Many environmentally and socially responsible entrepreneurs and investors starting a new business are frustrated by forces that will steer them into some restrictive relationship with the financial world (investors, brokers, dealers, fund managers and other financial income-interceptors), an undesirable situation often realized by the business when it is too late.

Very different from existing business structures, the structure of an SR Enterprise (SR stands for Socially Responsible) is designed to control its destiny by arrangements made by the entrepreneur, manager, investor and others at start-up time but also allows adequate flexibility, both periodically and as conditions change throughout the life of the business.

Before describing the SR Enterprise it may be helpful to mention non-standard usage of one or two words, explained in detail later as the new structure is described. The SR Enterprise issues no stock, but it does have equity, called "shares". The word "stock" is not used. An agreement all shareholders sign is the "Shareholders Agreement". Initially most or all of the shareholders accept responsibility similar to standard Board of Director duties but with additional duties as well.

SR Enterprises are organized and operated to secure all three of these benefits:

1. The "Shareholders Agreement" is designed to increase the likelihood of business success.
2. All participants, whether entrepreneur, manager, investor, or employee, will be more fairly treated and rewarded than in conventional businesses.
3. Social and environmental responsibility will be maintained and enhanced in an agreeable, understandable, and flexible way.

Justification supporting these benefits are presented throughout this document.

There is a downside in this early phase when, as of this date, no SR Enterprise has yet been attempted. Something never done before always makes conservatives uneasy, often rightly so. Until many SR Enterprises are in operation, getting agreement on a "Shareholders Agreement (SA)" may take considerable work. Ultimately the SA will be largely boiler-plate with places to accept or reject a paragraph or fill in blanks by appropriate dates, money amounts, etc.

Investors in an SR enterprise, whether individuals or organizations, buy equity in the form of shares. Key participants, under appropriate and favorable conditions, may be given share equity. All equity holders at start-up must sign the "Shareholders Agreement" (SA) that covers all the business's activities and contains options designed to handle the many challenges that businesses face. The SA provides for a committee of the investors, called here the Board of Directors, acting on behalf of all investors. In conjunction with acquiring equity, new holders must also accept and sign an SA that satisfies three requirements: (1) all equity holders have voting rights, (2) the business must be private, not a public corporation and (3) the SA should be crafted to minimize the necessity or likelihood of any SEC or state involvement. In addition the business and all its official filings and activities must conform to all the relevant and applicable legal and regulatory requirements at the state and federal level. In the SA there should be no conflict with SR enterprise legal requirements.

The SA should be written to treat shareholders as human beings, friendly and mutually supportive, so that when over time new shareholders come on-board (sign the SA) and earlier shareholders cash out, all remaining shareholders remain friendly and supportive of each other despite the many business problems that arise over time that tend to polarize investors in different classes – large shareholders vs. small shareholders, patient shareholders vs. shareholders who need to sell, management vs. investors, business officers (particularly CEO, President) vs. other shareholders.

About 750,000 new businesses are started annually in the US. If in a few years only a tiny 0.1% or 750 of these new businesses were SR enterprises, it would be an extraordinary achievement, and yet would be such a small percentage of current new business that, even if it were ten times larger, the financial industry and Wall Street would likely take no notice.

The Shareholders Agreement (SA) is based on two ideas, 6 Capped Return and 12 Zero Spread that seem unrelated and are quite different from each other. Not new but very rarely used within a company, these two ideas together are unique to the SR enterprise and along with supportive SA features, help justify belief in the three benefits expected from SR enterprises. Today all businesses understand that there are social and environmental issues that require their attention. This was not true a few years ago. The world is changing rapidly. The SR enterprise design accommodates to the change and, in fact, can be set up by the SA to lead it. It is also possible that the SA may be set up so that businesses that are not inclined to be particularly clean and green but wish to be SR enterprises will not find the third benefit burdensome. The SA will tend to make such businesses more clean and green than they might have been.

