Structuring Nonprofit Businesses

Structuring Nonprofit Businesses:Hybrid, Subsidiaries, Joint Ventures, and Other Options Brian Howe Special Thanks To Our Sponsors

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Structural Options for Nonprofits Running Businesses Brian Howe Attorney, Vox Legal

Guiding Principle: Implement best legalstructure to support the mission, not the other way around. 5

Option #1: Joint Venture Independent tax-exempt For-Profit Limitations:Must maintain control overaspects related to tax exempt Newmission. JointMust be small in comparison tooverall activity Venture 6

JOINT VENTURE: CONTROL OPTIONSOption Advantages Retains control but allows for outside“Controlled” input (unless wholly-owned) Option to consolidate tax returns ofCorporation multiple subsidiaries in holding companyNonprofit owns 50% of for-profit ormore Create maximum options for input“Non-Majority” (entrepreneur, employees, communities), while retaining some voiceOwnership Parent nonprofit not taxed on someNonprofit owns 50% of for-profit or payments received from subsidiaryless Parent nonprofit may avoid criticism for any controversial decision of for-profit

Option #2: Maximize Businessactivities within existing nonprofit Business activities conducted within non-profit corporation: Tax-Exempt Organization If related to exempt purpose, no income tax on net profits Business If unrelated to exempt purpose Activities (UBI), nonprofit will have to pay income tax on net profits and if business activities grow beyond a small part of overall activities then nonprofit may lose exempt status. 8

Option Advantages Access to grants and subsidies“Not-for-Profit” with Related business has no size constraintsRelated Business No income tax liabilityActivity Less controversy Appeal to entrepreneurially-spirited volunteers

Option #3: Create a subsidiary for-profit company Advantages Liability: Protects nonprofit assets from debts of business (and vice-versa) Tax-exempt Tax-free Dividends: Parent nonprofit can receive tax-free income from Organization subsidiary in the form of dividends (although dividends are not also deductible by subsidiary). For-profit Subsidiary Disadvantages Income subject to UBIT: Royalties, rents, and interest from “controlled” subsidiary are subject to UBIT. Start-up/ongoing costs: more expensive to run two corporations. 10

Option Advantages Write-off losses“For Profit” with Access to capitalUnrelated Business Access to entrepreneurs Access to jobs, image, and responsibilityActivity More freedom for operations

SEPARATION DECISION OPTIONS & RELATED ADVANTAGESOption Advantages Management and controlNo Separation Organizational and staff developmentRun for-profit as subsidiary of Safeguard community purposesNonprofit Shield from an uncertain market Lowers start up costs Focused purpose—less confusionSeparationRun for-profit as separate entity Inspires confidencefrom Nonprofit Access to capital and human resources No tax exemption issues Protects parent organization from liability

Option #4: Create a Contract HybridIndependent For-Profit Contracts Non-Profit

Option #4: Governing Principles of a Contract Hybrid Independent For-Profit Contracts Nonprofit (1) Independent majorities on each board (2) Tied together with contracts For-profit should negotiated at arm’s length conduct all (3) If for-profit uses non-profit unrelated business assets, nonprofit must receive activities. fair value (4) Boards independently review and approve everything (5) Benefits to for-profit must be necessary, indirect, and insubstantial

Option #4: Risks of a Contract HybridIndependent For-Profit Contracts Nonprofit (1) Reporting requirements on the New Form 990 may result in more intense scrutiny (2) No IRS official recognition

Option #4: Benefits of a Contract HybridIndependent For-Profit Nonprofit Benefits: (1) If structured carefully, Contract Hybrid can avoid much UBIT liability (2) Contract Hybrid allows nonprofit’s officers and directors to invest in for-profit (3) Payments from for-profit to nonprofit can be deducted or written off as expense

Option #4: Business Advantages of Hybrid Social Enterprise In-Kind Equity Consulting Profit Sharing Brand Liquidity Events Investor Guarantees Nonprofit Separate For-Profit Intellectual Property Market Access R&D Brand Marketing Consulting 17

Option #4: Hybrid Investment StrategiesInvestors Banks: * Commercial Loans * Equity Social Investors: Foundations: Social Investors: * Equity * Social Loans (PRI) * Grants Foundations: Social Venture Funds: Foundations: * Mission Related Equity * Social Loans * Grants IndependentEntities Nonprofit For-Profit Hybrid Social Enterprise 18 *Slide based on 2006 copyrighted material of Charly Kleissner

Option #4: Analysis of a hybrid Purely Philanthropic Hybrid Purely commercial Type of Traditional NGO Contractual Traditional for-profitOrganization arrangement between NGO & business Motives Appeal to goodwill Appeal to self-interest Mixed motives Methods Mission-driven Market-driven Balance of mission and market Goals Social value creation Social and economic Economic value value creation creationDestination of Directed toward Reinvested in mission Distributed toIncome/Profit mission activities of activities or operational shareholders and NGO (required by law expenses, and/or owners or organizational policy) retained for business growth and development

Option #5: Convert to for-profit Nonprofit Different State Assets & FMV of sale non-profit org Operations Independent For-Profit

Option #6: Create a for-profit and convertnon-profit to private foundation Nonprofit Independent For-Profit $ Risks: Private -IRS finding of self-dealing -IRS finding of excess Foundation private benefit

Social Venture Limitations:1. Profitability is not guaranteed2. A venture may clash with your culture or values3. Ventures may generate unfavorable publicity 22

Option #7: Creating a Legislative Advocacy Group(1) Allows for political and legislative lobbying(2) Can be used with any previous Nonprofit combination of structures 501(C)(4)

Option #8: Changing ExemptPurpose and Launching a For-Profit Charitable Nonprofit  Educational Org For-Profit

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Structuring Nonprofit Businesses

by NonprofitWebinars.com on Apr 13, 2011

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Structuring Nonprofit Businesses — Presentation Transcript