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WHAT SHOULD MY PRIVATE FOUNDATION DO FOR THE HOLIDAYS?

First and foremost, let me wish everyone who reads SocEntLaw the safest and happiest of holidays.

Next, I want to share something that, as the Grinch would say, has me “puzzled and puzzled ‘till [my] puzzler [is] sore.”*

Specifically, I cannot figure out why the Brewer Family Foundation’s tax lawyer, Ebenezer Scrooge, is insisting that the Foundation may buy $500,000 of stock in BP or give $500,000 to GreenPeace to celebrate the season, but that the Foundation cannot risk investing the same amount in SunSleigh, Inc. a “social enterprise” developing an affordable solar-powered car. I think old Ebenezer finally has lost it, and the Foundation needs a new tax lawyer.

Let me explain. Although not huge in terms of value, the imaginary Brewer Family Foundation’s mission is nonetheless a big one: to save the world, especially the environment. The Foundation’s endowment is $100 million and as required for tax purposes every year the Foundation distributes to charity at least 5% of the value of the Foundation’s assets. We’ve already met our 5% goal this year, but because our endowment is really well managed and generating an average 10% annual return, we’re feeling more generous than usual this December and have an extra $500,000 to spend. We’ve narrowed down our choices to the following three:

• Buying stock in BP (because we think BP stock is a really good investment right now even though it runs contrary to our mission of protecting the environment); or
• Giving money to GreenPeace expressly because we think GreenPeace hates oil companies and cares about the environment more than any other charity (except, of course, the Foundation); or
• Investing in SunSleigh, a local, privately-held company raising money to develop an affordable solar-powered car.

Personally, I would like the Foundation to invest the extra $500,000 in SunSleigh, but Ebenezer says we can’t.

More background: As I mentioned, SunSleigh is a private “social enterprise” company located here in Atlanta that is developing an affordable solar-powered car. A $500,000 investment in SunSleigh would equate to 1% of the SunSleigh stock. Like the Foundation, the owners of SunSleigh are so committed to the environment that they plan to sell the SunSleigh for as little as possible so long as they can generate a 2% return on invested capital. No doubt the investment will be very risky, and the Foundation might lose all $500,000, but in my well-considered judgment, SunSleigh really could help save the environment if it is successful. In fact, I sincerely and realistically believe that the Foundation might do more to save the planet by investing in SunSleigh than it could ever accomplish through all of its other investments and annual grants to environmental charities like GreenPeace. Moreover, SunSleigh really needs the Foundation’s $500,000 because it has been unable to attract normal investment capital due to SunSleigh’s commitment to keep the car’s costs low and pay only a 2% dividend forever.

So, I called my favorite tax lawyer, Ebenezer Scrooge, just to make sure that I was on solid legal and tax ground if the Brewer Family Foundation invested $500,000 in SunSleigh. After grilling me on all the particulars of the Foundation’s assets, mission, tax filings, annual distributions, and SunSleigh’s ownership, business plan, and stock offering—which, by the way, were all fine and legally compliant as far as Ebenezer was concerned—I was extremely disappointed to hear Ebenezer tell me that if the Foundation invested $500,000 in SunSleigh it could face a $50,000 penalty tax. Even more outrageous, Ebenezer said that I personally might have to pay a $50,000 tax as well. Further, if the Foundation invested in SunSleigh and lost the $500,000, then according to Ebenezer the IRS conceivably could revoke the Brewer Family Foundation’s tax exempt status.

I couldn’t believe my ears! After listening at length to Ebenezer explain in detail the complicated and confusing tax law applicable to private foundations, and after getting more and more frustrated, I finally said somewhat angrily to Ebenezer: “You mean to tell me that, in carrying out the Foundation’s mission to protect the environment, for a mere one-half of one percent of the foundation’s assets the tax law would prefer that I buy stock in BP or give the same amount of money to GreenPeace instead of investing in an idea that could make both BP and GreenPeace obsolete?”

Ebenezer sheepishly said, “Yes, that’s right.”

Then, I exclaimed, “You and the tax law are nuttier than a Christmas fruitcake.” I immediately hung up the phone and poured myself a spiked glass of eggnog to calm my nerves.

Do you know why Ebenezer probably is right? Revisit SocEntLaw in the future for the answer.

