Can a Nonprofit Own a For-Profit? Key Insights, Rules, and Examples

You’ve read the title of this article, so we’ll get you right to the short answer. Yes, a nonprofit organization can actually own a for-profit company. The long answer is, no shock, much longer, and comes with the caveats of many rules and regulations. 

Also, it’s important to note that this doesn’t work the other way around—a for-profit generally can’t own a nonprofit! All clear? Then let’s get into the very long answer with a full explanation.

How a Nonprofit Business Can Own a For-Profit Entity

So how exactly does a nonprofit end up owning a for-profit business? It’s a more common occurrence than you might think, and can legally happen in a few ways. A nonprofit can receive a for-profit business as a gift, for example. Or, a nonprofit can use its investments in a for-profit entity to acquire it—or even create it from scratch. 

Whatever the purpose of its original creation, the for-profit then exists as a subsidiary of the nonprofit organization. This means that they are separate legal entities, though the for-profit may distribute its profits to the parent nonprofit. The important takeaway here is that since they are separate, the nonprofit business itself retains its tax-exempt purposes.

Note that the startup or acquired for-profit doesn’t need to avoid the charitable business. For-profits that still seek out to do good charitable work are called “Benefit corporations” (B-Corp) and can make as big as charitable impacts as nonprofit corporations. 

The Importance of Separate Entities

This is dependent, of course, on the two businesses remaining entirely separate entities. This means being distinct in all ways: separate boards of directors, separate management, and separate finances. While the nonprofit remains a tax-exempt organization it is a best practice to avoid using any of its tax-exempt resources to help the for-profit.

Taxes and Profits 

This separation can extend to how the two businesses are taxed. If the for-profit generates any income that is entirely unrelated to the operation of the nonprofit, then it will be subjected to the Unrelated Business Income Tax, or UBIT. 

The for-profit can only actually distribute its income to its owning non-profit in the form of dividends, with the understanding that these funds be used only to support the nonprofit's mission. The general idea is that the for-profit is acting as support for the non-profit—not the other way around. 

Also, a final unrelated note. Nonprofits’ relationships with for-profits aren’t always about ownership. A nonprofit can, for example, make investments into a partner nonprofit. However, they have to prove that these are Mission Related Investments. In other words, the investments must have some payoff for the charitable purpose of the non-profit. 

Rules and Regulations for Nonprofits Owning For-Profits

That’s the basics of what the structure of such a relationship looks like - the nonprofit owns the for-profit as a subsidiary, and may use profits from it only to pursue its charitable purpose. However, there are a wide range of other rules and regulations that need to be adhered to. Following are some of the most notable. 

Maintaining Tax-Exempt Status

The non-profit should take all steps necessary to avoid the operations of the for-profit subsidiary from jeopardizing the 501(c)(3) tax-exempt status due to operational overlap. It’s a lot of terminology, but it is essential that same idea of separation we discussed above. If the for-profit’s activities begin to outgrow and dominate the non-profit’s activities, the IRS has the right to revoke tax-exempt status. 

Organizational Separation

We’ve really been harping on this point, but it bears repeating. The nonprofit and the for-profit need to be distinct - legally and operationally. No exceptions. This means separate boards, staff, financial accounts and activities. Each must essentially be functioning as a standalone entity.

Appropriate Use of Nonprofit Funds

When we said accounting should be kept separate, we were serious. One of the biggest rules that a nonprofit in this situation can make is using its own funds for the for-profit’s operation. The funds of the nonprofit must be used for its charitable purpose to maintain tax-exempt status. The for-profit exists to support the nonprofit, not the other way around. 

Transparency for the IRS

The fact that all these rules are being adhered to must be made very transparent to the IRS. The ownership of any for-profits must be disclosed on the annual Form 990. Transparency also includes disclosing the dividends and transfer of assets from the for-profit. 

Adherence to State Laws 

We’ve been talking a lot about federal IRS regulations here, but it’s worth adding in a rule about state regulations. These can, in some cases, provide different restrictions on top of the IRS restrictions. For example, some states may have their own reporting requirements for nonprofits. Make sure to check what your state requires you to report annually or during audits. 

Governance Best Practices

It’s best that the board of the nonprofit have some policies in place to manage conflicts of interest, to avoid any unwanted visits from the IRS. The best way to do this is to implement some conflict of interest policies that forbid board members from having financial interests in both entities. If such joint ownership is deemed necessary, transparency is always the name of the game. 

Avoid Private Inurement

This is related to the point about governance above and is a more specific rule. Individuals and “insiders”—board members, officers, shareholders—are not supposed to personally benefit from a nonprofit’s income or assets. This is standard for more nonprofits, but be aware that this carries over to the income and assets of the for-profit subsidiary. 

Avoid Excess Benefit Transactions

Private Inurement isn’t the only way to get your hand caught in the cookie jar. “Excess benefit transactions” refers to when benefits are given in excess to individuals who would generally be disqualified from them. Think of the officers, directors or their family members. Essentially, this refers to overpaying members of your nonprofit for their work on the for-profit side. 

Protection of Assets

It is considered best practice for a non-profit to not put any of their charitable assets at risk from the running of the for-profit subsidiary. Essentially, it’s best practice that none of the assets of the non-profit are put in a position where they could be put in liability without insurance. 

