This is the Q&A for the G-Corps proposal in the Giving America series.
Won’t traditional businesses tend to beat G-Corps because they have more access to capital? Because they can be more ruthless?
For the overwhelming majority of businesses, G-Corps have better access to capital, because every investor dollar can trigger a guaranteed match of community dollars at the same valuation. And the tax exemption makes each dollar go farther, increasing the relative capital advantage.
With respect to ruthlessness: people tend to think that companies with an unchecked profit motive are the ultimate competitors. But the reality is a bit more complicated. An unchecked profit motive drives businesses towards short-term gain. This gain gives them an advantage in short-term margin, which they then wield to outcompete their less-ruthless competitors.
But if you can find a way to overcome this short-term margin advantage, you can compete effectively in the long-term while retaining your soul. Costco and Arizona Iced Tea are both perfect examples of this — they offset their self-imposed profit caps by keeping costs lower than their competitors through streamlined operations, reduced expenditures (e.g. minimal marketing budgets), and innovative revenue streams. Costco buys in bulk, sells straight off of the pallet, limits its SKUs, and charges an affordable membership fee that increases shopper loyalty. All of this allows it to remain competitive against unchecked profit maximizers in the short term, so that it can focus on the long-term, where its careful practices allow it to dominate.
Because of their 21-35% tax advantage and their increased access to capital, G-Corps get the same kind of margin advantages that Costco works so hard for, without having to do any of this work. Add to this the lower turnover, cheaper compliance, and consumer goodwill that will likely result from their G-Corp designation, and I suspect G-Corps will be a lot more competitive than you might think.
What are the exit opportunities for G-Corps? Can they be bought by traditional corporations? Can they de-convert?
They have all the traditional exit opportunities, with a couple of caveats. They can IPO with the investor shares, though the worker and community shares would remain sheltered. They can be bought, but again, the worker and community shares would remain sheltered, and the charter would remain in force unless it is dissolved by a supermajority vote of the workers and investors. Finally, de-converting from a G-Corp would require not just a supermajority vote, but also a buyout of the worker and community shares (and potentially a tax clawback, depending on the circumstances of the exit).
Don’t nonprofits already serve this purpose?
Most nonprofits are tax-exempt, but that’s about the only thing they have in common with G-Corps. Nonprofits generally perform services that are structurally not profitable, and rely on grants or donations for their operating budget. G-Corps are normal, profit-seeking businesses, like an LLC or a C-Corp, just with a different corporate structure.
Won’t employers be disincentivized to hire, to avoid diluting shares?
With respect to profit sharing: this is actually the same employee cost question that every employer faces, just reframed as a question about shares rather than wages. Hiring an employee costs money (compensation), and employers will only hire if they expect the new employee to increase profit by a larger margin than they cost. As far as diluting shares for the purpose of voting: tenure-weighting helps balance the power of incoming employees so that hiring waves don’t create too much disruption.
Can we afford to make all these companies tax-exempt?
The tax exemption is offset directly by the community share. Citizens get 20% of the company exchange for the corporate tax exemption (which is currently 21%). Additionally, consider that many of the largest companies find ways to shield some or all of their profits from taxes through tactics like off-shoring. G-Corps structurally solve this loophole by replacing taxation with a direct profit share — if the investors are profiting, so are the rest of us.
Can the Treasury afford to offer reliable capital to all of these businesses?
Probably! The Treasury only directly provides capital to businesses that opt for a community share greater than 20%. This will be more likely in smaller businesses that aren’t already fully investor-owned. We could always implement an annual limit on Treasury purchases of community shares, but in my projections, investments by the Treasury would be well within our means. You can model this for yourself on the Giving America website.
How are worker shares paid for?
Giving up ~30% of the company’s shares to workers would be a real cost to founders/investors, so the investor class is compensated for it at a fair market valuation (calculated the same way the community share is). The shares would essentially be provided to workers as a loan, paid back over time with market-rate interest through worker dividends.
Here’s how it works. Let’s say a company worth $10 million, with 15 workers, converts to a G-Corp and the workers get a 30% share. That share is worth $3 million, which will be paid back to investors through the worker shares’ dividends over time.
If the company distributes $1 million in profit in the first year, $300k belongs to the workers. But before the worker payout happens, a portion — say, 80%, or $240k — goes to paying down the loan, so what is split between the company’s 15 workers is the other $60k.
Early payments mostly cover interest, so the $3 million loan amortizes slowly at first and accelerates as profits grow. As the loan balance declines over time, the share of the dividend that workers keep increases. Depending on the loan terms (which would be flexible around a baseline) and the company’s performance, it could take anywhere from 10-25 years to pay off the loan.
One nice side effect of this is that it encourages employee loyalty — coupled with tenure-weighted shares, the worker’s profit grows significantly over the time they stay at the company.
This structure is not novel — it’s a common funding structure for ESOPs (a type of retirement plan that relies on employee ownership), which cover millions of employees in the US, and Employee Ownership Trusts, which cover hundreds of thousands in the UK.
And to provide extra peace-of-mind to investors, the Treasury should guarantee these loans at 80% in the event of bankruptcy (or a sale that doesn’t cover the balance of the loan), through an FHA-style self-financed fee-based insurance program.
Why would an existing, successful business convert to a G-Corp?
The better question is: why wouldn’t they? The raw math is actually roughly break-even, and the social and regulatory benefits provide additional intangible value.
Three things happen to today’s shareholders when a company converts (say, at a 40/30/30 investor/worker/community split):
First, they trade the base 20% of shares to the community in exchange for the permanent tax exemption. A 21% tax on profits is economically equivalent to owning about 21% of the company’s equity, so shareholders are giving up 20 points to escape a 21-point claim — a slightly favorable trade (and even more favorable if you consider that this shields them from potential corporate tax increases by future administrations).
