, regulation can provide frameworks that help social enterprises grow; on the other end, these regulations can “stifle innovation” and impose obstacles on social enterprises in carrying out their mission.[5]
Stifling Innovation
Traditionally, U.S. market regulations have followed a shareholder primacy model, meaning that they reflect a singular focus on profit and wealth maximization for shareholders.[6] Even today, such regulations enforce compliance through surveillance, monetary penalties, and other disciplinary measures that are meant to preserve a corporation’s ability to generate and maximize wealth.[7] This assumption that shareholder wealth is the most important interest is incompatible with social enterprises that seek to prioritize their mission and impact.[8]
Social enterprises grapple with the “two masters problem,” which involves balancing their societal impact with the need to generate a profit to carry out their mission.[9] Because these interests are incongruent with shareholder primacy, some regulatory laws fail to properly incentivize compliance and account for consequences other than effects on shareholder wealth.[10] For example, social enterprise leaders are typically mission-driven, so detect-and-punish disciplinary tactics based on objective metrics will not have the same deterrent effect as it would on traditional, money-motivated companies.[11] Additionally, compliance for social enterprises does not directly address risks of corruption that could hurt customers and society at large by hindering the enterprise’s social and environmental impact.[12] Finally, many founders of social enterprises lack the same level of business acumen as for-profit corporations, and regulatory law is often too complex for proper implementation.[13]
Opportunities for Growth
To address some of the shortcomings of regulatory compliance for social enterprises, most states have adopted at least one alternate legal form that caters to the interests of social enterprises.[14] One such alternative is a low-profit limited liability company, which is a type of limited liability company that identifies and must accomplish at least one “charitable or educational purpose.”[15] This legal form is regulated by state statute, does not require disclosures to the government or the public, and is subject to reversion back to limited liability company status for lack of compliance.[16]
Another alternative is a flexible purpose corporation (FPC), which is a type of corporation that must identify in its articles of incorporation a special purpose that benefits at least one group of stakeholders other than shareholders.[17] Directors and shareholders, rather than external regulators, can enforce the corporation’s commitment to their special purpose through governance or fiduciary litigation, and directors are permitted to consider the identified purpose of the corporation in its business decisions.[18]
Finally, many states recognize public benefit corporations, a type of corporation regulated by an approved third-party standard to ensure that it consistently makes a positive social and environmental public impact and is transparent about its business practices.[19] Unlike FPCs, directors are required to consider the corporation’s impact on all stakeholders in making business decisions, and shareholders can sue to enforce these obligations.[20]
Solutions
While these alternate legal forms are a useful means of adequately regulating social enterprises, lawmakers can still reform market regulation to expand upon shareholder primacy and factor in stakeholder impact.[21] The Lex Mundi Pro Bono Foundation researched and discovered four ways that regulation reform can support social enterprises:
Foundations: An important first step for reform is to clearly define the meaning and function of a social enterprise, as well as clarifying the roles of fiduciaries in furthering an enterprise’s social and environmental impact.[22]
Incentives: Today, most jurisdictions tax social enterprises the same way as for-profit enterprises. Regulators should consider providing tax incentives for social enterprises to reward mission-driven business.[23]
Safeguards: Regulators should also consider creating a reporting or certification system to give greater legitimacy to social enterprises and prevent abuse of this designation.[24]
Flexibility: Regulators should implement laws that “account for size, structure, mission and impact.”[25]
Despite these gaps in regulatory compliance, social enterprises continue to arise throughout the United States and 80 other countries, and there is great demand for more socially conscious business.[26] Now more than ever, it is clear that these reforms are necessary to ensure that regulatory compliance is compatible with social enterprises and can support widespread social and environmental impact.[27]
[1] Isis Bous and Allison Laubach, How the right legal frameworks can catalyze a social enterprise surge, World Economic Forum (June 4, 2024), https://www.weforum.org/stories/2024/06/how-stronger-legal-frameworks-can-catalyze-a-social-enterprise-surge/.
[2] See Joseph W. Yockey, The Compliance Case for Social Enterprise, 4 Mich. Bus. & Entrepreneurial L. Rev. 1, 2-3 (2014) (footnotes omitted) (citing Jonathon Kalan, The Silicon Valley of Shit: Nairobi is Ground Zero for Sanitation Innovation, GOOD (Nov. 18, 2011), http://www.good.is/posts/the-silicon-valley-of-shit-nairobi-is-ground-zero-for-sanitation-innovation; March of the Lettuce Bot, The Economist 5 (Dec. 1, 2012), http://www.economist.com/news/technology-quarterly/21567202-robotics-machine-helps-let tuce-farmers-just-one-several-robots).
[3] The State of Social Enterprise: A Review of Global Data 2013–2023, World Economic Forum 4 Apr. 18, 2024), https://www3.weforum.org/docs/WEF_The_State_of_Social_Enterprise_2024.pdf.
[4] Id. (defining regulatory compliance as a “general term used to describe the rules, policies, and systems that firms use to detect and deter agent misconduct within their ranks”).
[5] Kumar, supra note 1.
[6] Frederick Alexander, Holly Ensign-Barstow, and Lenore Palladino, From Shareholder Primacy to Stakeholder Capitalism, Harv. L. Sch. F. on Corp. Governance (Oct. 26, 2020), https://corpgov.law.harvard.edu/2020/10/26/from-shareholder-primacy-to-stakeholder-capitalism/.
[7] Id.
[8] Yockey, supra note 3, at 3.
[9] Dana Brakman Reiser, Regulating Social Enterprise, 14 UC Davis Bus. L. J. 231, 233 (2014), https://blj.ucdavis.edu/sites/g/files/dgvnsk15221/files/media/documents/BLJ-14.2-Reiser.pdf.
[10] See id.
[11] See Alexander et al., supra note 7.
[12] Brakman Reiser, supra note 10.
[13] See Joseph W. Yockey, The Compliance Case for Social Enterprise, 4 Mich. Bus. & Entrepreneurial L. Rev. 1, 16 (2014), https://repository.law.umich.edu/cgi/viewcontent.cgi?article=1016&context=mbelr.
[14] Brakman Reiser, supra note 10, at 232 (citing Laws, Ams. for Community Dev. (Sept. 27, 2013), http://americansforcommunitydevelopment.org/laws).
[15] Id. at 233.
[16] Id. at 233-34.
[17] Id. at 235-36.
[18] Id. at 236.
[19] Id. at 237-39.
[20] Id. at 238-39.
[21] See Isis Bous and Allison Laubach, How the right legal frameworks can catalyze a social enterprise surge, World Economic Forum (June 4, 2024), https://www.weforum.org/stories/2024/06/how-stronger-legal-frameworks-can-catalyze-a-social-enterprise-surge/.
[22] Id.
[23] Id.
[24] Id.
[25] Id.
[26] World Economic Forum, supra note 4, at 9.
[27] Bous and Laubach, supra note 22.