Capped Return

In some ways SR shares are like stock, but the Capped Return, a cap on the amount of money all investors will receive, means SR shares are equity but not stock. The concept allows a cap to be any whole number, 1, 2, 3, etc. The SA can allow new rounds of financing to occur with different caps. To understand the idea of a cap better, let's consider extremes on the low and on the high sides that make sense for certain, common business situations:

Low Caps. The money needed to start a small business mostly comes as a loan from friends or family. If the business succeeds, the loan can often be repaid in a year or two. Friends and family are usually happy just to get their money back. That's a cap of one. A cap of two is in money terms identical to simple interest of 10% for ten years. So if an investor accepts a cap of two and the cap is reached in less than ten years, that investor has done better than writing a ten-year note with a generous 10% simple interest and a balloon payment returning the initial investment. Such small caps of 1 or 2 can be associated with first-round, small-business start-up funding.

High Caps. On the high-side, consider a cap of a hundred. How many investments have investors made in a company that looked promising at start-up and returned a hundred times investment? In 40 or 50 years as a successful investor and donor, I've had returns of 5 or 10, never as large as 100. A tiny percentage of companies, typically "household names", might appear to have offered the equivalence of caps of 100, but very, very few of them occur as a consequence of dividends and capital returns. Quite a few investors do achieve the same money outcome by appropriately buying low and selling high or through IPOs. Making money by trading in and out of stocks offers the possibility of enormous returns (and, of course, enormous losses too). This aggressive trading is typically little affected by the small stream of occasional dividends.

An Illustrative, Promising Situation. An excellent opportunity for an SR enterprise is a three part start-up business story: (1) An entrepreneur wants to start a new business and has a good reputation for being competent, ethical, and responsible among a small group of potential investors. (2) Potential investors know each other and the entrepreneur and have confidence the entrepreneur is competent, ethical and responsible, (3) The business seems to potential investors a surefire winner.

In this case an SR enterprise cap in the range 5 to 10 is reasonable. Many experienced investors have accepted this rule of thumb: a tenfold return is more likely to be rewarding than nine out of ten typical start-up investments. A ten-fold return is exactly what a reasonably successful SR enterprise with a ten cap gets.

Capped Shares of Enterprises Compared with Stock–based Companies. All investors in a stock-based company wish to have their stock freely saleable even if they are not ready to sell. Generally after some period of time, they get their wish. If and when it's legally saleable they can sell very quickly (for actively traded stocks, in seconds or minutes). Stockholders thinking of selling some shares must watch the market daily, rely on investment advisors, or take their chances. All these options are time driven. Watching a stock ticker display flying by or the rapidly changing stock prices on a computer monitor implies that the value of stock is highly time-dependent.

Capped returns are largely not time dependent. Their value does not come from the activity of outsiders, who generally know little about the company, but from the commitment and involvement of the insiders (including all investors) re-enforced by the provisions of the SA that are designed to require action in the best interests of investors, equity-holding employees and others important to the success of the enterprise.

The difference between an SR enterprise and a stock-based company is like night and day. Capped shares as equity (and no equity in the form of stock) benefits patient investors, who in turn benefit the enterprise.

Zero Spread

Board as Market-Maker. Market-making is handled like this. The Board of Directors of an SR Enterprise periodically (quarterly, annually, or in rare cases , as necessary) sets a single, fixed price P for whatever shares are bought or sold throughout the period. The Board acts like a market-maker for the company's shares but with absolutely zero spreads and no fees or commissions, just one set price per share, call it "P", set at the start of each period by the Board. P should be chosen so that it's as likely to interest buyers as sellers over the whole period. Brokers, dealers, and investment bankers, cannot make any money with Zero Spread so the financial industry, that for many years lagged in understanding social responsibility, will have little interest in SR enterprises. The disinterest of the financial industry is a plus for businesses committed to being ethical as explained further in sections 17 Wall Street's Role for Stock and 18 The Wall Street Stock Myth.

