A New Way to Scale Social Enterprise
Athletes Unlimited, a Delaware registered for-benefit corporation co-founded by hedge fund investor Jonathan Soros, has created a new form of equity that requires financial investors and the company to share financial returns on pre-agreed terms with the company on the basis that the profits shared are directed to advancing the corporation’s mission to develop athletes as civic leaders and role models. Called “mission equity,” this new security is a form of capped equity in which the owner of a stock, whose price reflects the full value of the enterprise, agrees at purchase to a maximum annual rate of return with any surplus value taken by the company for investment in the company’s stated mission.
As an owner of capital who wants to use it to improve the world, my professional life has been divided into two parts. On the one hand, I seek to smartly grow that capital through investments. On the other hand, I seek to use capital for the public benefit through charitable and other giving.
I have long sought ways to bring these two areas of work together by making investments that incorporate the public benefit and, more importantly, to create a framework for other like-minded investors to do the same. I want to be able to invest with scale in businesses that don’t maximize for shareholder value but instead are willing to reallocate some benefits to other stakeholders. I believe that in many cases harnessing the power of commercial enterprise, whether by increasing public benefits or by reducing harm, can result in changes that are out of reach of the non-profit sector. But unlocking this opportunity will require financial innovations that allow large flows of capital to move in and out of these types of investments.
My newest venture, Athletes Unlimited, seeks to explicitly blend profit and purpose through disruptive innovation in professional sports. With an ambition of building a substantial media and entertainment business, we have created a network of professional sports leagues using a new model. We play five-week seasons using a custom-built scoring system that makes every single play count toward the final result and crown individual champions in team sports. We have already launched leagues in three sports — all for female athletes — with plans to add more over time.
These on-field innovations are being matched off the field. Athletes Unlimited is giving athletes an unprecedented role in the development of our leagues and substantial influence over all key decisions, functionally eliminating team owners. We are committed to developing our athletes as civic leaders and elevating them as role models. We are developing policies and business practices that lead with our values. And with the hope of building a model that can vastly expand the opportunities for investors willing to trade financial return for impact, we have developed a new way of financing the company that links profit and purpose at the core of the capital structure.
Building a Marketplace
Opportunities to invest in businesses that are explicitly willing to trade shareholder financial return for public benefit — which I’ll refer to here as social enterprise — do exist, but they remain a niche minority in the growing impact investing landscape, small in scale and targeted at specific social problems or geographic areas. Most of the businesses that stake a claim to labels like inclusive, accountable, and stakeholder capitalism follow the “doing well while doing good” maxim that dominates commercially promoted impact investing. Companies like Ben & Jerry’s — a wholly owned subsidiary of Unilever since 2001 — are able to expand their market appeal or increase their prices by touting their socially-minded business practices to consumers, but ultimately they make no compromise on their goal of maximizing profits. There is no Unilever of social enterprise.
The emergence over the last decade of benefit corporations — a legal structure that requires directors to consider interests other than shareholders — has been a major step forward in challenging the idea that shareholder profit must always be the bottom line. But the benefit corporation structure alone provides no benchmarks for how to strike a different balance, nor any mechanism for how to exchange value based on the benefit created.
For social enterprise to reach the scale and ambition of modern corporations we must find ways to fill those gaps and allow dynamic flows of capital similar to conventional equity markets. This idea — creating a marketplace specific to social enterprise — is not a new one; the challenge has vexed advocates for decades. How do we create a market that incorporates both financial value and social value, the so-called second bottom line?
To create a fully functioning marketplace for social investments, we need to solve two key problems: first, we need a mechanism for the investor to signal how they value the impact being created, the same way that price signals an investor’s financial expectations for a company. And second, we need some way for price — the first bottom line — to relate to this new impact signal.
For years, the effort to solve these challenges has focused on measuring the social impact of companies. Transparency and accountability would provide the assurance that impact was being created and a marketplace could then follow, the argument goes. The focus on metrics has indeed led to important advances in conventional capital markets as ESG (environmental, social, and governance) ratings have become more commonplace, providing investors with information about a company’s non-financial performance.
