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BUSINESS PLANS

The Social Entrepreneurship Spectrum: Hybrids
 

It's very complicated, but you can link together a nonprofit and a for-profit. Here's how.
Mozilla, Firefox, logo, hybrid business model

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In the hybrid model, a nonprofit and a for-profit are linked. In some cases, one is a subsidiary of the other; in others, the two entities are bound by long-term contracts in which one entity fulfills a basic need for the other and vice versa.

The Classic Example

In 2005, the nonprofit Mozilla Foundation formed a for-profit subsidiary, Mozilla Corporation, to handle the explosive growth of the Firefox Web browser. Now, the for-profit makes about $104 million a year from revenue-sharing agreements with its search partners, including companies such as Google and Yahoo. Meanwhile, the Mozilla Foundation, which is the corporation's sole shareholder, handles the development of the open-source software and brings in just over $222,000 in charitable donations.

The Model Works Best When

1. The nonprofit's unrelated business income threatens its nonprofit status.

2. The for-profit needs help managing its philanthropy. As corporate responsibility programs have grown, some for-profit companies are starting their own nonprofits and foundations to manage charitable activities.

3. Each entity needs something offered by the other.

The Advantages

You get to have your cake and save the whales, too. The nonprofit remains tax exempt and eligible for foundation grants. The for-profit can raise unrestricted funds from angels and VCs and make tax-deductible donations to its nonprofit partner. Because they are legally separate entities, for-profit subsidiaries often have more flexibility than the income-generating arms of nonprofits. They can also pay talent whatever they see fit, without being charged with excessive compensation.

The Challenges

Hybrid arrangements can get complicated fast. They require separate boards and management staffs, given that significant crossover in leadership might signal a conflict of interest to the IRS. Any time there is a service transaction between a nonprofit parent and a for-profit subsidiary, both boards have to approve it and be able to show that the for-profit paid actual market rates for the product or service (proving that the parent and subsidiary are conducting arm's-length transactions and not receiving special favors). What's more, because hybrids are fairly new, there are no IRS rules on the model.

The Tax Implications

Each entity is taxed as if it is independent of the other. Nonprofits are still exempt from federal income tax, as well as taxes in states and localities in which their tax-exempt status is approved. For-profits are taxed according to their corporate structures.

The Newcomers

Story Pirates
Founded in 2003 by a group of Northwestern grads, this New York City– and Los Angeles–based nonprofit provides after-school writing and drama programs to underserved schools and produces stage shows for the public. To accommodate growing ticket sales, Story Pirates founded a for-profit of the same name. The two organizations are linked through licensing agreements that allow them to share their name and content.

Parent Earth
The for-profit Parent Earth Inc. and the nonprofit Parent Earth Foundation have the same mission—to educate the public about healthy eating habits—but they perform different duties. From offices in New York City, the nonprofit produces educational videos about food, while the for-profit generates advertising revenue on ParentEarth.com and pursues sponsorship opportunities. With this structure, the for-profit will be able to sustain the nonprofit while it waits for grant funding.

From the May 2011 issue of Inc. magazine




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