Can Your Nonprofit Convert into a For-Profit?

October 11, 2017

There are occasions where a 501(c)(3) nonprofit may wish to convert into a for-profit entity. This typically occurs for nonprofit organizations that exist primarily on program service revenue, as opposed to contributions, who one day find that most of its “competitors “ are for-profit businesses. Is this the right move for your nonprofit organization?

Additional reasons that your nonprofit may consider converting include:

  • The need to attract investment capital investors.
  • Avoiding the scrutiny associated with nonprofit status.
  • Concern about an audit disclosing too much unrelated business income or a general change in direction of what the organization is doing.

Once you have decided a conversion makes sense for your organization, it becomes primarily a legal issue. You will need to navigate the state laws in your jurisdiction to determine what is required for a nonprofit that is no longer organized primarily for the public good. Additionally, you will need to know what is allowed in terms of transitioning to a new status. This includes entity liquidation and reconstitution as a new for-profit entity, some form of a merger into an existing entity, or whatever creative way may be allowed to achieve the legal conversion. In addition, various disclosure of what you are doing will need to be shown to the IRS in a final 990. A state attorney general, regulators, a state agency from which you do business, the public, or any donors you may have may potentially be notified.

It is important to keep in mind that assets accumulated as a nonprofit can only be used for the purposes for which the nonprofit was set up. Assets may not just be converted for a nonprofit changing to for-profit status. The transaction allowing the conversation needs to be properly represented on both sides.

For example, let’s say a nonprofit has accumulated $2 million in net assets, and they wanted to convert into a for-profit. Their $2 million would have to remain in the nonprofit form. Perhaps the nonprofit would decide to liquidate and the assets would be distributed to other nonprofits promoting similar charitable work. The business would then reincorporate as a for-profit. Another option would be for the for-profit to purchase the assets, leaving money in the nonprofit which they could grant out to organizations doing similar work.

A good appraisal of the nonprofits’ assets should also be obtained if there are non-cash assets, so there is a basis for the transaction. You don’t want questions years later to pop up about the legitimacy of the conversion and what you did. Much of these transactions are legally driven, so it is very important to obtain good counsel for guidance. You will also need to consider if you still have assets from “restricted” contributions for particular purposes. Those monies would still need to be used to satisfy those restrictions.

Transitioning your nonprofit into a for-profit organization can be a complicated. Please do not hesitate to contact Aronson’s Nonprofit & Association Services Group with any questions you may have at 301.231.6200.