Second, the GAF buys any community shares above the base 20% (in this case, 10%) at fair market value. That isn’t a loss at all.
Third, the worker slice is essentially a loan from investors, paid for over time, with interest (see the Q&A entry above). This might cause some wistful reflection for investors if the company grows faster than the interest compounds (as it would if the company is successful), but that is strictly a winner’s problem. Plus, what is lost in upside risk is somewhat compensated in reduced downside risk by the Treasury guarantee. This essentially allows them to “lock in” the value of the company at the moment of conversion as a fixed, guaranteed income stream, while keeping the rest of their equity untouched.
Convert to G-Corp: (1 − .20)/(1 − .21) × V ≈ 1.01V
Stay as C-Corp, with return to 35% tax rate: (1 − .35)/(1 − .21) × V ≈ 0.82V
And this calculation doesn’t include the QSBS-style exemption on future appreciation, the Fund’s match on future raises, or the regulatory benefits.
But there are a few reasons existing businesses might not want to make the switch. Boards and executives might be skeptical, even if the shareholder math works out. Private, founder-owned businesses may not want to give up control. Corporations that are currently successfully dodging their taxes may see the tax-rate math a bit differently. Most importantly, it’s new, the transition would be onerous, and big businesses are conservative. Most would (fairly) want to wait and see how the new structure performs over time before committing to a corporate restructure.
Won’t everyone just maximize the share given to investors (40%), and minimize the share given to workers and the community?
On first blush, this may appear like the optimal strategy for the purely self-interested founder, but the reality is actually much more complex. There are incentives to maximizing the shares given to each group.
Since the Giving America Fund will reliably buy shares at a fair value with few strings attached, the founder who is optimizing for access to capital will likely want to allocate a small amount of shares to investors to set a favorable valuation, and then maximize the shares owned by the community (40% to community). In fact, because the Fund matches each raise in proportion to the split, a 40%/40%/20% community/worker/investor split would be optimal for aggressive growth — in this scenario, every dollar raised from investors would be doubled by the Fund’s match.
On the other hand, the self-interested founder who is optimizing for cash flow will want to offset wages with a strong employee share (40% to workers). Because the workers’ compensation includes the profit-sharing dividend, the higher the worker share, the less the employer has to spend on biweekly wages1. And when it comes to paying out worker dividends, the house always wins — the cost of the dividend is directly proportional to the success of the business. In this way, the dividend operates both as a cash-flow-friendly payment structure for the founder and a motivator for the employees. (Additionally, as long as the founder remains an employee and retains shares as an investor, they can personally double-dip in both the worker and investor shares.)
The only self-interested founder who is incentivized to optimize for investors is the risk-taker. This is the founder who would limit access to capital in order to keep as much of the founding shares for herself (taking advantage of her capital gains tax exemption), or who believes she can attract investors who will pay a much higher rate than the fair valuation she would get from the Giving America Fund.
In reality, I suspect most founders will be motivated a bit by all three of these factors, plus their intrinsic desire to be good to their workers and contributors to their community.
Okay, I get that the Giving America Fund isn’t communism, but surely this one is communism!
Still not communism! For a number of reasons.
First, the G-Corp designation is entirely optional; no one is forced to take it on. G-Corps compete on the free market with all other corporations.
Second, political leaders have almost no power over the community share. Community shares are owned by sovereign wealth funds, and are governed by direct democracy in the form of ballot measures. Political leaders do not have the authority to change the charters of their sovereign wealth funds, or to decide how they vote. Voting happens mechanically, and funds maintain lean staff. There is almost no discretion within this structure for governments to abuse.
Third, the community share may have strong opinions, but it does not direct company policy. Although it is owned by governments, it is structurally limited in a few ways. Perhaps most importantly, the funds would not have the power to initiate any votes. They are passive actors; they only respond mechanically to actions initiated by workers or investors. Additionally, with a maximum share of 40%, they would be structurally incapable of accomplishing any result on their own. Regardless of what is in the fund charter’s “rules,” a significant share of either the workers or investors would have to actively choose a business decision before it happens.
This point is really important. The government shouldn’t be able to muscle a company into anything — that’s how we get into worries about communism and authoritarianism. But with a G-Corp, what a (democratically-governed) sovereign wealth fund can do is throw its significant weight behind anyone within the worker or investor class who is concerned about, e.g., pollution or outrage-driven social media feeds. By voting a “FOR” or “AGAINST” line into the charter, citizens can basically put out a bat signal to anyone within a G-Corp who is willing to act on their behalf. I think this restores the company’s soul in a structurally-ideal way.
G-Corps aren’t communist, they’re contributist. No one is seizing the means of production here. Instead, ownership is balanced in a healthy tension between all who give to the company — investors, workers, and the community in which the company exists — and everyone is incentivized to make the company a profitable and successful contributor to the world.
Why G-Corp when Commonwealth Corporation starts with a C?
C-Corp was taken, and G is for Giving. Commonwealth Corporation is the official name because it captures the structure and gravitas of the designation for formal documents, while G-Corp remains the easy thing to say. But this is just a proposal, the name doesn’t have to stay.
But what about [insert concern here]?
There is, of course, much more to address, but not everything deserves space in this proposal. I believe the structure is sound; more implementation details will be hammered out in time. If you have additional thoughts or questions, post them in the comments and I’ll try to respond!
Economically, I expect this will operate something like employee stock options; some companies will offer a higher ownership share in exchange for a lower salary. There are meaningful differences, though — the worker share is a modest profit-share while you’re at the company, not a potential windfall for later. Also, “dollar for dollar,” salary is still more valuable than profit-share for a number of reasons (predictability, no potential for dilution), so it is unlikely that salaries will decline to offset the profit-share entirely.