Why Patagonia Is a Game Changer—a New Legal Model
Yvon Chouinard, founder and majority owner of Patagonia, Inc, recently announced that he transferred the entirety of the company’s voting shares into the Patagonia Perpetual Trust, a “purposes trust” dedicated to combating climate change and preserving undeveloped land. The trust will appoint the company’s board going forward. The company’s profits of roughly $100 million per year will be paid to a separate 501(c)(4) nonprofit, which now holds 100% of the company’s non-voting shares. The nonprofit Holdfast Collective is required by its charter to use the funds to “fight the environmental crisis and defend nature.” According to its press release, “every dollar that is not reinvested back into Patagonia will be distributed as dividends to protect the planet.”
Why is this significant?
Patagonia is a certified B Corporation and already gives one percent of sales each year to grassroots environmental activists. The innovative structure allows the company to allocate all of its profits to environmental causes. It is an excellent example of a “steward ownership” model and a game changer for the social enterprise movement for two reasons. First, it changes the company’s very reason for existing, from an enterprise whose primary purpose is to make money for shareholders, into one whose primary purpose is to protect the planet. Secondly, the structure takes the ultimate authority over the company’s future direction and priorities away from personally-motivated parties and places them in the hands of trustees who are duty-bound to place the stated purposes of the trust above anyone’s personal interests, including their own. By separating governance rights from economic rights and placing the directors under an affirmative fiduciary duty to give priority to environmental protection, the incentives have also been changed: instead of running the company to maximize profits, the managers can now be incentivized to accomplish the dual goals of making reasonable profits (for economic sustainability) and managing the company in a socially and environmentally responsible manner (in this case, to satisfy the requirements of the trust). The profits, meanwhile, will be directed to a tax-exempt non-charitable entity that can use them to fund environmental and other initiatives, including political initiatives, supported by the family and the company.
Who controls the trust and the company?
It is unclear from news reports exactly how the trust is governed, but it appears the family has control of the trust. By controlling the trust, the family indirectly controls the company. The trust has said the company’s leadership, including its board and CEO, will not change.
Who owns the company, and who gets the profits?
The company is now owned by two classes of shareholders: 2% of the stock is voting stock owned by the trust. The other 98% is non-voting stock owned by the nonprofit, with the right to receive all of the company’s profits in the form of dividends. Dividends are declared by the board, which is appointed by the trust, not the nonprofit. As noted above, the nonprofit can use the funds in any way it sees fit, including for political purposes.
How do the taxes work?
The family has made two large gifts. The first gift consists of voting stock given to the trust, which will generate a capital gains tax liability of roughly $17.5 million, since the trust is not tax-exempt. The other gift consists of the non-voting stock given to the 501(c)(4) organization, which is not taxable (no gift tax or capital gains tax). However, because the nonprofit is tax-exempt under Section 501(c)(4) of the Internal Revenue Code, not Section 501(c)(3), the gift is not treated as a charitable contribution and is not tax-deductible. The company made an initial $50 million donation to the Holdfast Collective in 2021 and plans to give another $100 million in 2022. These gifts are also not tax-deductible as charitable contributions because Holdfast is not a charity, but they may be at least partially deductible as a business or marketing expense of the company. The company will pay taxes on its income going forward, as will the trust. The nonprofit will not have to pay taxes on the profits it receives.
In a similar move, Barre Seid, a Chicago entrepreneur, recently donated 100% of the shares of his company Tripp Lite, an electronics manufacturer worth approximately $1.6 billion, to a 501(c)(4) nonprofit called the Marble Freedom Trust (which immediately sold the shares in a prearranged sale, avoiding capital gains tax). Like the Holdfast Collective, the nonprofit is a 501(c)(4) organization, not a charity, that will use the funds to carry out the founder’s agenda, including political activity. However, unlike the Patagonia case, the company’s purpose, its activities, and its managers’ incentive to maximize profits are unaffected by the arrangement. So it’s basically a tax transaction, which is not uncommon in the philanthropy world. Also, the Marble board is controlled by a political operative who is also paid by the organization, so—unlike with Patagonia—there are no safeguards against misuse of the funds.