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Collaborating with a For-Profit: Some Risks but Huge Potential
April 16, 2008
by Tom Triplett
Contents
Types of For-Profit and Nonprofit Collaborations
Organizational collaborations
Financial collaborations
“Reverse” investments
Collaborations without financial investment
What to Avoid
Opportunities for Growth
Definitions
As more and more nonprofits explore new avenues for revenue, many are weighing the benefits and challenges of collaborating with for-profit entities. Because this type of collaboration can provide access to sources of capital that are not typically available to a nonprofit, it can be an attractive option to those who know how to properly structure the partnership. For those who don't, the partnership can lead to failure, compromised mission, and dissatisfied employees. How do you know if a nonprofit/for-profit collaboration is for you? The following are examples of the variety of forms such collaborations can take.
Types of For-Profit and Nonprofit Collaborations
Organizational collaborations
These are not ordinary relationships in which a nonprofit rents space from a for-profit landlord or buys office supplies from a Wal-Mart. Instead, these are situations where a nonprofit and its for-profit partner come together for a shared enterprise that complements the missions of both.
The most well-known example is the Girl Scouts, who use licensing arrangements with a consortium of bakers to bake and distribute their famous Samoas, Thin Mints, and Tagalongs through the Girl Scout network. The cookie sales offer a learning experience for the Scouts, while the bakeries satisfy their mission of making a quality product that generates a profit.
The second model looks like a classic supplier contractual relationship, but it is really much more. Pioneer Human Services, a Seattle-based nonprofit, serves individuals on the margins of society, helping them to become more successful through housing, employment, training, treatment, counseling, and re-entry programs. Pioneer’s manufacturing division, Pioneer Industries, is a precision sheet metal manufacturer. Because the quality of their products is so high, the Boeing Corporation has contracted with Pioneer for over two decades to produce parts for its cargo airliners.
An important characteristic of the contractual relationship between Pioneer and Boeing is that the collaboration is a business one. Boeing buys from Pioneer not because Pioneer is a nonprofit, but because Pioneer produces a quality product at a market rate. Both Boeing and Pioneer like to highlight the fact that they have this relationship with each other, but their collaboration is grounded in their complementary business missions. Boeing needs parts for its airplanes, and Pioneer wants jobs for its clientele.
A third type of innovative relationship between a for-profit and a nonprofit is a smart lease. Such leases go beyond a typical landlord/tenant relationship; they are structured in a way that helps achieve the missions of both entities. A good example of this is the relationship that the Minnesota Children’s Museum has had with its for-profit tenant St. Croix Marketing (SCM), a for-profit that runs “Kid Spark” on the first floor of the Children’s Museum.
The for-profit sells high quality, developmentally-appropriate toys for kids. Both entities partner in respect to toys tied to particular Museum shows. Beyond that, SCM seeks to sell toys that are consistent with the Museum’s mission of educating children through educational play activities. And as an additional way of compensating the Museum, SCM agreed to share a portion of its profits above a specific amount with the Museum. Thus, the relationship between the Museum and the for-profit SCM goes far beyond a mere landlord/tenant situation.
Financial collaborations
Relationships between nonprofits and for-profits can be more specifically financial in nature. This is particularly true in the field of community development, where nonprofits have learned how to access traditional sources of private capital through collaborations with for-profit entities. Nonprofit organizations like LISC (the Local Initiatives Support Corporation), the Community Reinvestment Fund, the Nonprofit Finance Fund, and the Nonprofit Assistance Fund have all learned to leverage their own financial resources (often generated from foundation grants) with the resources of for-profit entities.
Non-profit entities seeking non-traditional revenue sources have been forced to become extremely creative by U.S. laws which maintain a bright line between the nonprofit and for-profit sectors. By using “quasi-equity” and other nontraditional sources, these creative nonprofits have been able to move beyond the usual philanthropic and earned income revenue sources. By partnering with for-profit financial institutions, nonprofits have greatly expanded their access to capital.
The mechanisms used to achieve this access are laden with acronyms. For example, equity equivalent investments, also called “EQ2s,” are often used by commercial banks to help them meet their federal Community Reinvestment Act requirements. Many foundations use program related investments (PRIs) as a way to invest a portion of their corpus into non-profit enterprises. A third example is New Markets Tax Credits a fairly recent federal program that has allocated almost $20 billion of federal income tax credits into community development activities in low income and high unemployment neighborhoods.
