Nonprofit Subsidiary of a For-Profit Company
November 5, 2010 11:48 AM   Subscribe

How much control can a for-profit company exert over a nonprofit subsidiary delivering human services? Is this arrangement legit?

Not asking about a nonprofit foundation but an organization delivering child welfare services like a group home.
posted by jmf2525 to Law & Government (12 answers total) 1 user marked this as a favorite
You might need to be a bit more clear about the example in particular.

In the case of privatized systems, like juvenile welfare, in a sense, quite a bit of control? But it is all written into the contracts that guide the arrangements of between the funding body and the private company. When you ask "is the arrangement legit," do you mean via the execution of the programs by a for-profit company?

But when you say "not a foundation" though, what do you mean? Do you mean 501(c)(3) or do you mean government agency? And are you referring to the U.S. or other countries?
posted by RJ Reynolds at 11:57 AM on November 5, 2010

A for-profit company that, in order to pursue state funding available for child welfare programs, creates or absorbs a existing 5.01(c)(3) such as one that runs group homes for adolescents. No state involvement other than as funder and licensing body.

I'd assumed that the nonprofit's Board had to be fully independent of the parent company's Board by nature of its responsibility to uphold the public trust, and to maintain its tax-exempt status.
posted by jmf2525 at 12:40 PM on November 5, 2010

IANAA, but it would seem the main test would be whether the "non-profit subsidiary" is returning revenues back to the for-profit company. If they ARE, then something isn't going to be kosher.

For-profit enterprises are frequently closely associated with non-profits. For example, the card companies collectively own the PCI Security Standards Council. I'm not sure of the fiscal structure of this organization, but I wouldn't be surprised if they aren't styled as a non-profit. Non-profit /= charity.
posted by randomkeystrike at 12:42 PM on November 5, 2010

Tax-exempt entities cannot be owned by anyone but their members. As soon as this entity was acquired/absorbed by a for-profit entity the tax exemption disappears.

See here for a more detailed discussion.

A for-profit can name all the board members of a non-profit, but this is not the same thing as owning the non-profit. In no case may any of the benefits of the non-profit pass in any way to the for-profit.

But it really sounds like what you need is an extended sit-down with a non-profit attorney in your jurisdiction. I am a lawyer, so I'm pretty confident in telling you the above to get you started, but I'm not your lawyer--and even if I were, I wouldn't do this for free.

Tl;dr version: this is a mess, and you need your own lawyer.
posted by valkyryn at 12:48 PM on November 5, 2010

IANAL, but I do have an M.S. in Nonprofit Management, so...

It makes a difference whether the for-profit company creates versus absorbs the 501(c)3.

If they create it themselves, that's actually pretty common. Lots of corporations have nonprofit subsidiaries which do exclusively charitable work. The 501(c)3 usually has one or two token corporate board members, with the rest others. Overlap is common, but it's never 100%. It's more rare for a corporate entity's nonprofit subsidiary to actually provide services (programs), but it happens.

If a corporation subsumes a nonprofit, there's the question of where the nonprofit ends and the shareholders/for-profit begins. This is less common. There's also the question of the subsuming, generally: did the nonprofit fold and the corporation take over operations? Did the nonprofit agree to their new corporate overlords, retain their jobs, and just take paychecks from a new owner? What do the shareholders do here?

As for the whole "they did the nonprofit thing so they could have access to state money," which seems to be the crux of your question... In a general sense, it's totally okay for a corporation to have a nonprofit arm, as long as they money doesn't move between the corporate and the nonprofit accounts all willy-nilly. Most corporations that have nonprofit subsidiaries fund the nonprofit with money from the company. It cannot go the other way; the nonprofit's revenue from government funding and contracting cannot go into the company. The books must be separate.

You seem concerned that the corporation just created this nonprofit thing in order to cash in on state funding. Believe me, if the money moves the wrong way, the corporation will be in a world of IRS hurt. If they're already doing this and you know it to be true, you have the right and the responsibility to be a whistleblower to the IRS.
posted by juniperesque at 12:50 PM on November 5, 2010

on refresh - arrangement sounds much like I described it, but what's in it for the for-profit company if they have to be a 5.01c3 to bid on the services? Odd.

For-profit companies also provide gov't services, including social services, of course. My brother works for a company that administers the entire Medicaid program for my state.
posted by randomkeystrike at 12:52 PM on November 5, 2010

on refreshx2, much more informed minds than mine have weighed in. I'll go hide now. :-)
posted by randomkeystrike at 12:54 PM on November 5, 2010

Nonprofits / charitable organizations are frequently linked to for-profit companies. The for-profit companies often provide funding and resources and gain tangible business benefits from the arrangement.

The way most nonprofits are structured, there are employees and there is the Board of Directors / Trustees. (Some nonprofits also have voting or nonvoting "members" that play a role in governance.) In a vaccum, there is no set requirement that members of the Board, the Executive Committee, or other categories of employees be separate from a for-profit company providing the majority of funding or otherwise entering into contracts with the 501(c)(3). So -- again, in a vaccum -- it could be legally permissible for the CFO of the nonprofit to be the CFO of the for-profit corporation, or for the entire Board of Directors to overlap (although there are other pitfalls issues with 100% overlap).

