By Ryan Shaening Pokrasso
Social entrepreneurs are disruptive to both nonprofit and for-profit structures. By pursuing self-sustainable (i.e., revenue-generating) models, they challenge traditional thinking in the nonprofit world, and by solving social issues, they also challenge the traditional for-profit model. This often leaves entrepreneurs wondering what structure would be best for their venture. The choice to set up your venture as a for-profit, nonprofit, or some hybrid of the two largely depends on (1) your anticipated sources of funding and (2) your planned activities. Before making this important decision on how to structure your venture, you may want to take the following considerations into account.
How Hybrid Structures Work
When it comes to creating a hybrid structure for your venture, there are two options:
1 - PARENT-SUBSIDIARY. The first hybrid structure option is to have the for-profit be a subsidiary owned (in whole or in part) by the nonprofit. To do this, the nonprofit has to qualify as a “public charity,” which means that it must get most of its funding from public sources in order to satisfy the public support requirement. Note that you cannot have a for-profit own a nonprofit because there is no private ownership in a nonprofit.
2 - BROTHER-SISTER. You can also have the nonprofit and for-profit be entirely separate entities that work together.
Under either structure, as a general rule, money can flow from the for-profit to the nonprofit, but not from the nonprofit to the for-profit (except as specified below). The for-profit entity can donate money to the nonprofit (lowering its tax liability by up to 10 percent of its net income), but because all assets of a nonprofit must be permanently dedicated to charitable causes, a nonprofit cannot give away its funds to the for-profit.
However, the nonprofit can purchase goods and services from the for-profit at reasonable rates as long as the proper formalities are followed. For example, when a nonprofit purchases a for-profit’s services, the board of the nonprofit must be fully informed of the terms of the purchase (which must be at or below market rate), and none of the board members with an interest in the for-profit may participate in the board’s decision to approve the transaction. For this reason, the board of the nonprofit must not be identical to the group of decision-makers in the for-profit.
While the hybrid structure is sometimes tricky to navigate, it can offer social entrepreneurs the best of both worlds: the advantages of both nonprofit and for-profit organizations. No matter which structure you choose, it is important to understand the advantages and disadvantages of each option and make thoughtful decisions to set up your venture in a way that serves your unique goals.
Ryan Shaening Pokrasso is an attorney who founded Elevate Law & Strategy in the San Francisco Bay Area to assist entrepreneurs using business as a tool for social change and environmental stewardship. Ryan advises for-profit and nonprofit businesses as general counsel on matters ranging from entity formation and financing to intellectual property.