12.1  Socially Responsible Corporate Structure
The SR Corporation

by Alan F. Kay
12/19/02 © 2002

A combination of two simple ideas can lead to a corporate structure that fits within existing corporate law and produces a uniquely socially responsible organization, called an SR Corporation or an "SR". 

Businesses that are start-ups probably need to satisfy the two requirements of Table 1 to become a successful SR:

For businesses that are not start-ups, but whose management and shareholders wish to restructure as an SR, what may work best is to carefully incorporate a new "shell" that is an SR, which then absorbs the original business with the support and involvement of enough management and shareholders to make this merger legal and practical.

From this point on, I consider only start-up SRs that satisfy the conditions of Table 1.  It is assumed that the key players have found a legal and practical way for them to become an SR, that is reflected in the Certificate of Incorporation, the By-Laws, and a Shareholders Agreement. 

Two ideas promise to make the SR highly desirable. The first idea, a "Capped Return" is not new, although at this moment I don't know of any organization that has proven the viability of the idea by becoming successful with capping all returns to investors from the start.  The second idea, "Zero Spread", I believe is new and fulfills two basic functions: (a) compensates investors for the total lack of value of their shares after they have received a cumulative cash return equal to the "cap", and (b) makes possible, perhaps even likely, that no matter how much further investment the Company may need to expand, the Company will be able to get the required funds without involving investment bankers, brokers, dealers, or the financial industry (aka "Wall Street").  Normal business loans, under some circumstances offered by banks, may be negotiated and effectively utilized by an SR. 

(1) The Capped Return.  An investor invests an amount I, knowing that it will never receive more than N times I, where N is a fixed number, the "cap".  Cases where N is 2, 10, and 100 are considered later.  These three are enough to illustrate the advantages and disadvantages of any specific value for N.  The basic idea is that by a priority formula in the Shareholders Agreement, investors receive payments from the company from time to time (normally periodically, either annually or quarterly ).  With each payment the investor's percent ownership drops until the investor has received a cumulative payment of N times I, at which time the investor has no further ownership.  Over time the investor may make several investments and/or sometimes sell some shares. Each such transaction is separately treated as described for the single investment case. 

Another important feature is that shares may be issued by the Company not only to investors but also, to reward and incentivize management, employees, directors, and advisors while conserving cash.  Such shares are issued upon approval of the Board and according to the rules of the Shareholders Agreement that insures that this will only be done sparingly, as necessary, and according to the Business Plan, wherever and as long as the Plan is still relevant.  The percent ownership of investors and all holders of shares at the time is diluted by these new shares. 

The procedure for redeeming shares by the Company and paying out the total capped return to shareholders depends on a concept of "excess cash".  Periodically, quarterly or annually (and in rare cases, whenever the Board deems it necessary), the Board determines the excess of the Company's actual revenues over costs for the period being closed out and the projected excess of revenues over costs of the subsequent period from a complete set of financial statements and projections where "projected costs" include all cash needs, such as expected needs for desirable expansion, cash acquisitions, capital purchases, and debt reduction.  Cash available at the end of the closed-out period plus cash available in the projected period is the "excess cash". 

When there is substantial excess cash and the Company is on a "successful" performance track, shares are redeemed by the Company.  When the Board approves the Company's financial statements for the past period and its projections for the following period, it also establishes two other numbers, uniquely required for an SR: the excess cash A and a stock price P.  If A is zero or negative, it may still be necessary or desirable in view of the Company's social mission, to set-aside from operating funds cash, hopefully small, to repurchase shares required by law or the unusual needs of shareholders. 

If A is positive, exactly one half of the excess cash, A/2, is used to redeem shares at the Company-set price P.  Redemption occurs as follows: first priority goes to any legal obligations to redeem shares, second priority to those shareholders who for urgent needs wish to redeem shares and then finally to all other shareholders.  Amounts in each class are determined by the Board to treat all as fairly as possible.  How long the shares have been held and the desirability of getting all shareholders fully bought out at the same time are to be included as factors in the Board's determination of the amount each shareholder receives.  It is anticipated that at least in the early years, the number of shareholders is not large so that individual needs can be taken care of without a strict pre-approved redemption algorithm.  All redemption of the amount A/2 is at the established price P.  In exchange for the redeemed shares, the Company pays out the amount A/2 to the redeeming shareholders. This redemption process at price P, fixes reduction of the size of the percentage of the company owned by shareholders. 