Market-Making Limitations That Hurt Human Relations Avoided by SR Enterprises. Let us examine a market-making capability which is needed, but cannot be achieved by stockholders in 99+% of today's corporations. In small stock-based companies management frequently owns company stock and some or all employees may own stock (often relatively little) and/or may have stock options, perhaps valueless or not yet exercisable or are of uncertain potential value. Over the years such companies find that the situation becomes an opening for discontent. Some stockholders, such as (1) former employees or (2) ex-employees currently consultants to the company, and (3) others in the company extremely short of cash, finding their stock restricted or non-saleable, are upset. All can ultimately become troublemakers. If the company could make a market in its own stock, the problem could be ameliorated, but conflict of interest prevents that.

Often I have seen CEOs of such companies personally and quietly making an interest-free loan to a good long-term employee who has been hit by expensive family or medical problems. The potential of such internal sources of company discontent convinces me that the Board of the SR enterprise openly being a market-maker with no spread and with an ongoing obligation to buy or sell shares is a very positive step in making the enterprise work well for human beings.

How Capped Returns and Zero Spread work together

Selling/Buying Shares. At the beginning of a "period" (each quarter or year, or in rare cases other, as permitted by the SA) the Board having met with the shareholders and determined their interests in buying or selling their own shares has to announce (1) the cap that will be used during the period (typically, the same as the previous period) (2) the zero-spread price per share P that will be used during the period, and two other amounts: (3) the minimum and (4) the maximum number of shares that can be sold to buyers at the discretion of the Board, a portion of which maximum may be authorized at the discretion of the President or Chair without further approval by the Board (the small net residue of shares bought and sold by this process are retained as treasury shares and cash) and (5) Excess Cash (described in the next section). The need for some minimum (3) avoids the complexity of dealing with a large number of shareholders likely to have little interest in the operational aspects of the enterprise and together contribute little to the financing of the enterprise. Initially some de minimus amount like $1000 might be appropriate increasing perhaps to $10,000, or much more, as the business grows.

If, during the period, the sales of shares above the purchases of shares exceed the allowed maximum (4) the Board by the rules of the SA can ignore or tentatively accept the purchase, subject to the will of the shareholders to accept, reject or make a counteroffer. A very large offer, especially one seeking a large cap, might have significant negative affects on small and early shareholders, and depending on the need for more investment, the vote of the shareholders may favor a counter-proposal that includes requiring that some of the money offered be used to buy out less patient shareholders or accommodate the needs of individual shareholders for cash. If the shareholders decision includes requiring the sale of shares, such shares must come from the holdings of shareholders in a fair manner. The shareholders have to make clear their individual desires to sell at a premium (a price higher than P), to sell at the price P, or have no interest in selling. Indeed, the latter case (no selling interest) will automatically happen whenever the purchaser is an existing shareholder. A new buyer, on the other hand, has to sign onto the Shareholders Agreement whose provisions have been designed to satisfy the human interests of the shareholders as agreed upon by all shareholders. A new shareholder accepts that he/she/it is compatible with the SA. The Board need have no concern for, or involvement in, these share purchases other than making proper adjustments to shareholder ownership records (see 22 Shareholders Accounting Needs). A cash-needy seller who wishes to sell need not sell all of its shares but if it is not selling all, it must continue to retain a minimum, the then de minimus amount (3). If there are several shareholders who wish to sell collectively a fairly large number of shares, the existing "patient" shareholders may choose to sell only at a premium, which is the same for all. At the same time, shareholders concerned with their social and ethical mission, may choose to sell without requiring a premium. (Explanation - some people are more socially responsible than others.)

When an SR Board specifies (1) the price P to be used for the period, as well as providing (2) the cap for the period, (3) the minimum number of shares that can be purchased by a new buyer and (4) a maximum number of shares that the Board is obligated to sell to a buyer on a net basis, it must also produce a dollar amount (5) for "Excess Cash", fixed, like price, for the period. Excess Cash is the Board's estimate of the affordable size of the cash distribution to shareholders -- money that is not needed to operate and/or expand the business. Share buyers during the period must be told the amount of Excess Cash.

