How ‘benefit funds’ align stakeholders and provide transparency for LPs

Fund managers and investors are seeking innovative ways to structure funds and build thematic portfolios that balance financial returns with social impact. The Delaware statutory public benefit limited partnership codified in 2019 offers a promising solution. In 2023, our firm developed the “benefit fund,” the first-ever venture capital fund using this structure. 

The “benefit fund” effectively addresses common challenges faced by general partners and limited partners, providing a framework that aligns the interests of benefit fund managers and their investors with the mission and purpose of impact investing.

Legally mandated public benefit

Venture capital funds and other investment funds that are structured as benefit funds have a specific obligation to pursue a designated public benefit, such as improving (or reducing the negative effects on) the arts, education, environment, health, medicine, or religion. Unlike traditional investment funds, benefit fund managers, in connection with their investment decisions, have a duty to balance:

• The public benefit,
• The impact on stakeholders, and
• The financial interests of limited partners.

By creating a clear and enforceable legal duty for impact alignment, benefit fund managers can be held accountable for their investment decisions and they can better refute claims of “greenwashing,” “faithwashing,” or other forms of embellishment. In other words, it provides both a legal defense for benefit fund managers to consider factors other than the monetary interests of the limited partners when making investment decisions, and also an enforceable right of limited partners to ensure that the managers are in fact balancing those three considerations.

Comprehensive reporting requirements

Transparency is paramount in impact investing, and benefit fund managers are required to provide a detailed report to limited partners biennially, which must include a description of the fund’s investment activities, the fund’s objectives, the impact measurements and metrics utilized, an assessment of the fund’s success in achieving its designated public benefit, and an evaluation of the impact on stakeholders.

LP’s enforcement mechanism

To ensure accountability, benefit funds include a statutory right for limited partners holding at least 2% of the fund’s interests to bring a derivative lawsuit against the benefit fund manager. This right can be exercised if limited partners reasonably believe the benefit fund manager has failed to adequately consider or balance the public benefit, stakeholder impact, or financial interests of limited partners. 

This enforcement mechanism cannot be limited or altered by the fund’s governing documents, providing limited partners with a powerful tool to hold managers accountable and incentivizing compliance with benefit fund obligations. This same mechanism is utilized and remains unaltered in a number of publicly traded benefit corporations governing documents, including Allbirds, Coursera, Vital Farms, Veeva Systems, and Warby Parker.

Take Samaritan Partners Fund I LP, the nation’s first institutional-level venture fund to be structured as a benefit fund. This fund’s designated public benefit focuses on providing capital to companies that are focused on decreasing barriers to people with disabilities and from underserved communities. 

Benefit fund manager Chris Maher notes that the use of the benefit fund structure not only helps to show investors its commitment to the designated public benefit, but also to demonstrate to potential portfolio companies its alignment with their social impact goals, which in turn has increased deal flow. 

Implications for fund managers

The benefit fund structure offers several advantages for impact-focused fund managers:

1. Clear Alignment: The legal structure provides a framework that explicitly aligns with the fund’s social purpose.
2. Enhanced Credibility: The mandatory reporting and enforcement mechanisms can help build trust with investors and stakeholders.
3. Differentiation: In a crowded market, the benefit fund structure can serve as a differentiator, potentially attracting investors who prioritize genuine impact and increasing deal flow from like-minded portfolio companies.
4. Legal Clarity: The structure provides a clear legal framework for balancing financial returns with social impact, potentially reducing ambiguity in decision-making.

Challenges and considerations

While benefit funds offer significant potential, fund managers should be aware of certain challenges:

1. Novelty: As a relatively new structure, benefit funds may face adoption hurdles and lack established best practices.
2. Reporting Burden: The comprehensive reporting requirements, while beneficial for transparency, may require additional resources.
3. Investor Education: Some investors may be unfamiliar with the benefit fund structure, necessitating additional explanation and education.
4. Potential for Litigation: The enforcement mechanism, while a strength for accountability, could potentially increase litigation risk.

Looking ahead

The benefit fund structure represents a significant development in impact investing, offering a legal framework that aligns with purpose-driven investing while providing enhanced certainty, transparency, and accountability for limited partners. As this type of thematic investing continues to grow, benefit funds could become a preferred structure for fund managers seeking to credibly demonstrate their commitment to both financial returns and social impact to both their investors and portfolio companies.

For fund managers considering this structure, it will be crucial to stay informed about emerging best practices, contribute to the development of industry standards, and engage in ongoing dialogue with investors, regulators, and peers. By doing so, they can play a pivotal role in shaping the future of impact investing and driving positive change through financial markets.

Jon Tong is a senior associate and Frank J. Martin is a partner and general counsel at Cole-Frieman & Mallon LLP.
Guest posts on ImpactAlpha represent the opinions of their authors and do not necessarily reflect the views of ImpactAlpha.