The other half of the excess cash A/2 is donated to a non-profit, socially responsible organization, which has a Board and officers who are well-known in the socially/environmentally responsible world-wide community.  This organization is called here "Wisdom Keepers" (WK).   WK takes possession of both the shares redeemed and half the total excess funds A, which it can at its sole discretion and within the bounds of applicable law distribute, donate and give to worthwhile projects and programs of organizations promoting socially and environmentally needed causes in accordance with a Charter established by the Company and an Agreement between the Wisdom Keepers and the Company. 

No interest or dividend accrues or is paid. The investor can offer to sell to the company any or all of the shares at any time at a price which is determined by the Board in accordance with the Shareholders Agreement to be fair whether the company is very successful, goes belly-up, or anything in-between.   

At some point, if the Company is sufficiently successful (whether to the extent anticipated in the Business Plan or not), the Wisdom Keepers will wind up owning the Company and being the sole shareholder.  All former shareholders will have received their full capped returns and own 0% of the Company.  According to its Agreement with the Company, Wisdom Keepers must choose the Directors of the Company, but it is limited in the criteria it uses for those choices, by its Agreement with the Company.  The criteria allow the Company Board itself to make wise decisions on operating the Company successfully.  The situation is not unlike some large and fairly large companies which are employee, family, or non-profit owned, and are dedicated to protecting and enhancing social and environmental responsible activities.   Examples have been Scott Bader, Bertelsmann, and Hershey. 

Note that until the Company is quite profitable, the Wisdom Keepers (WK) have no Company ownership and have received no funds from the Company, and so WK need not be established until about two years after the Company starts operation.  Another important point is that several, even many, SR start-ups could use the same WK organization if that proved desirable for, among other things, saving overhead costs and adding stature, recognition, and reserves to WK. 

(2) Zero Spread.  The Company may occasionally need further investment.  To get the cash it needs, as required by the Shareholders Agreement, the Company must offer to sell at the same price P that it buys or redeems shares.  This single price P established at the beginning of a time period (a quarter or a year) remains in effect until the Company establishes a new price, say P', for the next period.  This means that the Company is prepared to make a market, bidding and offering, at least in small or emergency amounts (and at the end of every successful period, with larger amounts), with no spread between bid and offer price, and no fees or commissions charged in any purchase or sale transaction.  

This is remarkable.  Why would the Company be trusted to choose a price fair for all?  Because of zero spread, the Company has no financial interest in market-making, unlike all professional market makers, brokers, dealers and investment bankers.  More important is this.  Investors and others who obtain company shares for services get a fixed total return, the CAP, and no other financial incentive, regardless of what prices, P, P', etc., the Company chooses.  Therefore, in the capped SR world, neither the directors, the management, nor the shareholders have any financial interest in what the price of the shares are, or will be.  This is entirely different motivation than exists in the current financial world.  

Nobody really knows what the value of a Company's stock should be better than the Company itself.  But this fact has not been meaningful or useful, because (except rarely when there is an imminent leveraged buy-out) management and shareholders of a Company always want the price to be as high as possible.  That drive by companies to push up their stock price, by fair means or foul, has been glaringly exposed as the curse of capitalism in 2002.  (Think Enron, WorldCom, Merrill Lynch, etc.) 

But with Capped Return and Zero Spread, the Company only wants the price that best improves the performance of the Company and so should be, and will be, trusted to set an appropriate price.  Lacking the latest detailed knowledge of what is happening in the Company, no outsider can do as well at pricing the Company.  

In 2002 we have seen how corruptly Wall Street behaves in these matters.  Star analysts with seven figure incomes working for large brokerage firms in an unbridled capitalist climate got investment banking business for their firms from multi-billion dollar companies, by hyping the stock of these companies, such as giving the CEOs opportunities to buy stock at a pre-hyped price and selling it almost instantly at the hyped prices of a professionally managed public offering. Former Salomon telecom analyst, Jack Grubman, is an example.  CEOs and top executives of dozens of other companies, ignoring the role of inside information affecting their behavior, sold stock in amounts ranging from $200 million to over a billion, while employees and other ordinary people were buying until the bubble burst.