But ratings and metrics don’t really solve even the first of our two problems. They can give some objective assessment of impact based on specific criteria (wages, carbon footprint, board composition, etc), but they cannot signal how an individual investor values those different criteria. More importantly, the metrics say nothing at all about interests that are not captured by the measurement (professional opportunities for female athletes, for example). Ratings of all kinds have an important informational role, but have not been able to anchor a marketplace for social investments.
I believe that the answer to the challenge of finding a market signal for impact may lie in a new way of thinking about distributing the economic value of the firm that is embedded in the corporate structure. At Athletes Unlimited, we have developed a unique way of financing the company that gives investors the opportunity to achieve a satisfactory financial return while directly supporting the non-financial mission of the company. We are calling this new security “mission equity.”
In a conventional corporate structure, equity holders are the owners of all residual value after liabilities are repaid. The potential value is unbounded and, for several generations at least, the prevailing orthodoxy has been to maximize the financial value that accrues to shareholders. By contrast, when purchasing interests in Athletes Unlimited, investors agree to a limit on the financial return they might receive on their investment. Or, to look at it from the other way around, investors signal clearly a return at which, if all goes well, they will be satisfied and are willing to forego surplus returns.
In the capital structure, the mission equity as a class is still the residual owner of the value of the company, but unlike the unlimited upside of conventional equity the financial benefit each investor may receive from this security is limited by the cap they agree to up front. Instead of dividends, all distributions to investors take the form of a share repurchase at a price established at the time of issuance, and the repurchased shares are set aside as a pool to further the mission.
In the case of Athletes Unlimited’s initial investors, that repurchase price is set by a formula using a compound rate of return from the initial purchase price, but any formula could be used (simple interest, fixed price, spread against a benchmark return, etc.). It is important to emphasize that the use of an interest rate does not create any form of guaranteed return. It is, essentially, like equity with an attached call option. The call option is held by the company, but must be exercised at the same time for all shareholders in lieu of distributions.
A Market Signal for Impact
The cap that an investor is willing to accept on their return adds a second signal — in addition to price — that reflects the value they place on the company’s non-financial mission. In Athletes Unlimited, for instance, one investor may be inspired by the focus on civic engagement. A second may be compelled by the opportunity to enhance professional opportunities for female athletes. And a conventional venture capitalist will insist on a cap high enough to justify the investment to their own investors, regardless of what they think of our mission.
For a more general example, say a company using our structure needs to raise $3 million. It is able to find demand at $1.00 a share from three investors with different views on the value of the mission. Investor A accepts a return cap of 5%, Investor B a cap of 10%, and Investor C a cap of 15%. If the company is in a position to distribute $1 million a year later, it will do so by repurchasing shares from Investor A for $1.05, Investor B for $1.10, and Investor C for $1.15. All the repurchased shares are then set aside, and any future distributions that would go towards those shares instead go to a pool that will further the company’s non-financial goals.
As you can see, repurchase prices for the different classes of shares can diverge, presenting a different financial value for those shares to a third-party buyer. Add to that different series of fundraising, and the values can quickly splinter any available market for shares making it too fragmented to produce useful signals. To solve this problem, we allow the cap values to reset with the consent of the company when shares are sold to third parties. Shares are freely tradable without the company’s involvement, but without the consent the new shareholder would keep the same caps as the seller.
So to extend the example above, let’s say that the company is proceeding well, and two years later shares are valued at $3.00. Investor B seeks to sell their remaining shares to a third party. They are free to do so for any price, but if the shares were subject to repurchase from the company that same year, the new investor would only get $1.21, and so would price the shares accordingly. But if the company consents, the transaction can proceed at $3.00 per share, likely with $1.21 going to investor B and the remaining $1.79 going to company. The consent may also involve changes to the return cap going forward, and, as with the repurchased shares, the by-laws require these proceeds be added to the pool supporting the company’s non-financial goals. Like many private companies today, the company would act as clearinghouse for secondary transactions in its shares, and as trades became more frequent rules-based consents could allow them to flow relatively unencumbered while driving towards a single market price.
