The Wall Street Journal recently reported that xAI, the artificial intelligence startup founded by Elon Musk, has completed a $5 billion funding round at a pre-money valuation of $45 billion ($50 billion post-money). According to the Journal, Sequoia Capital, a16z and Valor Equity Partners participated in the funding round. We can hardly blame these Silicon Valley heavyweights for wanting to bet big on artificial intelligence and on Elon Musk’s track record of success. But one wonders whether, in their eagerness to do so, they have overlooked xAi’s corporate structure as a for-profit company, which allows it to pursue stated societal goals in addition to purely financial returns .
xAI’s structure as a for-profit company is notable, but far from unusual for an AI startup. xAI illustrates a growing trend of AI startups adopting governance frameworks that prioritize societal impact alongside profit. For example, Anthropic organized itself as a public benefit corporation with the stated goal of “the responsible development and maintenance of advanced AI for the long-term benefit of humanity.” Likewise, OpenAI has would have adopted plans restructure into a charitable society.
So why do AI startups like xAI adopt the for-profit company structure and investors overlook the risks?
What is a for-profit corporation?
A for-profit corporation is a legal structure that allows a business to pursue social and environmental goals in addition to profit. Unlike traditional corporations whose directors are bound by fiduciary duties aimed at maximizing shareholder value, for-profit corporations have a mandate to consider the interests of all stakeholders: employees, customers, communities and the environment. This dual-purpose framework is enshrined in a charity’s charter and is 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 good…(and is) managed so as to balance the pecuniary interests of shareholders, the best interests of those materially affected by the conduct of the corporation, and the public interest …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 that it wishes to promote.
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 profit corporation model particularly attractive to AI startups for several reasons.
AI systems wield tremendous influence, from shaping public opinion to making critical decisions in healthcare and justice. The for-profit corporate structure allows AI companies to integrate ethical principles into their operations.
With increasing scrutiny over potential misuses of AI, such as biases in algorithms and oversight issues, corporate benefit status signals to the public that a company is committed to “doing good.” It strengthens the trust of 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-focused investors are attracted to organizations that can generate both financial returns and demonstrable societal benefits. Structuring as a for-profit company provides a competitive advantage when it comes to recruiting talent and investors.
Governments around the world are adopting regulations intended to ensure that AI technologies are developed and deployed responsibly. By adopting a for-profit business model, AI startups are aligning with this regulatory trend by demonstrating their commitment to ethical AI governance.
What risks do charitable companies and their shareholders face?
Charitable corporations are required to produce a public good and balance the pecuniary interests of their shareholders, the interests of other stakeholders, and the public good identified by their charters. Consequently, they run the risk of not achieving their stated public interest objective or that the positive impact expected from being a public benefit company does not materialize. This in turn could have a negative effect on a charity’s reputation, which could negatively impact its operations and financial results.
Public benefit corporations are also required to publicly disclose their overall public benefit performance and assess whether they have achieved their identified public benefit objective. Charities run the risk of not reporting in a timely manner or being unable to provide the report at all. If a report is not viewed favorably by regulators, investors or others, a utility company’s reputation and status could be harmed.
Unlike traditional corporations whose directors have a fiduciary duty to focus exclusively on maximizing shareholder value, directors of charitable corporations have a fiduciary duty to consider not only maximizing shareholder value, but also the specific public interest of the company and the interests of other stakeholders. Therefore, benefit companies may take actions that they believe are in the best interest of the stakeholders affected by the company’s specific benefit objective, even if those actions do not maximize financial results. The pursuit of longer-term or non-pecuniary benefits may not materialize in the expected time frame, if at all, but may have an immediate negative effect on the amounts available for distributions to shareholders and result in a decline in the share price. the action.
Charitable corporations are less attractive takeover targets than traditional corporations would be, and opportunities for shareholders to realize their investment through an acquisition may be limited. Under Delaware law, for example, a charitable corporation cannot merge with another entity if the surviving entity’s charter “does not contain identical provisions identifying the public benefit(s)“, unless the transaction receives the approval of two-thirds of the outstanding voting shares of the target utility company. Public benefit corporations may also not be attractive targets for activists or hedge fund investors, as new directors would still need to consider and give appropriate weight to the public interest as well as value to the public. shareholders, and shareholders committed to the public interest can enforce this through derivative suits. It may also be more defensible for a charitable corporation’s board to reject a hostile offer, even when the takeover would bring the best short-term financial return to investors.
Unlike traditional corporate boards which must focus exclusively on shareholder value, charitable corporation directors are required to consider the stated public interest and the interests of other stakeholders. In the event of a conflict between the interests of shareholders and the interests of specific public interest or other stakeholders, there can be no assurance that such conflict will be resolved in favor of shareholders, which could have a material adverse effect on the business of the company and lower the share price.
Shareholders of a Delaware charitable corporation (if they own, individually or collectively, at least two percent of the outstanding shares) have the right to bring a derivative action claiming that the directors failed to balance the interests of shareholders and those of the public good. This potential liability does not exist for traditional companies. Such litigation could be costly and distract management.
Key to remember
The adoption of the profit corporation structure by AI startups like xAI signals a shift in business priorities, emphasizing long-term societal impact alongside financial returns. However, this innovative approach is not without risks. From increased accountability and reputational vulnerability to the risk of shareholder conflict, charitable corporations face unique challenges in balancing their dual missions. Yet as the AI industry grapples with profound ethical and societal questions, this model provides a governance framework that aligns company operations with broader public interests.
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