ANALYSIS: Public Benefit Funds Offer Altruistic Investing Option

Delaware has created a novel type of investment fund that, if shown to be successful, may herald a new trend in impact investing. These “public benefit” funds are statutorily designed to prioritize both societal benefit and financial gain.

They serve as a counterpart to the better-known benefit corporation, which also combines a for-profit entity with an intention to make a positive impact in the world. To date, only one fund (Samaritan Partners Fund I LP) has taken advantage of this new form—but Samaritan only held its initial closing in April, so it is early days.

Bumps in the Road for Impact Investing

Investing to do good, while also seeking financial gain, has become a priority for an increasing number of investors. Unfortunately, this altruism has sometimes run into some unpleasant realities such as anti-ESG laws, charges of greenwashing (misrepresenting the importance a company or fund has assigned to ESG factors), lower financial returns than alternatives, and difficulty executing a corporation or fund’s stated societal benefit goals.

Public benefit funds, as a relatively new kid on the impact investing block, must contend with a more fundamental challenge: Investors don’t yet know much about it. Although the Delaware law enacting benefit funds was passed in 2019 and amended in 2021, this type of fund is still fairly new, even to those in the industry. Owing to this novelty, there understandably exists considerable uncertainty about what a benefit fund is and how it operates. How is a benefit fund different from a standard fund? What are its unique benefits for socially-motivated investors? Are there additional risks for its fund manager?

What Is a Delaware Public Benefit Fund?

Benefit funds are set up as Delaware limited partnerships with at least one general partner with liability exposure. As is typical of other private funds, limited partners are the fund’s investors.

Source: Cole-Frieman & Mallon LLP, Bloomberg Law

General partners are active in the day-to-day operations of the fund and usually have made an investment in the fund themselves. They can be compensated through fund distributions (because they have invested in the fund) as well as via carried interest (a performance fee in the form of a share of the investment profits) and management fees. General partners also typically serve as the fund manager managing the fund’s assets.

How Do Benefit Funds Compare to Standard Funds?

A public benefit fund is a type of “impact” fund; that is, it is an investment fund designed to go beyond the goal of financial returns to also make a positive social or environmental impact.

A standard private investment fund focuses on producing a high yield for investors—and little else. A Delaware benefit fund can only be structured as a limited partnership, but standard funds have additional options such as being formed as an LLC or, in some states, as a limited liability limited partnership (LLLP).

Standard funds are more flexible than benefit funds when it comes to investments. A manager of a standard fund has considerable latitude in how to invest the limited partners’ money.

Benefit Funds’ Distinguishing Characteristics

Public benefit funds have three critical features that set them apart from other investment vehicles. These are outgrowths of their special mission and the statutory requirements that seek to ensure that these funds pursue that mission.

1. Enduring Investment Considerations

The investment flexibility of standard funds is replaced in benefit funds by investment considerations that bring an important level of consistency.

A benefit fund manager must balance three investment considerations: 1) pursuit of a designated public benefit; 2) the impact on stakeholders; and 3) investors’ financial interests. Collectively, these three considerations represent part one of a benefit fund’s three critical features—features present in all benefit funds as mandated by Delaware law. As such, these special characteristics of benefits funds may not be modified or altered by contract, ensuring consistency across this category of fund.

2. Special Reporting Obligations for Fund Managers

The second critical feature of benefit funds is their special reporting obligations. The manager of a benefit fund must adhere to more frequent and more robust disclosure obligations.

The fund must report to shareholders at least every two years, and that reporting must go beyond discussing the fund’s investment activities and financial results to include the fund’s impact to stakeholders, not simply shareholders. A public benefit report provided to investors every two years must include the following information: (1) How is the fund meeting its declared social benefit goals? (2) What are the fund’s chosen key performance indicators?

3. Investor Enforcement Rights to Ensure Impact

Should investors feel a public benefit fund isn’t investing in a way that is fully aligned with its stated goals, the third critical feature of benefits funds may come into play.

Unlike a standard fund, investors enjoy a derivative right to enforce a manager’s obligations to consider the social impact of their investment decisions, in addition to focusing on maximizing yield. Shareholders that individually or together own 2% or more of the fund’s interests are empowered by Delaware statute to sue to enforce the fund’s three benefit consideration mandates.

The 2% threshold represents an extremely low bar for bringing an enforcement action—and therefore poses a risk that a fund manager would do well not to ignore. A standard fund typically requires a majority in interest of investors to bring a similar action.

Investing for Impact

The Delaware public benefit fund gives investors another option to put their money to work in a way that provides both yields and a positive social impact. It takes impact investing and adds important features to ensure consistency, require robust disclosure obligations, and allow investors to enforce the dual mandate of the fund: simultaneously pursuing financial returns and a social good.

If fund managers can achieve returns for a benefit fund similar to those garnered by standard funds, it may prove to be a popular investment choice for the socially minded in the years ahead.

Bloomberg Law subscribers can find related content on our new Benefit Funds Toolkit, our Equity Deal Analytics page, and on our Securities Practice Center resource.

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