To emphasize, these quasi-equity investments are not true equity in the for-profit sense. In fact, some of them look more like debt financing than equity. And, their use is most likely in the community and housing development fields. But a broad swath of nonprofits outside of these fields is evaluating how to use these mechanisms as well.
“Reverse” investments
Another example of nonprofit/for-profit collaboration is a “reverse” investment. In these situations, the nonprofit invests in the for-profit enterprise.
The Cystic Fibrosis Foundation is a national nonprofit dedicated to finding a cure for the inherited chronic disease. But because the number of individuals afflicted is relatively small (approximately 30,000 in the U.S.), big pharmaceutical companies have little economic incentive to work in this field; there simply would not be enough profit for them.
So the Cystic Fibrosis Foundation invests a portion of its assets into for-profit corporations that are willing to take risks and find a cure for this “orphan” disease. For example, the Foundation has taken a strong equity position in a Cleveland-based biotechnology firm that is seeking a cure using a novel biotech approach. This is an excellent example of a nonprofit using its financial resources to help support a for-profit enterprise in a way that will ultimately benefit both entities.
Collaborations without financial investment
Finally, let us consider a collaborative that involves no exchange of funds.
SYSCO Corporation is a large foodservice supplier serving institutions like colleges, convention centers, and hospitals. The Food Alliance is a nonprofit whose mission is to promote sustainable agriculture by recognizing and rewarding farmers who produce food in environmentally friendly ways. The organization certifies local farmers who produce healthy, often organic foods using sustainable farming practices.
In 2004, SYSCO Minnesota developed SYSCO Farmers Market, a partnership with farmers, processors and manufacturers in Minnesota, Iowa and Wisconsin. Through this Farmers Market partnership, SYSCO makes locally and sustainably produced food available to restaurants, colleges, and hospitals in the area. This collaboration has no money exchange: SYSCO’s Farmers Market helps promote its sales to institutional buyers, and its purchase of product from certified local producers helps to grow Food Alliance’s base of participating growers.
What to Avoid
The examples cited above are all situations where collaborations have succeeded. But there are many examples of failures in the field. Failure can occur for a variety of reasons; some of the main ones include:
- The collaboration is not equally balanced. One party or the other is substantially stronger than the other, causing the mission of the weaker party to be compromised.
- The profit motivation becomes too overwhelming, and the nonprofit begins to lose sight of the mission for which it was granted nonprofit status in the first place.
- The nonprofit finds it is not as entrepreneurial or hard-nosed as its for-profit partner, and the collaboration and the business suffers.
- The nonprofit’s leadership becomes so entrepreneurial that a culture gap is created within the nonprofit’s own staff and its core programming suffers.
- The business plan that the parties have adopted proves inadequate in that it relies too heavily on roles to be played by the parties that are foreign to their basic culture and personalities.
- While the business enterprise generates substantial revenues, it also has high costs, making the net “profit” small.
- The nonprofit’s traditional philanthropic funders begin to question why they should continue to finance the nonprofit when it acts so much like a business.
An important legal issue will arise if the income-generating enterprise is not related to the mission for which the nonprofit received its tax-exempt status. At the least, the nonprofit may be subject to the federal Unrelated Business Income Tax which would reduce its total “profits.” At the worst, if the unrelated business income is too large a portion of the nonprofit’s total income, it may jeopardize its nonprofit status.
None of the above factors should be seen as deal-breakers if recognized and anticipated early enough. Each of them can be handled. For major enterprises that are not tied to mission, the activity can be spun off to a taxable subsidiary. And for some issues, there are countervailing arguments e.g. many philanthropic funders encourage their grantees to develop alternative revenue sources as a way to reduce future reliance on grants and contributions.
Opportunities for Growth
As nonprofits consider the range of opportunities available to them in for-profit partnerships, they may consider one of the many forms suggested above. Or, they may create an entirely new model. But as the sector continues to innovate and as the distinctions between “for-profit” and “nonprofit” continue to blur, we will inevitably see growing interest and proliferation in these types of enterprise collaborations.
Definitions
Debt Financing
When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise to repay principal and interest on the debt. The other way of raising capital is to issue shares of stock in a public offering, called equity financing.
Licensing
When a company enters into an agreement with a second company for the right to use and therefore leverage aspects of the second company's brand identity on a product or service manufactured by the first company.
For more information, please contact Tom Triplett at 651.556.4504 or email him at ttriplett@FieldstoneAlliance.org
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