Many nonprofit organizations find it difficult to generate sufficient funding to maintain their operations. Especially with the ongoing challenges associated with the global financial crisis, generating revenue is a constant struggle. One strategy nonprofit agencies may employ to generate additional income is through one or more for-profit ventures associated with the nonprofit organization. While this arrangement is possible, both the law and federal tax code place limits on how nonprofit organizations are allowed to coordinate with for-profit enterprises.
Nonprofit Versus For-Profit
The purposes for establishing and maintaining nonprofit organizations and for-profit businesses differ significantly. The main purpose of a for-profit company is to produce income above and beyond expenses; the products or services provided by the company are a means to that end. On the other hand, nonprofit organizations exist to provide a service for a target community or the public at large. The nonprofit must either collect income through donations or membership fees or generate funds through fees charged for direct services provided to clients.
Unlike for-profit companies, nonprofit organizations do not distribute dividends to stockholders. Instead, nonprofits reinvest earnings above and beyond their operating expenses into expanding services within their own organizations, funding other nonprofit ventures or generating revenues through Program Related Investments – purchases at below-market rates of financial instruments in for-profit companies that are related to the nonprofit organization’s stated mission. Some nonprofit corporations form their own limited liability companies, or LLCs, through which they make PRIs.
Collaborative Nonprofit and For-Profit Enterprises
Nonprofit organizations often work collaboratively with for-profit companies in one of two ways. In one scenario, the nonprofit company controls at least 51 percent of the operations of the for-profit company, with a significant overlap in managing officers, staff and other strategic personnel. In the second scenario, the nonprofit organization and for-profit company operate independently, but interact through one or more contracts negotiated at arms' length and beneficial to the operations of both the nonprofit organization and the for-profit company.
Low-Profit, Limited Liability Companies
A handful of states and independent Native American enclaves recognize legal structures known as low-profit, limited liability companies or L3Cs. Like conventional LLCs, L3Cs may be owned by a variety of entities ranging from individuals to corporations and other L3Cs. A primary function of an L3C is to attract donations from private foundations, which must distribute a portion of their annual earnings to charitable purposes or risk incurring tax penalties from the Internal Revenue Service. L3Cs may also generate their own profits, although generating income must remain secondary to the purpose of providing a charitable or educational service.