The 2023 Federal Budget allocated nearly $200 million over 6 years to address entrenched community disadvantage, including $11.6 million to promote social impact investment. It’s not huge, but it's a start. As the Treasurer says, Government can’t fully fund every good idea.
But what if there was something the Government could do to encourage social impact investment that was essentially free?
Successful social ventures require worthy ideas, inspired operators, private sector investors alongside government funding, measurable outcomes and accountability. They also need to take some kind of legal form, but there is currently nothing in the Australian menu of corporate structures that is fit for purpose. Purpose is the key word – the inclusion of a social purpose alongside a profit purpose. Legislating a new type of body designed to embrace these joint purposes will cost the Government next to nothing, but could influence how much private sector capital is attracted.
A 2019 report by the Government’s Social Impact Investing Taskforce (SIIT), chaired by ex-banker Michael Traill, described the rainbow of investment types from grants and philanthropy, to social impact investing (a social objective with some returns), to sustainable investing (with a positive screen), to socially responsible investing (a negative screen), to mainstream investment where financial returns are the overriding objective.
While the Budget has provided support for smaller projects at the social impact side of the rainbow, what about nationwide problems such as the housing shortage, energy transition and preserving the environment?
The SIIT report noted the need for transparent measurement of social outcomes, and that large scale social enterprises need to be attractive to mainstream institutional funders. There is a need for bodies that have strong governance structures and professional management. ASIC has acted to direct appropriate allocation of capital by making greenwashing an enforcement priority, and Treasury is proposing a uniform taxonomy for sustainable investment, but how can social impact funds attract private sector funding?
Serious capital seeks a structure with limited liability, but quality company directors may not want to be exposed to risk for favouring social purposes over profit. Directors have a duty to exercise their powers and discharge their duties with reasonable care and skill, in good faith in the best interests of the corporation and for a proper purpose. The primary interest is shareholder profits.
Writing extra-judicially, High Court Justice James Edelman observed that “whether a director exercised their powers and fulfilled their duties with reasonable care and skill in all of the circumstances requires consideration of the purpose for which the power or duty was conferred”.
Since 1998, Australian companies have not been required to have a stated purpose that frames the directors’ duties. Without one, no company director can be sure that acting for a social purpose will meet their duties.
There are legal arguments that directors can choose to limit their duties by voluntarily including a purpose in the company’s constitution, an approach taken by smaller entities with B Corp certification. If we are to encourage private investment into social impact ventures at scale, we need a structure that unambiguously provides legal protection to companies and their directors who pursue joint objectives of purpose and profit.
Purpose versus profit - International trends
Purpose has been combined with profit in legal structures in the US and UK. The US Benefit Corporation is a for-profit entity that can attract mainstream investors, but must entrench in articles of association a purpose to create a public benefit by reference to a third party standard.
There is a requirement to consider various stakeholders but absent willful misconduct, illegal activities or self-dealing, directors who depart from shareholder maximisation conduct are protected. Pursuit of the public benefit is deemed in the best interests of the Benefit Corporation. There are accountability mechanisms to prevent greenwashing, and enforcement is by private litigation.
The UK Community Interest Company model involves a regulator that determines the reasonableness of the community interest claims. The articles must include restrictions on transfer of assets, dividends, loans and payments on winding up. This hybrid non-profit vehicle is intended for greater government involvement, compared with the Benefit Corporation that was designed for social-business ventures.
Trusts – An Australian trend?
In Australia, larger impact investment vehicles have taken the form of trusts. Trusts are currently more flexible than companies when it comes to including non-financial purposes and, for passive investments, they also provide a better tax treatment than companies. However, the regulatory and licensing regime surrounding trusts, and lack of familiarity for foreign investors, limits their attractiveness for most large-scale impact investments outside of traditional passive asset classes (such as real estate or infrastructure investments).
UNSW Professor Bronwen Morgan has observed that “Australia stands out in the Anglophone and European world as almost unique in lacking a recently enacted legal structure that is distinctively useful for social enterprise”.
Historically, society has granted corporations the privileges of being a legal “person” distinct from its members with limited liability in exchange for a charter requiring the body to achieve a public purpose. For-profit corporations have been used for diverse public purposes, from financing foreign trade (such as the British East India company) to facilitating public works (such as the US transcontinental railway).
Although a 2006 CAMAC report did not support the idea of a new legal structure for impact funds, the landscape is changing. An Australian Law Reform Commission report in 2019 made the case that a dedicated legal structure for social enterprises was one of the five ‘most pressing areas for law reform in Australia’. Now is the time to consider it.