* “And the Grinch, with his Grinch-feet ice cold in the snow, stood puzzling and puzzling, how could it be so? It came without ribbons. It came without tags. It came without packages, boxes or bags. And he puzzled and puzzled ’till his puzzler was sore. Then the Grinch thought of something he hadn’t before. What if Christmas, he thought, doesn’t come from a store. What if Christmas, perhaps, means a little bit more.”
― Dr. Seuss, How the Grinch Stole Christmas

HYBRID MODEL FOR NONPROFITS HIT SNAGS

Since its founding in 2003, the GlobalGiving Foundation has used its Web site to channel more than $30 million to charitable projects like buying seeds for farmers in Zimbabwe and feeding orphaned chimpanzees.

It also sent approximately $10 million in payments and loans that were never repaid to a company, ManyFutures Inc., that was largely owned by GlobalGiving’s founders, Mari Kuraishi and Dennis Whittle, former World Bank executives turned social entrepreneurs.

ManyFutures provided the technology platform on which the GlobalGiving Web site operated, and which it hoped to sell to others. But the company never broke even, even though it paid nothing for the platform, which had been donated to ManyFutures. In late 2008, GlobalGiving converted its loans into ownership of the company, paying Ms. Kuraishi and Mr. Whittle just $12,000 for their stakes.

They had invested $1.4 million. “I lost a large majority of my net worth doing this,” Mr. Whittle said. “It’s been personally very painful.”

GlobalGiving is one of the most prominent examples of the hybrid model of social enterprise that married a profit-making business to a nonprofit organization. Such dual-mission companies have sprouted over the last decade as a means of addressing the financing difficulties faced by many nonprofit groups, particularly as they need capital to expand. “It is virtually impossible to grow a social enterprise in any significant way relying wholly on donated money, earned revenue and debt financing, which are the only sources of financing available to nonprofits,” said Allen Bromberger, a lawyer with extensive experience in nonprofit financing. “These hybrid structures allow social enterprises to tap conventional investors interested in making profits while continuing to pursue their social missions.”

But like Dr. Dolittle’s pushmi-pullyu, the animal that had trouble moving because its two heads could not agree on a single direction, the hybrid model for nonprofits is proving problematic. On occasion, the need to generate returns for investors overwhelms the social mission. In other cases, the business falters altogether and cannot support the nonprofit.

Within the last two years, several ventures have split up or been dissolved. For example, World of Good’s commercial unit was bought by eBay, and its nonprofit arm is now struggling to stand on its own. Another prominent hybrid, Pura Vida Coffee, almost collapsed. And some, like GlobalGiving, demonstrate how hard it is to “cash out” of a venture that is not purely commercial. It wound up using foundation grants to prop up its losing profit-making partner.

Mr. Whittle said two things drove their decision to create a hybrid. “We looked at the philanthropy and didn’t think we could raise the capital required to support the technology, and we wanted to impose a brutal bottom-line discipline on what we were doing,” he said.

Investors have increasingly voiced concerns about hybrid groups. “This conjoined structure really has problems,” said Kevin Doyle Jones, a partner at Good Capital, one such investment firm. “Embedded in it is an inherent risk that individuals are profiting from donations that were made for public benefit.”

These entities, he cautioned, should avoid engaging in “private inurement,” or providing excessive benefit to a person who is close to or has a controlling interest in a nonprofit — though tax law says nothing about how much is too much.

Even newer models are evolving. Several states have passed legislation that permits the creation of so-called LC3 companies, which can raise money from traditional capital markets but place social benefit ahead of profit, and B Corporations, which are certified based on their ability to demonstrate that their business produces certain social goods. But Will Rosenzweig, a founder of the specialty tea company Republic of Tea and now the managing director of Physic Ventures, another firm that looks to invest in companies that bring social benefit, expressed skepticism of the new models. “I think you really have to make a choice and be a business or be a nonprofit,” he said. “It’s hard to be both.”

Concerns about the hybrid model surfaced in a very public way earlier this year when a tiny nonprofit in Seattle, Unitus, abruptly announced that it was letting go almost all of its employees and no longer accepting donations.

The award-winning nonprofit had helped commercialize the microfinance industry through its profit-making venture capital arm, which had made investments in several microfinance banks that were poised to go public, generating huge returns for investors, some of whom were Unitus board members.

