The Wall Street Journal recently reported that xAI, the artificial intelligence startup founded by Elon Musk, completed a funding round of $5 billion at a pre-money valuation of $45 billion ($50 billion post-money). Rumored to participate in the round according to the Journal were Sequoia Capital, a16z and Valor Equity Partners. One could hardly blame these Silicon Valley heavyweights for wanting to make a big bet on artificial intelligence and Elon Musk’s record of success. But one may wonder whether in their eagerness to do so, they’ve overlooked xAi’s corporate structure as a benefit corporation, which allows it to pursue stated societal goals in addition to purely financial returns.
xAI’s structure as a benefit corporation is noteworthy, but far from unusual for an AI startup. xAI typifies a growing trend of AI startups adopting governance frameworks that prioritize societal impact alongside profit. For example, Anthropic organized as a public benefit corporation with a stated purpose of “the responsible development and maintenance of advanced AI for the long-term benefit of humanity”. Similarly, OpenAI has reportedly adopted plans to restructure itself as a benefit corporation.
So why are AI startups like xAI embracing the benefit corporation structure, and are investors overlooking the risks?
What Is a Benefit Corporation?
A benefit corporation is a legal structure that allows a company to pursue social and environmental goals in addition to profit. Unlike traditional corporations whose directors are bound by fiduciary duties to maximize shareholder value, benefit corporations are mandated to consider the interests of all stakeholders: employees, customers, communities and the environment. This dual-purpose framework gets memorialized in a benefit corporation’s charter and often monitored through transparency and accountability measures, such as periodic impact reporting.
For example, Section 362 of the Delaware General Corporation Law defines a “public benefit corporation” as “a for-profit corporation … that is intended to produce a public benefit … [and is] managed in a manner that balances the stockholders’ pecuniary interests, the best interests of those materially affected by the corporation’s conduct, and the public benefit … identified in its certificate of incorporation. A public benefit corporation is required to identify in its certificate of incorporation one or more specific public benefits to be promoted by the corporation.
Why AI Companies Are Adopting the Benefit Corporation Model
AI is an industry at the crossroads of innovation, ethical considerations and societal impact. This makes the benefit corporation model particularly appealing to AI startups for several reasons.
AI systems wield tremendous influence, from shaping public opinion to making critical decisions in healthcare and justice. The benefit corporation structure allows AI companies to incorporate ethical principles into their operations.
With growing scrutiny of AI’s potential misuse, such as biases in algorithms and surveillance concerns, benefit corporation status signals to the public that a company is committed to “doing good”. It builds trust with consumers, partners and regulators who value transparency and accountability.
Many talented professionals want to work for companies whose missions align with their values. Similarly, impact-driven investors are drawn to organizations that can deliver both financial returns and demonstrable societal benefits. Structuring as a benefit corporation provides a competitive edge when competing for talent and investors.
Governments worldwide are passing regulations intended to ensure AI technologies are developed and deployed responsibly. By adopting a benefit corporation model, AI startups align themselves with this regulatory trend by demonstrating a commitment to ethical AI governance.
What Risks are Faced by Benefit Corporations and their Stockholders?
Benefit corporations are required to produce a public benefit and balance their stockholders’ pecuniary interests, the interests of other stakeholders and the public benefit identified by their charters. Hence, they face the risk that they will not achieve their stated public benefit purpose or that the expected positive impact from being a benefit corporation will not be realized. That in turn could have a negative effect on a benefit corporation’s reputation, which in turn could negatively impact a company’s business and financial results.
Benefit corporations are also required to disclose publicly their overall public benefit performance and assess whether they’ve achieved their identified public benefit purpose. Benefit corporations run the risk of not reporting on a timely basis or being unable to provide the report at all. If a report is not viewed favorably by regulators, investors or others, the reputation and status of a benefit corporation could be harmed.
Unlike traditional corporations whose directors have a fiduciary duty to focus exclusively on maximizing stockholder value, directors of benefit corporations have a fiduciary duty to consider not only maximizing value for stockholders but also the company’s specific public benefit and the interests of other stakeholders. Consequently, benefit corporations may take actions they believe will be in the best interests of stakeholders affected by the corporation’s specific benefit purpose, even if those actions don’t maximize financial results. Pursuit of longer-term or non-pecuniary benefits may not materialize within expected timeframes or at all, yet may have an immediate negative effect on any amounts available for distributions to stockholders and cause the stock price to decline.
Benefit corporations are less attractive as takeover targets than traditional companies would be, and stockholders’ opportunities to realize their investment through an acquisition may be limited. Under Delaware law for example, a benefit corporation may not merge with another entity if the surviving entity’s charter “does not contain the identical provisions identifying the public benefit or public benefits,” unless the transaction receives approval from two-thirds of the target public benefit corporation’s outstanding voting shares. Benefit corporations may also not be attractive targets for activists or hedge fund investors because new directors would still have to consider and give appropriate weight to the public benefit along with stockholder value, and stockholders committed to the public benefit can enforce this through derivative suits. It may also be more defensible for a benefit corporation’s board to reject a hostile bid, even where the takeover would provide the greatest short-term financial yield to investors.
Unlike traditional corporation boards which must focus exclusively on stockholder value, benefit corporation directors are obligated to consider the stated public benefit and the interests of other stakeholders. In case of a conflict between the interests of stockholders and the interests of the specific public benefit or other stakeholders, there is no guarantee such a conflict would be resolved in favor of the stockholders, which could have a material adverse effect on the corporation’s business and cause the stock price to decline.
Stockholders of a Delaware benefit corporation (if they, individually or collectively, own at least two percent of the outstanding shares) are entitled to file a derivative lawsuit claiming the directors failed to balance stockholder and public benefit interests. This potential liability does not exist for traditional corporations. Such litigation could be costly and divert the attention of management.
Key Takeaway
The adoption of the benefit corporation structure by AI startups like xAI signals a shift in corporate priorities, emphasizing long-term societal impact alongside financial returns. However, this innovative approach is not without risks. From heightened accountability and reputational vulnerability to the potential for stockholder conflict, benefit corporations face unique challenges in balancing their dual mission. Yet, as the AI industry grapples with profound ethical and societal questions, this model provides a governance framework that aligns corporate operations with broader public interests.
[View source.]