Especially in the first few years, there may be no Excess Cash, either because the revenue-to-cost ratio is low, a bad sign, or in some happy circumstances the Board is approving a rapid expansion, generally a good sign. The distribution of Excess Cash is the only way shareholders get monetary return from the enterprise, aside from what should be normally a very small amount, sales of shares under the terms and conditions described in 14 Selling/Buying Shares. Excess Cash is not simply a dividend, but also a return of capital. (See section 16 Making the IRS Happy)

The largest single problem of new or growing businesses generally is getting adequate capital. Despite all the good things we expect the SR enterprise to do, investors by and large can be merciless when it comes to increasing their ownership or becoming a new investor. There is no aspect of an SR enterprise that prohibits it from paying agents reasonable fees, fixed or percentages of money received, for finding new investors among those who love the idea of participating in the Shareholders Agreement (SA) or alternatively, though seemingly less likely, finding lenders if the SA prohibits secured loans. The SA should make a clear statement about what is and is not permitted in this matter agreeable to all investors.

Wall Street's Role for Stock.

Financial organizations totally involved in creating and handling money and financial instruments for the whole country, naturally find that some of that valuable stuff sticks to their fingers. Many have certainly created very profitable investment and banking opportunities, compared to less profitable industries. The base of the financial industry (assisted by the cooperative Federal Reserve System and the industry-friendly SEC) is the creation, issuance, borrowing, lending, buying, selling of stock. Investment bankers and large broker-dealers operate and profit from the major stock exchanges, the NASDAQ and other markets. Corporate and municipal bonds trade at prices responsive to the rates of federal bonds, whether these are interest rates, coupon amounts, or amounts of redemption above issuance, and as affected by (a) early redemption options and (b) discounts for bulk purchases. Federal bonds are backed by the full faith and credit of the US government. Other bonds, not so backed, have to offer higher rates. Stocks, being more at risk than bonds, have to offer still higher de facto rates, whether dividends, return of capital, or increases in value, data for which is universally available. Return of capital is a rare item, a very small portion of stockholders benefit from that. Dividends are for the most part in a low range under 5% /yr. as a percent of stock price per share. Stock price growth is required so that Wall Street can tout equities as the instruments that generally have better returns than bonds or other intangibles. The burden falls on established corporations to outperform bonds by their secondary market stock price growth about 15%/yr.

One of the prevailing myths of Wall Street is that over any 10 year period any reasonable stock portfolio, such as a portfolio based on Dow-Jones, the S&P 500, and other indices only gain in value, not withstanding recessions, depressions, war, and all the turmoil of the hundred plus years for which there exist accurate stock quotations and transaction volume data. What is true is that these carefully crafted indices are surrogates for portfolios and are unlike portfolios. The indices (a) have no commissions or spreads that cut into portfolio value, (b) do not pay any of the fees charged by mutual, hedge and other funds, and (c) are updated by replacing stocks removed from the index by others (examples: Hewlett Packard in, Woolworth and Sears out) that have the benefit of the wisdom of those professional insiders who update the indices, often helped by making wise decisions, including raising the index a little by having the substitution effective as of an earlier time, useful even if only a few hours earlier.

The net effect is that the pressure of Wall Street, without necessarily utilizing the slightest conspiracy, will drop a company's stock disastrously whenever, in any day, in any year, it strikes Wall Street that the company is not on schedule to achieve close to the same growth rate mentioned in 17 Wall Street's Role for Stock -- profit growth at 15%. This growth is required so that Wall Street can tout equities as the instruments that in the long run have better returns than bonds or other intangibles. That the company may have had 50% or 100% growth for a few early years makes no difference to Wall Street's dismissive treatment when growth has slowed.

What seems like a contradiction to Wall Street's desire for a corporation to achieve around a 15% annual profit growth, is that if a company's stock price bounces around, up and down, the more the better. Wall Street can make even more money from such oscillations. Wall Street insists on profit growth and loves the ups and downs too.