There are, of course, examples of pushmi-pullyus whose two heads have learned to collaborate. In a structure reminiscent of mutual insurers of yore, members of the nonprofit Freelancers Union own the profit-making Freelancers Insurance Company, and both are affiliated with the charity Working Today. Board members of the nonprofit sit on the board of the profit-making company, and employees of both determine how expenses are allocated among the three organizations.

“It’s complicated but necessary,” said Sara Horowitz, who often jokes that she is the lowest-paid chief executive of an insurance company in America. “The structure ensures that there is no way that Freelancer’s Union could be sold for the benefit of any individuals or that the nonprofit could be abused for the benefit of the company.”

That allows Freelancers Insurance to focus on lowering the price of insurance than a conventional company could, she said.

For many hybrids, however, neither partner is achieving its mission and, as Unitus found, pulling them apart is tricky. “These tiered capital structures where you have some mission-oriented capital combined with commercial capital can be challenging,” said Laura Callanan, a consultant in McKinsey & Company’s social sector office. “When everything is going well, everyone is getting along and interests are aligned. But when financial challenges hit, the fact that there are different objectives creates questions about how the pain is shared.”

When World of Good Inc. was sold to eBay and the GreaterGood Network this year, its nonprofit half was effectively orphaned, stripped even of its name.

World of Good Inc. had been established in 2004 to help connect small artisans around the world to major retailers. World of Good Development, its nonprofit partner, was charged with developing a free online tool to help calculate a fair wage and improve negotiating power with buyers.

“Those activities needed to be done in the public interest, and so we put that tool into open-source space,” said Priya Haji, chairwoman of the nonprofit board and a founder of the company.

Traditional venture capital supported World of Good Inc. The nonprofit held a 5 percent stake in it and was to receive 5 percent of its profits. “The nonprofit’s work never benefited the business,” Ms. Haji said.

Nor did the business’s operations ever benefit the nonprofit. “They were never profitable, so we did fund-raisers to support the organization,” said Holly Boyer, a board member of World of Good Development and its former executive director. “The business would host a fund-raiser and sell products where we were part of the event and would speak and talk about our work and get half of the proceeds from the sales.”

When World of Good Inc. was sold in February, the nonprofit got a $100,000 grant from eBay and its shares were retired. Ms. Boyer said the grant was intended to help the nonprofit rename itself, since eBay purchased the World of Good brand.

Whether the nonprofit got a fair deal for its stake in World of Good Inc. is unknown. “The transaction was private, so I’m not at liberty to talk about it,” Ms. Haji said.

Pura Vida Partners, the nonprofit partner of Pura Vida Coffee, also is changing its name, the result of a similar divorce imposed by Jeff Hussey, a no-nonsense investor who took control of the company in 2009, having sunk more than $3 million into it to keep it afloat.

“The business model was flawed,” Mr. Hussey said. “Whenever you have an organization of human beings with a blurry mission you get blurry results.”

Pura Vida was created in 1998 by John Sage and Chris Dearnley, former classmates at the Harvard Business School.

They set up a foundation, Pura Vida Partners, and gave it ownership of the company. But when the company needed money to grow, it could not get access to traditional lines of capital because of its ownership structure, a problem that led it to embark on a series of complex financial transactions involving wealthy private investors, including Mr. Hussey. “There was a lot of pretzel logic and gymnastics to create financing vehicles and structures that would let us continue to grow and continue our social mission,” Mr. Sage said.

Those transactions diluted the nonprofit’s stake in the company to 9 percent by 2009, when Mr. Hussey took over. “We could either agree to the dilution or lose the business — and all the funding streams for the nonprofit that had been established through the business,” Mr. Sage said.

Mr. Hussey purchased the nonprofit’s final shares for $200,000. “I overpaid,” he said. “I had to because of the laws governing nonprofits.”

Today, the Create Good Foundation, as the nonprofit will be known, is a stand-alone charity that supports clean water and economic development projects in the areas where the profit-making company, Pura Vida Create Good, buys its raw materials.

“Our goal now is to sell coffee, wine, tea, chocolate and other things and do it profitably,” Mr. Hussey said. “There’s nothing blurry about what we do and why we do it.”

from New York Times October 25, 2010

By STEPHANIE STROM

photo: SantiMB