MIXING IT UP: ESTABLISHING A NON-PROFIT PARENT TO OWN A FOR-PROFIT SUBSIDIARY
As we’ve discussed in previous blog posts, Steward Ownership can take many forms, such as Perpetual Purpose Trusts, Employee Ownership Trusts, Cooperatives and Golden Share Models. In some situations, however, a founder may find that operating their company as a subsidiary of a non-profit charity/foundation is the best way to deliver on their mission and purpose over time.
This option might be particularly attractive to founders whose primary objective is to seek to benefit some charitable purpose exempted under the IRS (e.g. public education, scientific research, poverty alleviation, human rights, etc. ), but they find that commercial revenue-generating activities are the best way to support that cause.
Both nonprofit public charities and private foundations designated by the IRS as 501(c)(3) can own for-profit entities (C corporation, S corporation or LLC) as subsidiaries. The business itself may or may not advance the nonprofit’s purposes through its operations, products or services, however the value of the business assets and/or its profits can be distributed to the nonprofit, which can in turn deploy them to advance its charitable mission.
For example:
The Mozilla Foundation has a mission to improve and protect the Internet as a public commons, ensuring it remains accessible to all. Mozilla Corporation, a wholly owned for-profit subsidiary of the Foundation, makes consumer Internet products such as the web-browser Firefox that advance the same values outlined by the charitable mission.
The Newman’s Own Foundation has given away more than $500M towards its mission to “use the power of giving to help transform lives and nourish the common good” with the focus areas of encouraging philanthropy, supporting equity and human rights initiatives, children with life limiting conditions, and food access for underserved communities. The Newman’s Own Inc, is a for-profit brand of everyday grocery products and pet foods.
How does governance work?
The nonprofit will have its own Charitable Board which is responsible for distributing dividends generated by the company to causes aligned with the charity’s purpose.
The subsidiary for-profit will have a Corporate Board that act as “stewards” at the company level, responsible for overseeing the performance and operations to ensure it is viable, delivers results to fulfill its obligations (to other investors and other stakeholders) and continues to generate distributions that can be used to further the purpose through the foundation.
In alignment with steward ownership principles, the for-profit subsidiary should have clear language written into its incorporating documents that specify its commitments to purpose.
What are the advantages of a nonprofit owning a for-profit subsidiary?
a. Allowing business activities beyond those that are clearly charitable
Nonprofits that are dependent on donations often lack security in their income stream. By engaging in revenue-generating activities, these entities can create self-sustaining income. However, IRS rules strictly limit the amount of business income a nonprofit can derive from revenue generating activities that are unrelated to the performance of the organization’s tax-exempt (e.g., charitable) functions. Establishing a for-profit subsidiary allows the opportunity to pursue a wider range of revenue generating activities.
b. Attracting investors
In addition to the nonprofit providing initial capitalization of the company, the subsidiary can raise money by offering equity to outside investors who are seeking an economic return. This can supplement those funders who are willing to donate to the nonprofit parent, increasing it’s resiliency. The equity investments can be structured as a non-voting preferred stock with dividends, or as a total obligation to pay back the investor (e.g. 1-3X the original investment) over time.
c. Rewarding other stakeholders
The for-profit company might also further the charitable purpose and/or improve business performance by sharing a portion of the profits with other stakeholders including employees, suppliers, customers, or community in addition to the nonprofit parent. These types of profit distributions can be done at the subsidiary level as part of compensation or a rebate policy.
What are the disadvantages?
a. Added cost and complexity
The administrative costs and complexity of establishing and maintaining two entities with separate Boards, assets (bank accounts, property), accounting and legal requirements can be burdensome. For example, if the two entities share office space there needs to be a formal agreement to “rent” it at fair market value.
b. Maintaining alignment
Since the nonprofit holds all or the majority of ownership in the for-profit, it has control in appointing its Board. It is therefore important that the two organizations have cultural and goal alignment. One strategy to ensure this might be having subsidiary staff or leadership participate in the parent as Board members or officers. While some overlap may be permissible, there is a risk of blurring the lines around whose interest the individual is representing, especially when it comes to transactions between the entities.
Why would a founder choose Foundation ownership over Purpose Trust ownership?
A purpose trust is a type of trust which has no beneficiaries, it instead exists for advancing a non-charitable purpose of some kind through the assets it holds. When a purpose trust owns a for-profit business, the profits are typically distributed at the company-level for non-charitable activities that advance the purpose (e.g. in an employee focused purpose trust, all the excess profits go to employees as additional compensation). In a situation where benefiting a charitable cause is planned as the primary activity to which business profits will be directed, Foundation ownership could be a better choice.