Caps of 2, 10, and 100. 

(2) Since the Business Plan itself projects that the Company will be in the black within a year or two, to anyone who is convinced of the soundness of the Plan, a cap of 2, in this case seems to the investor very like a bond or note with a high interest rate.  From the point of view of the SR world, a cap of 2, sounds to a clean, green NGO like a reasonable return, unlike a share of uncapped stock which might make a Gates, a Rockefeller, or a Buffet into a billionaire with return multiples of thousands.  This attitude might help to convert the hundred thousand, or so, clean, green NGOs worldwide into potential customers or investors in the Company.  For any investor who is as much interested in social and environmental returns as in money returns, the Company's shares, even capped at 2, can be seen as a very satisfactory investment. 

(10) Many investors are very pleased when they get a 10 times return on their investment.  Statistically less than 10%, probably less than 5%, of investments all of which seemed very good when the investment decision was made, get a 10 times return or better.  It is logical to expect most investors to be quite satisfied with such a high return.  But some investors, using logic similar to that of buyers of big pay-off lottery tickets, get a psychological boost with the thought that regardless of how unlikely, they may well get the winning ticket and then "be rich beyond their wildest dreams".  More modestly, they may think, "Someone as smart, responsible and well intentioned as I am, is entitled to an occasional huge payback.  It is only fair." 

(100)  A "high" value of 100 is included here simply to show how slight the difference is between uncapped returns and a capped return of 100.  If 100 is not high enough to do that, how about a million?  At some point the difference is at most psychological and at best very illogical.  Nevertheless, even if an SR that is a long term success, had a cap of 100, at some time, it would be able to achieve that SR advantage and give all shares to the non-profit WK.  So even 100 is better for the social mission than no cap at all. 

When SR is well-understood, caps closer to 2 and certainly not more than 10 are all that would be required for a good SR start-up. 

Flexibility.  "Zero Spread" and no fees or commissions on transactions, means that no broker, dealer, or investment banker will have anything to do with the Company.  The financial industry will walk away, since it can make no money on the Company.  As a final precaution and fall-back, unlikely as it may be, is this feature.  A super-majority of directors, representing a super-majority of shareholders, by the Shareholders Agreement, are empowered at any time to drop the zero spread concept (or make it slightly above zero numerically) and at any time to issue capped shares of different classes with different cap multiples, if that flexibility best achieves the intention of the company, expressed in the social mission. 

Pacing Finance.  It is useful to focus on the basic underlying difference between SR corporations and almost all others.  Everyone who has been involved in starting and growing a successful business knows that it is a difficult, slow, long term proposition.  Multi-billion dollar ADP was in business for ten years before it reached annual revenue of a million dollars.  Even Microsoft, Cocoa Cola, Intel, Walmart, McDonalds and a few others in a select class that sometimes seems to have a license to print money, had long slow difficult starts and may be overtaken someday by emerging giants.  

Yet the financial industry and its clients push all public companies and every player in the securities markets to move faster, to buy or sell quickly, to make their fortunes and move on.  Aside from mad day-traders, no one cares whether a securities transaction took place at precisely 3:14:42pm or some other time.  What matters is the net price of the transaction.  But all features of the system of systems: marketmaker/specialist, broker/dealer, exchange/Internet systems work to give these financial players their substantial income.  About one third of all corporate profits in 2001 went to the financial industry and a good portion of that came from the churning of the equity markets, which in the past year had trades occurring at prices typically swinging, peak to trough, intra-day or day-to-day, 1 or 2%.  You do not have to be on the wrong side of trades a very large part of the time to make a "small fortune on Wall Street" when, that is, you started with a large fortune. 

Capped Returns are designed to take timing out of the equation.  If you are ready to make an equity investment in a start-up with the hope of a long term profit, whether that long term is two years or four years is secondary to getting the good return.  Dividends and interest payments are not specifically in an SR equity investment.  They are bundled with the total return.  Capped returns in an SR are neither debt nor equity, but something unique, called "shares" expressed as a percent ownership of the company.  

The Zero Spread concept gets Wall Street out of the picture altogether in an SR.  In the long run that very fact, coupled with openness and fairness of equity pricing in the SR model, will attract more investors, burned over and over by Wall Street, to invest in SRs.  SRs will not need Wall Street.

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