Together the use of both "capped returns" and "zero spread" produce enormous synergy, like making one plus one equal to ten. Here is the story. Unlike an SR Board's sole incentive to price shares fair to both buyers and sellers, the job of the CEO in all public companies is to get its stock price up. That's right, Mr. CEO, your top priority job is to get the stock price up! Many, if not all, firms will do everything they can do to inflate their stock price -- ethically or unethically. Unethically? Need I mention WorldCom, Merrill Lynch, Enron, etc? Ethically? What are highly successful, top money making CEOs to do when they see that competitors may pull ahead or great opportunities may be lost. Certainly they will say and do whatever they can to defend their stock price, often accepting dubious risks. The stock price dropping from the preceding year, still does not stop complacent, crony Board members from voting increases in CEO compensation with the thought that the drop could have been worse if the CEO had not worked so hard. Average CEO compensation today amounts to a much larger multiple of average labor wages than the multiple CEOs achieved over average labor wages ten or so years ago.

In comparison, neither the CEO nor any manager of an SR enterprise has any personal financial incentive for a high share price. Neither the price P set periodically by the Board of an SR enterprise nor the size of the distribution of Excess Cash has any effect on the CEO's total compensation. The CEO's reputation for being fair and ethical enhances the perception of SR enterprise's trustworthiness. Which CEO would anybody trust to tell them how their company is doing financially, the corporate CEO or the SR enterprise CEO? We've connected the dots. Follow the bouncing ball here. How would you prefer to start a company, as a corporation or as an SR enterprise? "The SR enterprise" is a no-brainer.

A case can be made that until the shareholder gets a return equal to their investment, Excess Cash is a return of capital and should not be taxed. I am strongly opposed to that. I believe, as an ethical matter, all excess cash received should be taxed as dividends. That approach is not only right, it will enhance the ethical nature of the enterprise. The SA may overlook my advice if the enterprise believes it still complies with all relevant law.

Pre-period Board Decisions Required

As the period is coming to an end, in preparation for setting the amounts required in the next period, the dollar amount for price per share, the amount of Excess Cash and others, the SA should make clear that the Board must consult with the shareholders to determine their own interest in buying or selling shares. If the business continues to look as good as it did at start-up, shareholders will be patient investors, uninterested in selling shares, perhaps interested in buying shares. Some shareholders may have become cash-needy. In this case, choices requiring action have been presented in 14 Selling/Buying Shares.

Shareholders Accounting Needs

Over time, any one shareholder may accumulate several accounts with varying caps even if it does so in different names. For proper treatment of capitalization in the company's financial statements, the Shareholders Agreement must provide that all shareholders accounts applying to a single household or a single organization should be presented both aggregated and separately.

The Magic Formula.

Cash distributions can only be made from Excess Cash and all Excess Cash approved by the Shareholders must be determined and distributed early in the period. A fair distribution is best achieved by a simple formula as follows. The total amount that has already been returned to a shareholder as Excess Cash adjusted for money received or paid in the purchases and sales of shares between shareholders (if any), called the "Adjusted Excess Cash" (AEC) is expressed as a percentage, called U, the "Universal percentage". The magic formula is that U remains the same for every shareholder, no matter how many rounds the shareholder has participated in and how much he/she/it has invested in each round. This formula means that all shareholders start with U at zero, when no cash distributions have been made. The percentage U climbs each time an AEC distribution occurs, with the value of U the same for all shareholders but generally different, of course, with each AEC distribution. The final cash distribution makes U equal 100% at which point there are no longer shareholders. We consider the question of who owns the company when U is 100% in the next section, 24 Wisdom Keepers to the Rescue.

The key good that comes from using the magic formula is that up until the day of the last AEC distribution, all patient shareholders stay on as shareholders until that day when all shares (and so all shareholders also) are gone. If this were not the case one can imagine all the bickering and consternation brewing over any formula for distribution raising the issue of which shareholders are being better treated than the others, especially if and when some are paid off in full, ahead of others. When a new shareholder comes into the enterprise by buying shares and signing the SA, it is assigned the same value of U as all shareholders at that time, of course without receiving any portion of previous cash distributions.