Public Perception

This transparency we keep going on about isn’t just for the IRS’s benefit. It’s best-practice for the nonprofit to be absolutely open to the public about its relationship with any subsidiary for-profit corporations. This helps build trust and credibility, invaluable currencies to a non-profit. You don’t want to be viewed as a pass-through company just using tax law for your own benefit. 

Political Activities 

Lastly, it's important to take a moment to reflect on the position that charities take as advocates for their cause. They are often perceived to have a position of trust granted by their activities. It is, understandably then, extremely unethical to lean on that trust in order to promote the activities of their for-profit. From the largest private foundations to small businesses, nonprofits should work for the public benefit.

Benefits of Nonprofit Owning a For-Profit Business

So, with all these rules and regulations, why bother having your nonprofit acquire a for-profit business? There are actually a few major benefits to this arrangement. 

A Diversified Revenue

Generally, nonprofits rely mainly on donations, grants and other fundraising methods to earn the revenue to perform their charitable activities. A for-profit can provide a stable, continuous source of income for the operation of the nonprofit that doesn’t have to rely on the fundraising cycle. This can allow a nonprofit to become more ambitious in its enterprises. 

Greater Mission Impact

A for-profit subsidiary can, in many cases, directly support the main mission of its non-profit parent. For example, if a nonprofit’s purpose was to support employment within its community, the for-profit could be providing those jobs and training. The benefit is that the for-profit can be self-sustaining, making this a more achievable goal. 

Enhanced Partnerships

By having stakes in both the nonprofit and for-profit arenas, a nonprofit can often discover greater chances for valuable partnerships. A non-profit on its own may not have full access to things like investment opportunities, co-branding or sponsorship that a for-profit can access. Some business partners that are more profit based may be more amenable to working with the for-profit subsidiary. It’s all about diversifying resources beyond the funders. 

Increased Visibility and Influence 

Relating to the above, a for-profit subsidiary is a great way for a nonprofit to make its presence known in new areas. Customers of the for-profit can be informed about the nonprofit owner, and its charitable message can be spread further. This, in turn, can help lead to more donors and partners for the non-profit. 

Access to Capital Markets

Note that a for-profit has full access to capital markets, something a nonprofit might not have. This means that the for-profit can seek out venture capital, equity investments and loans. By bolstering the for-profit, this in turn gives greater financial power for the non-profit. 

Challenges and Risks of Nonprofit-Owned For-Profits

So as you can see, tapping into the power of for-profit business can provide a lot of growth potential for a canny nonprofit. However, there are, as always, challenges and risks involved as well. Here’s some of the things you might want to watch out for—but note this is just a quick guide to think of before the incorporation of the for-profit. It’s always best to get full legal advice before you take the plunge. 

Regulatory and Legal Risks 

Remember all those rules, regulations, and best practices we went over above? There’s not just a checklist to go through. Rather, there’s something you will need to keep in mind every year for the duration of the operation of the subsidiary for-profit organization. You’ll have to design clear bylaws for your nonprofit board to avoid accidentally crossing these legal lines during your business activities. Many for-profit subsidiaries are set up as a limited liability company (LLCs) for this reason. 

Financial Risks

Any business endeavor comes with financial risks.  That’s just the reality of being an entrepreneur, charitable or otherwise. And it holds true in this case as well. If you set up a for-profit as a subsidiary and it fails, this could threaten the financial stability of your non-profit.

Beyond the due diligence of risk assessment, there are some ways to mitigate this risk. This is why we advised keeping the finances very separate in the business structure—the less damage to the nonprofit from a financial perspective the better. Don’t start over-relying on the for-profit either. A nonprofit with diverse revenue streams is a healthy one. 

Conflict of Interest

It’s one thing to follow the letter of the law. But things can get very muddled and confusing if there starts to be too much overlap between the nonprofit and its subsidiary. Even if no laws are broken, staff members can feel that they must pick between one company or the other. Attention can be split, and bad feelings can emerge if there is worry that the nonprofit is drifting from its mission.

This is why it's essential that you put policies in place to avoid this. The most essential of these essential policies is that there be two separate, independent boards. These boards also need to have entirely transparent decision-making processes. 

Reputational Risk

A for-profit subsidiary might make financial sense for the nonprofit, but it should think carefully about if it makes reputational sense. Even if it's not true, the perception can be created that the nonprofit is drifting from its original mission. 

It’s essential then that the non-profit is transparent about the purpose of the for-profit. If possible, the for-profit should align closely with the activities and mission of the nonprofit. Never give the idea that the values and mission have been in any way compromised. 

Operational Complexity

The hope is that the for-profit will create more options and opportunities for the nonprofit. But there is the chance that it can instead bog things down, due to the operational complexity involved. Remember, each entity will have its own distinct legal and financial requirements. This can potentially create inefficiencies in time and resources. 

All that’s really needed here is some careful planning. The best place to start is to get the right staff on board who have experience in both the nonprofit and for-profit space. Make sure that the roles and responsibilities of every are clearly delineated and not overlapping. There should be regular internal oversight by each board to check that said overlap isn’t creeping up.

Making sure that you’re using the best accounting and management technology can be a huge hassle-saver here as well. But much of the work will just come down to experience and education on the part of your staff. If you need somewhere to get started on learning more about nonprofit education, and grantmaking, make sure to check out our quality online webinars. These can help you master the organization tools needed to cut through the worst operational complexities.