While searching for sources of funds these days, nonprofit boards and execs are looking under every nook. Revenue generating ventures are certainly one of these possible sources while recognizing that there are some pretty large risks. When a venture idea has indeed been identified, one of the many questions raised by nonprofit boards asked is what might be the best legal structure? Two most common options: operate the venture as a program of the nonprofit or create a for-profit subsidiary.
An article in the New York Times about two nonprofit theaters getting ready to take-on some major productions, does a great job in illustrating the why's of creating a for-profit subsidiary. Taking from the article, it's this simple:
The Public (Theater) created the for-profit fund-raising arm when it was moving “Hair” to Broadway during the 2008-9 season. It was set up to allow the theater company to have a potentially lucrative stake in its commercial productions without putting any of its own money into them. The for-profit arm is a wholly owned subsidiary of the Public, structured to allow it to raise and invest money in commercial productions while shielding the nonprofit side of the theater company from any financial losses (and other liabilities I might add) in those productions.
Profits from commercial productions go back to the for-profit subsidiary, which is both the conduit for paying back investors and a source of revenue for the Public’s nonprofit work.
Add this explanation to the fact that this structure also reduces any risk of Federal unrelated business income tax (UBIT), this when a real and substantive profit is generated, and the rationale for developing a for-profit arm becomes clear.
However, for nonprofits that develop thrift or similar volunteer-operated ventures, the need to shield from financial losses and other liability-related risks remains but the UBIT risk does not because of an IRS ruling on these types of ventures.
Whatever the choice, the bottom line: boards beware! Ventures, particularly in these times when so many small businesses are failing, can be very risky efforts.