Thursday, July 24, 2008

How Does the Private Benefit Doctrine Apply to Nonprofit Venture Capitalism?

Today's New York Times has an interesting story about nonprofits that invest in small for-profit start-ups as part of the nonprofits' efforts to spur urban renewal and economic revitalization  --nonprofit venture capitalists.  It is pretty much a settled fact that urban renewal and  economic revitalization are "charitable purposes" as stated in the 501(c)(3) regulations:

The term "charitable" is used in section 501(c)(3) in its generally accepted legal sense and is, therefore, not to be construed as limited by the separate enumeration in section 501(c)(3) of other tax-exempt purposes which may fall within the broad outlines of "charity" as developed by judicial decisions. Such term includes: relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of Government; and promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.

What caught my eye initially about this story was a link to one of the nonprofit urban renewal company websites, a website that has obviously been expertly approved or engineered by tax exempt counsel.  The Jumpstart Website explains its venture capital technique in terms both charitable and capitalistic, beautifully woven together:

JumpStart accelerates the growth of bright ideas into brilliant businesses in Northeast Ohio in three fundamental ways:

  1. Providing tools and organizing events to connect people with bright ideas throughout Northeast Ohio
  2. Providing experienced professional consultants to the most promising ideas and companies
  3. Providing critical early investment capital to entrepreneurs and businesses that have high growth potential and will likely grow to attract additional private-sector investments in the future

JumpStart's early efforts have yielded promising results. Whether reviewing newspaper articles throughout the region, looking at the number of JumpStart applicants, or attending any one of the many JumpStart Exchange events, you'll see that JumpStart has made great progress in revitalizing Northeast Ohio's entrepreneurial spirit.

And then later, the website returns to the requirements for tax exemption under IRC 501(c)(3):

The Corporation is organized and shall be operated exclusively for charitable and educational purposes, including for such purposes as combating community deterioration and lessening the burden of government in the Northeast Ohio area by developing and maintaining programs and activities directed at:

  • Encouraging the creation of new employment opportunities for unemployed residents of the City of Cleveland and other Northeast Ohio areas by providing managerial and technical assistance to aid the development and expansion of small businesses engaged in activities which have a high potential for providing employment opportunities and thereby contributing to the alleviation of economic distress in these areas;
  • Conducting activities to supplement City of Cleveland, Cuyahoga County and State of Ohio economic and job development programs directed at encouraging the initiation of expansion, growth, and maturation of small businesses with a potential for providing enhanced employment opportunities and thereby contributing to economic revitalization of the City of Cleveland and other communities in the Northeast Ohio area which have experienced economic decline and community deterioration;
  • Providing education and information to individuals concerning the development and operation of small businesses for the purpose of encouraging the initiation, expansion, growth, and maturation of both new and existing small business which can provide employment opportunities and thereby aid in alleviating unemployment, community deterioration, and economic distress in the City of Cleveland and other communities in the Northeast Ohio area.

It has been demonstrated that existing industries are no longer instrumental in providing growth within the region. The majority of growth nationally comes from small businesses. JumpStart's targeted assistance to early-stage high potential small businesses will ultimately create new employment opportunities for Northeast Ohio residents, which will alleviate economic distress and reduce the burden on government. The wealth created and jobs that result from our activities will help to revitalize the economy in Northeast Ohio.

There are obvious private benefit issues to be concerned with.  According to Guidestar, by the way, Jumpstart is a 501(c)(3) entity.  Should Jumpstart (and the other nonprofit venture capitalists discussed in the article) be tax subsidized when they exist to convey such an obvious benefit on peticular and  not so beneficial people (small business owners just trying to get rich).  The Service, I think, has not sufficiently evolved with regard to the area of private benefit most likely because its consideration of the extent to which tax exemption should co-exist with the  conveyance of  private wealth has occurred in  the context of health care, primarily hospital joint  ventures where everyone (except poor patients) are getting rich.  In most instances, that an organization must bestow riches on any particular noncharitable person in order to achieve a greater, indisputably charitable purpose, has been sufficient to cause denial or revocation of tax exemption.  One supposes that the sort of knee-jerk suspicion is justified in the  health care industry.

But I and a few others (most notably John Columbo) have made the point that the private benefit doctrine does not sufficiently allow for the fact that in our society a few people must normally benefit spectacularly in order to achieve a greater good for a lot more people.  Not quite "a rising tide lifts all boats" sort of feeling but close.  That is, the private benefit doctrine  should not prevent a nonprofit from conveying a conspicuous benefit on a noncharitable purpose if doing so is necessary (in a loose sense) to the accomplishment of a charitable purpose. 

So.  When the nonprofit venture capitalist invest in a future "Google," the owners of whom get filthy rich, people will and should question whether the nonprofit deserves tax exemption or exist merely to provide a private benefit.  In the past, the  existence of a  wealthy noncharitable  beneficiary has resulted in an irrebutable presumption of private benefit when investment is made in a non-corporate for-profit entity, even though the unrelated business income provisions clearly allow investment  in corporate ventures (whether the investment is related or not, neccessary or not, to the charitable purpose).  I  think instead we need to ask whether making that noncharitable beneficiary wealthy was necessary or perhaps just conducive (or maybe that is too easy a standard) to  the accomplishment  of the charitable purpose. 

dkj

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