Wisdom Keepers to the Rescue

Well in advance of eliminating all shares, the Board should seek out what has been called the "Wisdom Keepers" (WK), a group of people with business sense, highly respected in the socially and environmentally responsible world who for reasonable small fees and expenses agree with the SR enterprise to undertake two different services for SR enterprises, as follows.

(1) With no further investment income for the enterprise management and employees, the WK permits management and employee compensation through salaries, bonuses, and fees within the limits of an ethical standard and particularly that require that SR's top management total compensation in any year must be reasonable and not excessive. Bringing CEO compensation closer to average employee compensation produces social responsibility not otherwise achievable. Think about that.

(2) WK are the experts who frequently update enterprises on best practices to improve its social and environmental policies and behavior.

When early SR enterprises are first launched, such WK groups will not have been established. WKs will begin to spring up as the number of SR enterprises seeking WKs grows. An agreement between the SR enterprise and WK need not be negotiated until Excess Cash has started accumulating. The accumulation can rest in a money market fund and not distributed to shareholders if, and as long as, necessary. If the SR still recognizes that such a negotiation is in its best interest, it seeks out a compatible WK for detailed negotiation for the valuable services, (1) and (2) above. The SR enterprise is in a very strong position financially to negotiate a favorable agreement with a WK. The trickiest aspect of that negotiation, how the enterprise CEO can be replaced, may be handled by a majority of the Board or by a super-majority vote of former shareholders. If no such SR enterprise/WK agreement can be reached, then as provided for in the Shareholders Agreement (SA) either (a) the SR enterprise makes shareholder-approved cash distributions to a new non-profit the Company sets up for this purpose, or (b) if the Company does not set up such a non-profit, the money must go to other existing non-profits approved by its shareholders (as suggested under other circumstances in 11 A Boost for Social and Environmental Organizations).

Onset of Failure

As can happen in any company in difficulty if the preponderance of shares among the shareholders makes clear in discussions with the Board prior to a period (or otherwise) that cash is what is wanted, the Board may have to adjust Excess Cash and increase distribution to satisfy all shareholders (as in 14 Selling/Buying Shares), or if not able to do so, seek out new investors (see 18 Finding Adequate Capital). If neither succeeds, the company may be facing bankruptcy. Being socially responsible will make corporations less likely to fail, but cannot be a guarantee of success.

An Escape Clause

In extremis, by approval of a supermajority of shareholders, the Shareholders Agreement (SA) permits the cap to be removed and the company can irreversibly go "mainstream".

Explosive Growth Potential

Let's end this on an up-beat note. Most start-ups (including their first round investors) do not have the first-hand experience to appreciate the way benefits accrue to a business structure like the SR Enterprise that combines capped return and zero-spread. Consequently most start-ups will be reluctant to accept the complexity of creating a solid Shareholders Agreement that satisfies all parties. They launch their business in some conventional way (partnership, corporation, LLC, etc.). Some time later, when they begin to understand the consequences of Wall Street's siren song with enticing investment offers that engulf the business, it seems too late to switch to an SR Enterprise. But that need not be, despite the fact that SR Enterprises have often been labeled as start-ups. A conventional business structure can be re-started as an SR Enterprise provided the business owners and key management agree to do so.

Here is one way for that to happen. They first agree to create the shell of the SR Enterprise, which is the Shareholders Agreement. Then at a closing, the initial business is dissolved and all sign the Shareholders Agreement. This can be done by small and mid-sized companies, but seems daunting for large companies. This still may be possible for the large company if it allows a division that particularly wants to be an SR Enterprise to be spun off to become one. In this case, the closing includes the key representative of the large company agreeing on the whole deal. With such techniques, the conversion of conventional companies to SR enterprises could come with explosive growth.

>>> 12.1 The SR Corporate Structure

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