Current nonprofit sector research and recommendations for effective day-to-day practice from ASU faculty, staff, students, and the nonprofit and philanthropic community.
Patsy Kraeger, Ph.D.
This blog post is second in a two part series on Foundation Supported Social Enterprises. Click here to read part one.
Why did they do this?
The Nick Simons Foundation did not have a large staff. The foundation opened in 2005 when Nick Simons, a great lover and visitor of Nepal died. Nick Simons was keenly aware of the medical needs in high altitude low income countries such as Nepal. The family foundation members were interested in funding the development of a unique anesthesia machine that neither requires electricity nor compressed oxygen to function.
This device would be invaluable for infrastructure-weak health systems in low income countries that often suffer from energy shortages or no energy access at all. They wanted to be closely involved with the venture and they want to commercially market and sell the product- a product with a social benefit. They recognized in order to be successful that they need an income stream and they did not want to become a fundraising foundation. Instead they thought of operating a social enterprise. They formed Gradian Health Systems.
“For us at Gradian, this structure has worked terrifically – as a start-up social enterprise we are able to pursue non-profitable objectives with a steady, reliable source of funding (who gets to say that?!). As a new entity, our structure reduces (or eliminates altogether) the need to spend time and resources on fundraising and financial reporting, which allows us to focus on operations. We have also been able to piggyback on the foundation’s existing hard infrastructure (such as office space and technology) and soft infrastructure (such as tacit knowledge and mentors)”.
Foundation Leadership’s Decision Point: Fiscal Ease
The Foundation considered how complicated it would be to create a new venture and the reporting on the IRS Form 990. It turns out that it was not so complicated after they consulted the appropriate legal, tax and accounting professional. Because the foundation was further an exempt purpose through program related investment in a for-profit company they found that they could roll up that tax return into the Foundation’s 990.
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Funding innovation requires foundations to take a risk. In the venture capital world, funding innovation and calculating risk has become more of science than an art. I might suggest that this is the same in the foundation world. The "science" is determining whether the program related investment aligns with the foundations exempt purpose. The exempt purpose is typically also captured in the mission and vision statement of the foundation and its current funded portfolio of programs. A simple rule of thumb as a staring place for foundations might be to look at the unrelated business income tax (UBIT) “substantially related” rule for nonprofits that engage in social enterprise as a starting place and then seek professional legal and tax advice.
According to the IRS, the relationship between the business activity that generates revenue and the nonprofit’s exempt activity is when there is a causal relationship between the two. “The causal relationship must be substantial. The activities that generate the income must contribute importantly to accomplishing the organization's exempt purposes to be substantially related”.
Anecdotally speaking, a rule of thumb might be if someone has to blink their eyes twice to figure out the relationship between the for-profit business and the exempt activity most likely there is not.
Foundations have long been drivers of innovation through programmatic funding. Government t often then adopts these innovations, institutionalizes the programs and scales them up for large social change. Foundations who are interested in innovative goods and products that seek to change the societal norms through large or small scale change might think about examining avenues to invest in hybrid corporations when there is alignment to exempt purpose to further social good. Funding socially minded businesses co-creating social benefit and financial returns should be welcomed actors in community.
Patsy Kraeger is a Faculty Associate with the ASU School of Public Affairs. She is the co-chair of the Public Administration Section for the Western Social Science Association. Her research focuses on social enterprise models specifically hybrid corporations. She has worked in the public, private and nonprofit sectors. She is an active volunteer.