This structure also unlocks a relationship between price and impact without requiring a new buyer to pay a seller for the social benefit they created. It allows a single measure — price, representing the financial value of the company — to remain the dominant metric for exchange of shares. But in fact, two transactions are embedded in that price. As in any other company, the issuance or exchange of shares is a trade between shareholders and determines what claim a shareholder has on the residual value of the company. The second transaction, unique to this formulation, is an exchange between each individual shareholder and the mission of the company, represented by the portion of the value that shareholder chose to forego in furtherance of the mission. Each investor determines their own measure of what surplus they are willing to forego, and no investor has to compensate another for the other’s contribution.
Targeting the Subsidy
The allocation of the foregone proceeds to a discrete pool also solves a problem from the seller’s perspective that confronts mission-driven investors in other companies. Today, most investors who are willing to forgo their own returns do so by providing subsidized capital to fully commercial, profit maximizing businesses. These transactions may take the form of low-interest loans, overpriced equity, or even outright grants. When done by the government, they often take the form of tax credits and are optimistically called “public-private partnerships.”
Unstated in many of these relationships is that much of the value of the subsidy lands in the pockets of other private shareholders. For example, if I provide a grant or a below-market loan to a developer of housing, I help new housing be built (mission subsidy), but I also subsidize the financial return of the developer who will charge whatever the market will bear (private subsidy). And if I pay more than a commercial investor would for equity in a mission-aligned business without doing anything to change the underlying incentives of that business, I have merely subsidized the prior shareholders, who suffer less dilution as a result of my investment. By establishing a segregated pool of capital that benefits from foregone profits, in contrast, our model minimizes the benefit to other shareholders. And while there may remain indirect benefits, all investors are ultimately capped in the benefit they might receive.
To make this model work and create trust with investors, the company must establish the mission-related purposes the set-aside funds will be used for either by setting defined criteria or through a clear governance structure. At Athletes Unlimited, we have chosen to do both. Given that female professional athletes have been historically undervalued, we chose to allocate a portion of those future profits to the athletes themselves. No less than 50% of the surplus is allocated to them through a profit participation pool, giving each athlete an interest in the future success they are helping to create.
The other half will be directed by the company’s board, which seeks to balance representation through four different categories of members: the founders, as guardians of the mission; investors; athletes; and independent members representing the interests of the fans and the public. Another company could easily choose a different path, perhaps establishing a separate governance structure specifically for decisions about the mission funds. The only requirement is that it must engender trust in investors so that there will be reasonable fidelity to the mission for which they have sacrificed financial return.
Alignment with Management
Lastly, the mission equity formula can be adjusted to maximize alignment between investors, mission, and management, which is often a challenge for mission-driven companies. In a conventional capital structure, founder ownership and employee stock grants are an important part of the financial motivation for people to work with a company. While employees everywhere are demanding more from their employers — and likely doing far more than investors in driving more ethical practices — the mission equity model risks demanding too much financial sacrifice of those individuals relative to the conventional model.
To create a better balance, Athletes Unlimited has created a separate class of mission equity for employees that does not fix the price for repurchases at the time of issuance, but instead sets it at the time that an employee leaves the company. This allows key employees to enjoy the potentially substantial financial benefits of price appreciation during the time they are working with the company, but not in the unbounded fashion of conventional startups.
There is inevitably going to be some diminution in the price appreciation of the company resulting from the equity caps and our focus on mission. A new investor may assume that the company will make tradeoffs that reduce shareholder returns even apart from the specific pool set aside through the equity cap, and therefore downgrade their view of the company’s financial prospects. Indeed, as a public benefit company, both management and board members are required to consider the interests of all stakeholders and the public in their decisions, not just the interests of shareholders. But the existence of the equity cap could provide a guidepost for how the company might make tradeoffs between shareholder and other stakeholder benefits that does not exist in any other public benefit corporation.
We have yet to resolve the paradox that capitalism has produced innovation and prosperity unparalleled in human history while at the same time creating conditions that are unjust, unequal, often inhumane, and environmentally unsustainable. Our hope is that the mission equity structure can play a part in unlocking a next wave of innovation and financing for social enterprises that will allow investors, as well as consumers and employees, to guide companies in bringing mission and profit into better balance.