A NEW KIND OF HYBRID

A NEW KIND OF HYBRID
John M. Horak, Esq.
Reid and Riege


Eugene V. Debs (1855 – 1926) was a labor leader, union organizer, and a five time presidential candidate on the Socialist Party ticket (he ran from his jail cell in 1920 where he had been sentenced for obstructing the draft during World War I). His pithy comments about the City of Chicago (“…the product of modern capitalism, and, like other great commercial centers, unfit for human habitation”) captures his views of the unbridled capitalism of his day.

Jay Gould (1836-1889) is generally regarded as one of the most unethical “robber baron” capitalists of his era. Starting out as a store clerk, Gould (through stock manipulation and other hard nosed practices) ended up in control of a substantial part of the railroad mileage in the United States. He and a partner attempted to corner the gold market in 1869, leading to the infamous Black Friday panic in which thousands of people were ruined financially.

Looking at Debs and Gould in historical context, they certainly seem to be polar opposites – one on the lookout for fair and ethical treatment of workers exploited by those who own and control industry and capital, and the other bending and breaking the rules and other people in pursuit of greater wealth. And while both Debs and Gould have been dead for decades, their ideological tug of war remains a part of the social fabric, and has formed the contrasting views that many in the for-profit and nonprofit sectors have about each other: …the non-profit sector is full of self-righteous and unaccountable do-gooders whose hands are perpetually out; …the for-profit sector is chock-full of self-indulgent gluttons whose hands are perpetually in other peoples’ pockets.

While some may be convinced that the “nonprofit” and “for-profit” cultures (like matter and anti-matter) share no common ground except total destruction, we are not of that thinking. To the contrary, we believe that the common ground is actually quite vast and is slowly but surely being cultivated by people who are looking at these issues much differently than in the past 100 years or so.

This new thinking suggests (i) that wealth creation (for-profit activity) is not a “zero sum game” in which there must be a loser for every winner, (ii) that making a profit is a moral good (and perhaps a moral imperative) as long as it is done fairly and legally, (iii) that nonprofit organizations can and should engage in profit-making activities when it is practicable to do so, (iv) that nonprofit organizations have an obligation to manage themselves efficiently, to measure outcomes, and to compete in the market for charitable donations and support, and, importantly (v) that nonprofits are the glue that holds the social fabric together and (vi) that a vital nonprofit sector is a necessary condition for social stability and progress.

While we have touched on this topic before, and while it is increasingly being discussed in national publications and educational venues, we are working with a client on a project which, we believe, breaks some new ground.

Kate Emery owns a successful computer consulting firm called Walker Systems Support. She is also the founder of a charitable organization named the Global Harmony Institute. Like many successful business people, Kate is a creative thinker, and she came to us looking for a way to integrate the activities of Walker Systems and Global Harmony Institute.

One of the options she considered was to operate Walker Systems on the same model as organizations such as the “Newman’s Own” food companies – which pledge the payment of some portion of after-tax profit to charitable organizations. From a marketing perspective, companies that make this type of pledge hope that customers will buy more of their goods or services because the customers know and appreciate the pledge, and like the idea of buying a useful product and helping charity at the same time. However, Kate wanted to take the charitable commitment to another level, and, after giving the matter some thought, we came up with a plan to amend the certificate of incorporation (the corporate charter) of Walker Systems (the for-profit entity) to integrate into its legal and governance structure goals important to Kate, and to make the distributions of profit to charity more than a mere pledge.

Accordingly, we are drafting into the charter provisions which limit the amount of compensation that can be paid to any employee of the corporation (including Kate) to an amount not in excess of what is permitted under the nonprofit “intermediate sanctions” provisions of the Internal Revenue Code. Second, we are incorporating a “best business practices” section which requires Walker Systems to maintain a code of ethics and code of conduct for its directors, officers, and employees. Finally, and most importantly, we are adding a provision to create a new class of special preferred stock – which by its terms can only be owned by organizations which are tax-exempt under Section 501(c)(3) of the Internal Revenue Code, and which entitles the charitable organizations holding the stock to a preferred dividend payment (from earnings and profits) and to a liquidation preference if the business is ever sold.

Tax professionals reading this newsletter will recognize that that the structure we are proposing may not be the most “tax efficient” way to get profits and business ownership into the hands of nonprofit/charitable organizations, but working within the limitations of current law we are endeavoring to create a “hybrid” business structure which exists simultaneously to make money and to support charitable goals. Perhaps the terms “for-profit” and “nonprofit” have outlived their usefulness and we should, as some commentators have suggested, invent new terminology not encumbered by outdated models. Nevertheless, while only time will tell if experiments like this have long-term viability, it is interesting to play a role in the process and to do something that would probably have been outside the margins of what Debs and Gould could have conceived in their day.


This article, by John M. Horak, Esq.,is issued by Reid and Riege’s Nonprofit Organization Practice Group, which handles tax, corporate, fiduciary, financial, employment, and regulatory issues for nonprofit organizations. While this report provides readers with information on recent developments which may affect them, they are urged not to act on this report without consultation with their counsel. For information or additional copies of this newsletter, or to be placed on our mailing list, please contact John M. Horak (860-240-1077) jhorak@reidandriege.com, Leah Cohen Chatinover (860-240-1074) lchatinover@reidandriege.com, or other members of the firm of Reid and Riege, P.C., One Financial Plaza, Hartford, CT 06103. For other information regarding Reid and Riege, P.C., please visit our web site at www.reidandriege.com.