Choosing the Right Model for Your Nonprofit, For-Profit Hybrid Business Venture
Non-profit, For-profit Ventures
Today’s social enterprise often combines elements of for-profit and non-profit ventures. In addition to commercial activities, the enterprise may conduct or finance charitable activities designed to have a positive impact on society or the environment. Most of its activities will probably be expected to generate profits, but some will be designed or intended to generate social impact or to benefit stakeholders rather than shareholders. In fields like health care, education, media, and technology, the ability to deploy both invested and philanthropic capital and to generate earned and donated revenues simultaneously can be a huge advantage.
Unfortunately, U.S. law does not currently permit a single entity to accept tax-deductible donations (charitable contributions and grants); invested capital (equity investment for which investors seek a market return); and quasi-invested capital (such as program-related investments from foundations that are structured as investments but are made primarily to further mission rather than to generate a financial return.) Charities can issue debt but not equity, while businesses can issue equity but cannot take tax-deductible contributions, at least not directly. As a result, social entrepreneurs are often forced to choose between for-profit and nonprofit legal structures in ways that compromise their social vision, restrict their ability to finance and operate their ventures, and ultimately make it harder to meet their own needs as well as those of their investors, customers, employees, and other stakeholders.
Hybrid Structures for Nonprofit and For-profit Business Models
To address this dilemma, Bromberger Law has pioneered the use of “tandem” hybrid structures. Tandem structures combine nonprofit and for-profit entities through legal arrangements that bind them together, using governance structures or contracts that enable them to operate with a high degree of cooperation and coordination.
The simplest type of tandem structure is the parent/subsidiary arrangement. This can be a non-profit subsidiary of a business (i.e., a corporate foundation), or a for-profit subsidiary of a charity (i.e., a museum parking garage). The key feature is that one of the entities owns or controls the other. They are not equals, and generally, their operations and finances are kept separate. This is by far the most common and simplest type of hybrid arrangement.
Another common type of tandem structure is the joint venture, where two or more partners create a new, third entity to operate a venture. The partners share the risks and rewards of that venture but are otherwise separate and independent of each other. Joint ventures are especially useful when two established entities come together to conduct some joint activity that serves their mutual interests. They are very common in health care and education, for example. However, because of special IRS rules on the financing and governance of joint ventures involving charities, there are many situations where a joint venture has to be structured in a way that is less than ideal or will not work. In those situations, we use a “contract” hybrid.
A contract hybrid ties two or more entities together with a specialized agreement that regulates their interactions, allocates costs and resources in accordance with IRS rules, and provides for shared decision-making and dispute resolution. These agreements can also provide for stakeholder participation, can obligate the parties to operate according to certain principles or values, and can include other legal obligations that the parties find necessary or useful. A recent innovation involves using a “management” company to coordinate and manage the hybrid under contract to the partners, which is more work to set up but eliminates many problems that might otherwise occur as the venture develops.
Our Approach to Hybrid Structures
Hybrids can be complicated to create and maintain, and they don’t work in all situations. In situations where a nonprofit or a business can accomplish its goals without the need for a hybrid legal structure (for example, where a business can accomplish its social goals by making donations, or a charity can establish a business venture using a subsidiary that does not require outside investors), those approaches may be preferable.
At Bromberger Law, we work closely with our clients to understand their business plans and provide advice regarding the best structure to accomplish their goals – whether that is a single entity or a hybrid structure. We then help our clients through the process of setting up their social enterprise by forming nonprofit corporations, benefit corporations, LLCs, and other business entities. We provide advice on governance matters, prepare the necessary contracts to document the relationships between the entities in a hybrid structure and provide ongoing advice regarding financing and operations.