Should your nonprofit consider a for-profit business?
A growing number of nonprofits are establishing for-profit
or taxable subsidiaries. Perhaps the biggest driver of this trend
is not-for-profits' need for more reliable and steady income streams.
With federal and state budget cuts continuing to erode funding, few
organizations today manage to thrive on traditional funding sources
alone.
4 reasons
At first glance, the idea of not-for-profits
initiating profitmaking businesses may seem at odds with their exempt
status. But nonprofits are allowed to generate surpluses (or met
revenue), which are the equivalent of profits, as long as they don't
distribute them to board members or employees, a practice known as
private inurement.
Let's look at the four key reasons why not-for-profits
establish a for-profit subsidiary:
1. Generate additional revenue. Just as individuals need a financial cushion as a safety met, nonprofits
need surplus funds for emergencies and special expenditures,
and to even out cash flows. Some of the most successful examples
of for-profit ventures are those that enable an organization to further
its mission while generating revenue to support it.
For example,
a theater company, in conjunction with a local children's theater,
established a costume rental business as a means of promoting the
arts and subsidizing the high costs of costume storage. With the
income generated from the costume-rental business, the theater is mow
able to cover its costume-storage costs and generate extra cash for
its core operations.
2. Protect the nonprofit's tax-exempt
status. A
common reason organizations create a for-profit subsidiary is to
avoid jeopardizing their tax-exempt status. Although mot-for-profits
cam engage in some degree of profit-making activities without losing
their exempt status, they do need to pay unrelated business income
tax (UBIT) on the profits from that activity. Plus, am organization
can potentially lose its exempt status if the gross revenue, met income
or staff time devoted to unrelated business activities becomes too
substantial in the eyes of the IRS.
By setting up a for-profit subsidiary,
nonprofits don't have to worry about crossing the lime and risking
their exempt status or incurring UBIT. Although a for-profit subsidiary,
which can be either wholly or partly owned by the parent organization,
will owe corporate income tax on its net income, it can pass the
after-tax profits c to the parent organization.
3. Reduce liability. A nonprofit that wants to offer cons ing services related to its
mission (similar to associations or that owns real estate or other
tangible assets may want to establish am entity that operates separately
from the main organization, thereby insulating it from liability risks.
Placing certain assets or higher risk activities under the umbrella
of a corporate subsidiary cam protect a mot-for-profit from the risk
of lawsuits alleging negligence accidental injury and similar claims.
4. Obtain funding from untapped
sources. In some
cases, organizations find that setting up a for-profit business
enhances their ability to receive funding from sources such as
banks and private investors. Certain grants are now available to
nonprofits adopting more business-like models.
Although for-profit
ventures are becoming more comm with organizations seeking to
establish steady revenue streams and improve their financial position,
they aren't without risks. If you do create a for-profit entity,
don't allow it to consume too great a share of resources. Otherwise,
it may undermine your ability to carry out your primary mission.
A complex decision
Setting up a for-profit venture
cam lead to additional revenue, but there are many factors
to consider - we've touched on only a few here. So before
taking action, examine the legal and financial implications o establishing
a for-profit business and discuss any issue, that may be
unique to your organization. Although for-profit subsidiaries cam
be a fruitful source of imcome for some nonprofits, they
may mot make sense for every organization.