Likewise, through some sort of "management services agreement", the nonprofit may wind up paying the for-profit entity to provide services (such as accounting, IT, facilities, etc.).

In the charter documents of the 501(c)(3), there may be requirements regarding the membership of the Board of Directors -- i.e., that a certain percentage be regarded as "outside" directors. Likewise, in some grant applications, various affiliations of the 501(c)(3)'s directors and executives is a part must be disclosed.

Depending on how the organizations are set up (and what representations they've made as part of their grantwriting and otherwise), it's probably permissible for employees/executives of the for-profit organization to have a great deal of say in the day-to-day activities of the way the 501(c)(3) conducts its charitable programs. It might be an open question whether under this system the 501(c)(3) compares favorably against others (in terms of expense versus program ratios, etc.) and whether or not that's important to anyone.

If money is flowing from the 501(c)(3) to the parent company (via a management services fee or other contractual relationships), the reasonableness of those fees may be scrutinized by auditors. Lopsided fees sucking up a big portion of the 501(c)(3)'s funds would certainly show up on Form 990, but if there aren't any other donors this may fly under the radar.

In various litigation scenarios, the linked organizations may have "alter ego" issues, where a litigant might argue that the 501(c)(3) is an "alter ego" of the controlling for-profit company. The extent to which this argument would succeed is very fact-specific, and would depend on (among other things) how intermingled the two companies really are.

tl; dr -- if you are contemplating a whistleblowing scenario, make sure you understand that this is could be a complicated scenario and that some forms of "control" are entirely legitimate.
posted by QuantumMeruit at 2:04 PM on November 5, 2010

In this case the for-profit is based out-of-state and provides adoption services. The nonprofit also provides adoption services and was going to shut down to funding problems. The for-profit floated it a large loan to keep it in business and took over managment of the org. The two entities share a Board.

Any guidance as to what questions to ask up front that will get at the legitimacy of an arrangement such as this one?
posted by jmf2525 at 2:10 PM on November 5, 2010

Any guidance as to what questions to ask up front that will get at the legitimacy of an arrangement such as this one?

No, because we still don't really know enough facts, and I'm under the distinct impression that you may not either. We're talking about the arcana of business associations and the tax code here.

You. Need. To. Talk. To. Your. Own. Lawyer.

You'll want to talk to him about the mechanics of preserving your entity's tax-exempt status while somehow being related to a for-profit entity, but really, you've gotten everything that AskMe can give you.
posted by valkyryn at 2:53 PM on November 5, 2010

You are right, I'm not presenting enough facts because my question really is generic.

A variety of organizations apply to our organization for services and I'm trying to determine if there is any way for us to establish some basic criteria for our staff to use when presented with these out-of-the ordinary business structures. We can't afford to run them all by our attorneys. The solution is probably that we require applicants to present us with a legal opinion that their structure is OK with the IRS.

Thanks for the feedback!
posted by jmf2525 at 3:18 PM on November 5, 2010

You need to sit down and talk with your company's lawyer and/or folks on the business side who are more experienced with the type of issues you're concerned with.

Your original question ("is this legit") is unanswerable, and even if it were answerable with certainty, a hypothetical response of "yes, this is legit (under IRS guidelines, etc.)" would be only one facet of the overall picture in "should we do business with these types of interrelated entities".

If the nonprofit in question is violating IRS guidelines relating to 501(c)(3) entities, or if the requisite corporate formalities are not being followed between the for-profit entity which is lending money and the 501(c)(3) which received the money, so what? If you are providing SERVICES to these entities, it sounds like you need to make a creditworthiness call. The soundness of the underlying corporate structure is only one of a number of factors which should probably be considered. (Conversely, an opinion letter that says that the entity in question is a legitimate 501(c)(3) doesn't really answer questions about creditworthiness; an entity can have all its corporate formalities and accounting docs in a row but be totally insolvent and on the verge of liquidation.)

Besides corporate structure, other factors to be considered might include your negotiating leverage in obtaining guarantees from the "parent" for-profit entity, or other acceptable collateral, not to mention your company's willingness to engage in any sort of collections litigation should things go south.

So it may very well be that the underlying corporate structure is crap and the 501(c)(3) is about to have its charitable status revoked by the IRS -- but it may still be a sound business decision to enter into a contract with that entity if there is adequate collateral or an enforceable payment guarantee from the (solvent) for-profit entity.

IT ALL DEPENDS. Lawyers and others on Ask Metafilter can help you spot potential issues in the abstract, but you really need specific advice tailored to your particular circumstances. Besides your own lawyer, extended conversations with peer-type business folks about how complex corporate structures work and how they determine which clients pose credit risks may be very helpful in orienting you.
posted by QuantumMeruit at 9:22 PM on November 5, 2010

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