In November of 2023, hybrid business ventures – mission-driven social enterprises that incorporate both nonprofit and for-profit entities – went public.
First, OpenAI, the leading artificial intelligence firm behind ChatGPT, put hybrid ventures at the center of the public’s attention when it fired its celebrated co-founder and CEO, Sam Altman, before succumbing to internal and external pressure and rehiring him just 5 days later. Then, UL Solutions, the for-profit arm of a nearly 130-year-old nonprofit safety science organization, more literally went public, as it announced its plans for an initial public offering sometime in 2024.
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Altman originally co-founded OpenAI as a 501(c)(3) nonprofit organization with the mission of building artificial general intelligence that benefits all of humanity, unconstrained by the need to generate financial returns.
As the company grew and began to require more capital to advance its research, it formed a for-profit subsidiary that could issue equity interests, as nonprofits do not have owners and thus do not have equity to sell. The 501(c)(3) still conducted a range of charitable initiatives, but the research and development activities that were fundamental to its core mission were transferred to the for-profit subsidiary, which meant that the 501(c)(3)’s ability to ensure that those fundamental activities advanced its original mission was limited to the governance and oversight authority the 501(c)(3)’s board retained over the subsidiary.
Reportedly, the board’s duty to ensure that the for-profit subsidiaries furthered the mission of the nonprofit parent, and their concerns regarding how Altman’s actions hindered their ability to exercise that duty, led to Altman’s ousting. However, in the end, the influence of Altman and the investors in the for-profit subsidiary was too strong, and Altman reached a deal to return as CEO.
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Then there’s UL Solutions, one of three related organizations that make up the current version of an organization, formerly known as Underwriters Laboratories, whose roots date back to the early 1890’s, when its founder set out to create an electrical safety testing laboratory.
Over the ensuing century, Underwriters Laboratories evolved into a tax-exempt 501(c)(3) nonprofit organization with four main activities:
Then, in 2012, Underwriters Laboratories transferred its testing, inspection and certification activities to a group of for-profit subsidiaries that it controlled.
While tax-exempt organizations are permitted to carry on commercial activities, if those commercial activities do not meet the narrow standard of being substantially related to the organization’s exempt purpose, they will subject the tax-exempt organization to unrelated business income tax, and could even jeopardize the organization’s tax-exempt status if they become a substantial part of the organization’s activities. However, a nonprofit can avoid those issues by conducting commercial activities through a taxable subsidiary. In such a case, the subsidiary pays tax on its own income, just as any other taxable business would, and then can distribute earnings to the tax-exempt parent as dividends, which do not subject a tax-exempt organization to unrelated business income tax.
The aim of the 2012 move was to facilitate the growth of the testing, inspection and certification activities, which would increase the tax-exempt parent’s income from those commercial activities and thus strengthen its ability to accomplish its mission, without jeopardizing the parent’s tax-exempt status. As Underwriters Laboratories’ next reorganization showed, that appears to be exactly what the 2012 restructuring accomplished.
In 2022, in response to increasingly complex public safety risks and the opportunity to maximize each of its activities’ ability to further its safety science mission, Underwriters Laboratories used $1.8 billion in special dividends from its taxable subsidiary to reorganize. The 501(c)(3) organization, now renamed UL Research Institutes, retained its nonprofit research activities, but transferred its ownership of the taxable subsidiary, as well as its standards development and advocacy activities, to UL Standards & Engagement, which was permitted to engage in a wider range of advocacy activities as a Section 501(c)(4) tax-exempt organization.
The end result was three well-funded organizations that could exclusively focus on, and dedicate their resources to, their own unique, but complementary, activities, each of which furthered the shared mission of advancing public safety. If and when UL Solutions goes public, the only thing that will change is the millions, if not billions, of additional capital that the IPO will generate.
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As the public drama surrounding the internal power dynamics of OpenAI, a Silicon Valley darling, dominated the headlines and caused some to question efficacy and legitimacy of the hybrid form, UL Solutions’ textbook example of the utility and potential of hybrid business ventures went largely unnoticed.
At its core, Underwriters Laboratories was created to conduct scientific research on public safety issues, which remained its core mission and function even after it reorganized in 2012 and in 2022. In contrast, OpenAI’s core mission was to develop artificial general intelligence that benefits humanity. When it transferred its research and development activities to a for-profit subsidiary, it essentially lost its ability to independently pursue and accomplish its core mission.
The lesson to be learned is that hybrid ventures are most likely to succeed when the for-profit is created to enhance, rather than to enable, the nonprofit’s ability to accomplish its core mission and function.
If you would like to explore how a hybrid entity design might benefit your nonprofit organization or social enterprise, please reach out to Marc Lane, in confidence, at mlane@marcjlane.com or 312/372-1040.
Jeremy Kritt is an Associate Attorney with The Law Offices of Marc J. Lane, P. C.