Structuring Nonprofit Businesses:Hybrid, Subsidiaries, Joint Ventures, and Other Options

Brian Howe

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Brian HoweAttorney,

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Structural Options for

Nonprofits Running

Businesses

Brian Howe

Attorney, Vox Legal

5

Guiding Principle:

Implement best legal

structure to support the

mission, not the other

way around.

New Joint

Venture

tax-exemptIndependent

For-Profit

6

Option #1: Joint Venture

Limitations:

Must maintain control over

aspects related to tax exempt

mission.

Must be small in comparison to

overall activity

Option Advantages

“Controlled”

CorporationNonprofit owns 50% of for-profit or

more

Retains control but allows for outside

input (unless wholly-owned)

Option to consolidate tax returns of

multiple subsidiaries in holding company

“Non-Majority”

OwnershipNonprofit owns 50% of for-profit or

less

Create maximum options for input

(entrepreneur, employees, communities),

while retaining some voice

Parent nonprofit not taxed on some

payments received from subsidiary

Parent nonprofit may avoid criticism for

any controversial decision of for-profit

JOINT VENTURE: CONTROL OPTIONS

8

Option #2: Maximize Business

activities within existing nonprofit

Tax-Exempt

Organization

Business Activities

Business activities conducted

within non-profit corporation:

If related to exempt purpose,

no income tax on net profits

If unrelated to exempt purpose

(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.

Option Advantages

“Not-for-Profit” with

Related Business

Activity

Access to grants and subsidies

Related business has no size constraints

No income tax liability

Less controversy

Appeal to entrepreneurially-spirited

volunteers

10

Option #3: Create a subsidiary

for-profit company

Tax-exempt

Organization

For-profit Subsidiary

Advantages

Liability: Protects nonprofit assets

from debts of business (and vice-versa)

Tax-free Dividends: Parent non-

profit can receive tax-free income from

subsidiary in the form of dividends

(although dividends are not also

deductible by 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.

Option Advantages

“For Profit” with

Unrelated Business

Activity

Write-off losses

Access to capital

Access to entrepreneurs

Access to jobs, image, and responsibility

More freedom for operations

Option Advantages

No SeparationRun for-profit as subsidiary of

Nonprofit

Management and control

Organizational and staff development

Safeguard community purposes

Shield from an uncertain market

Lowers start up costs

SeparationRun for-profit as separate entity

from Nonprofit

Focused purpose—less confusion

Inspires confidence

Access to capital and human resources

No tax exemption issues

Protects parent organization from liability

SEPARATION DECISION OPTIONS & RELATED ADVANTAGES

Option #4: Create a Contract Hybrid

Independent

For-Profit Non-ProfitContracts

Option #4: Governing Principles of a Contract Hybrid

Independent

For-Profit Nonprofit(1) Independent majorities on

each board

(2) Tied together with contracts

negotiated at arm’s length

(3) If for-profit uses non-profit

assets, nonprofit must receive

fair value

(4) Boards independently review

and approve everything

(5) Benefits to for-profit must be

necessary, indirect, and

insubstantial

Contracts

For-profit should

conduct all

unrelated business

activities.

Option #4: Risks of a Contract Hybrid

Independent

For-Profit Nonprofit(1) Reporting requirements on

the New Form 990 may

result in more intense

scrutiny

(2) No IRS official recognition

Contracts

Option #4: Benefits of a Contract Hybrid

Independent

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

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Option #4: Business Advantages of Hybrid Social Enterprise

Separate

For-Profit

In-Kind Equity

Consulting

Brand

Market Access

Brand

Consulting

Nonprofit

Intellectual Property

R&D

Marketing

Profit Sharing

Liquidity Events

Investor Guarantees

18

Option #4: Hybrid Investment Strategies

Hybrid Social Enterprise

Entities Nonprofit

Investors

Independent

For-Profit

Foundations:

* Social Loans (PRI)

Social Venture Funds:

* Social Loans

Social Investors:

* Grants

Foundations:

* Grants

Banks:

* Commercial Loans

* Equity

Social Investors:

* Equity

Foundations:

* Mission Related Equity

*Slide based on 2006 copyrighted material of Charly Kleissner

Purely Philanthropic Hybrid Purely commercial

Type of Organization

Traditional NGO Contractual

arrangement between

NGO & business

Traditional for-profit

Motives Appeal to goodwill

Mixed motives

Appeal to self-interest

Methods Mission-driven

Balance of mission and

market

Market-driven

Goals Social value creation Social and economic

value creation

Economic value

creation

Destination of Income/Profit

Directed toward

mission activities of

NGO (required by law

or organizational policy)

Reinvested in mission

activities or operational

expenses, and/or

retained for business

growth and

development

Distributed to

shareholders and

owners

Option #4: Analysis of a hybrid

Nonprofit

Option #5: Convert to for-profit

Different

non-profit org

Independent

For-Profit

Operations

Assets & FMV of saleState

$Independent

For-Profit

Nonprofit

Private

FoundationRisks:

-IRS finding of self-dealing

-IRS finding of excess

private benefit

Option #6: Create a for-profit and convert

non-profit to private foundation

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Social Venture Limitations:

1. Profitability is not guaranteed

2. A venture may clash with your culture or

values

3. Ventures may generate unfavorable

publicity

Option #7: Creating a

Legislative Advocacy Group

Nonprofit(1) Allows for political and

legislative lobbying

(2) Can be used with any previous

combination of structures

501(C)(4)

Option #8: Changing Exempt

Purpose and Launching a For-Profit

Charitable Nonprofit

Educational Org

For-Profit

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