Structuring Nonprofit Businesses

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Tax-exempt organizations are entering into business arenas traditionally held captive by taxable commercial entities. Exempt organizations are becoming more entrepreneurial, but without proper advice there is a risk of nonprofits losing their exempt status or being excessively taxed. This webinar will provide an overview of options for new structures (joint ventures, hybrids, for-profit subsidiaries, etc.) and a discussion of issues stemming from related/unrelated business activities.

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Structuring Nonprofit Businesses

  1. 1. Structuring Nonprofit Businesses:Hybrid, Subsidiaries, Joint Ventures, and Other Options Brian Howe Special Thanks To Our Sponsors
  2. 2. Helping ordinary people raise extraordinary amounts for nonprofits is all we do, and we love it. A Proud Sponsor of NonprofitWebinars.com
  3. 3. Today’s Speaker Brian Howe Attorney, Vox Legal, PLLC Hosting: Assisting with chat questions:Sam Frank, Synthesis Partnership April Hunt, Nonprofit Webinars
  4. 4. Structural Options for Nonprofits Running Businesses Brian Howe Attorney, Vox Legal
  5. 5. Guiding Principle: Implement best legalstructure to support the mission, not the other way around. 5
  6. 6. 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
  7. 7. 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
  8. 8. 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
  9. 9. 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
  10. 10. 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 non- profit 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
  11. 11. 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
  12. 12. 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
  13. 13. Option #4: Create a Contract HybridIndependent For-Profit Contracts Non-Profit
  14. 14. 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
  15. 15. 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
  16. 16. 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
  17. 17. 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
  18. 18. 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
  19. 19. 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
  20. 20. Option #5: Convert to for-profit Nonprofit Different State Assets & FMV of sale non-profit org Operations Independent For-Profit
  21. 21. 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
  22. 22. Social Venture Limitations:1. Profitability is not guaranteed2. A venture may clash with your culture or values3. Ventures may generate unfavorable publicity 22
  23. 23. 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)
  24. 24. Option #8: Changing ExemptPurpose and Launching a For-Profit Charitable Nonprofit  Educational Org For-Profit
  25. 25. Find the listings for our current season of webinars and register at NonprofitWebinars.com Chris Dumas Chris@NonprofitWebinars.com 707-812-1234 Special Thanks To Our Sponsors

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