Friday, April 12, 2019
There is an interesting article in yesterday's New York Times regarding a "Charity Global, Inc," a charitable organization with about $70 million in net assets and which spends about half of that bringing clean water and healthy sanitation services to many of the nearly 700 million people around the world who live in water impoverished and sanitation distressed areas. The organization has helped bring clean water and healthy sanitation facilities to people in places like Ethiopia, Mali, and Rwanda. From the looks of its annual report and its 990's, this is a legitimate, indeed laudable organization that is making a real impact around the world. What caught my attention, though, is the article's description of the organization's compensation structure. Incidentally, the organization's 2017 Form 990 indicates that the founder and CEO, Scott Harrison, makes about $330,000 a year which doesn't seem like too much given its budget and its worldwide mission. The lowest paid "highest compensated employees" made about $120,000. But the article describes how the founder wants to bring modern business practices to the world of charity. In particular, according to the article, he wants to allow charitable workers to share in the "monetary upside" of charitable activities. Here is the initial somewhat startling hook from the article:
Last year, the founder of a charity that is focused on making sure everyone on earth has clean water and a co-founder of an e-commerce mattress company met for lunch at a SoHo restaurant. As the two ate, the talk inevitably turned to start-ups. “How come at a start-up you can participate in the equity upside?” Neil Parikh, the co-founder of the mattress company, Casper, said in recalling the conversation with Scott Harrison, the founder of Charity: water. “But at a charity, you’re helping all these people, and you can’t participate in the monetary upside?” It was a quandary that Mr. Harrison, who has forged close ties with the Silicon Valley elite over the years, had been mulling for some time. Now he is doing something about it. Under a new program, start-up founders will be able to share their wealth not just with impoverished families in the developing world but also with a rather more comfortable demographic — Charity: water employees. Here’s how it works: Entrepreneurs who own sizable stakes in private companies can donate some of their equity to Charity: water. When their company goes public or is sold, some of the proceeds will be paid out as bonuses to Mr. Harrison’s staff. [emphasis added]
The "monetary upside." I swear, young entrepreneurs are sometime better at coining phrases than rappers. Anyway, another tidbit from the organization's 990 shows that its Secretary/General Counsel's compensation is about $75,000. He might want to start earning that pay, first, by advising the founder to be a little more circumspect in his conversations about employees of a charity participating in the charity's "monetary upside." After the gag order, the General Counsel should start by taking a look at General Counsel Memorandum 39862 where the Service kicked around the idea of "private inurement, per se." Here is the very short version summary: Back in the late 80's and early 90's exempt hospitals, desperately competing for paying patients, whose fees helped subsidize the cost of medical research and charity care, entered into agreements with physician practice groups. The practice groups, of course, provided the medical services essential to the hospital. The compensation paid to the physician practice groups were, at least in part, directly tied to the amount of revenue those physicians generated. Remember, 501(c)(3) requires that "no part of the net earnings" inure to the benefit of an insider. And "revenue sharing" as revenue determined compensation schemes are called, are immediately suspect because, well, part of the net earnings are inuring under those plans. At least as a very literal matter. On the other hand, a charity needs workers and workers are compensated from "revenues." Compensation from gross revenue is ok if the compensation is really compensation and not a disguised distribution of net revenue. In other words the compensation must be "reasonable," a fact more easily perceived than defined. Anyway, the Service has never been quite comfortable with revenue sharing. When, in 1996, the private inurement prohibition was upgraded in to the "excess benefit prohibition" in an attempt to quantify the concept of private inurement, the Congress punted on the question whether revenue sharing was a "per se" violation of the prohibition against private inurement:
(4) Authority to include certain other private inurement
To the extent provided in regulations prescribed by the Secretary, the term “excess benefit transaction” includes any transaction in which the amount of any economic benefit provided to or for the use of a disqualified person is determined in whole or in part by the revenues of 1 or more activities of the organization but only if such transaction results in inurement not permitted under paragraph (3) or (4) of section 501(c), as the case may be. In the case of any such transaction, the excess benefit shall be the amount of the inurement not so permitted.
Treasury issued final regulations implementing the excess benefit legislation but didn't exactly decide the question. It clearly considered the question because Regulation 53.4958-5 entitled "Transaction in which the amount of economic benefit is determined in whole or in part by the revenues of one or more activities of the organization" contains only the word "Reserved." Still, knowing what we know about the defining characteristic, according to Hansmann, of tax exempt charities, we might issue a per curiam rejection of any charitable compensation structure explicitly designed to allow charitable employees to "participate in the monetary upside" from charitable activities. It just seems too obviously violative of Hansmann's "nondistribution constraint." The "monetary upside," since we are using big fancy words, is the raison d'etre of taxable, for profit entitites! Undaunted, Mr. Harrison explains it this way:
But earmarking sizable donations to pay bonuses to a charity’s employees is unconventional to say the least, and could elicit backlash within the philanthropic community. “It’s very strategic to structure gifts in this way,” said Darren Walker, president of the Ford Foundation. “But the issue of enriching employees of the charity is potentially problematic.”Mr. Harrison, who is also Charity: water’s chief executive, said the new program was a natural extension of his efforts to recruit employees who might otherwise take jobs at Facebook, Google or Amazon. “We want to attract the best possible talent,” he said in an interview at the organization’s TriBeCa headquarters, which WeWork helped design. “But how do we compete with massages and Michelin stars?” If working for a good cause isn’t enough, now Charity: water employees can have some Uber stock, too. “They’re making below-market salaries,” said Mr. Parikh, who has pledged 1 percent of his equity to the program. “In this tech boom, where a lot of their friends are participating in these I.P.O.s, why should they get left behind? It’s a win-win.”
So let's just make sure we understand this. Attracting the best and brightest to altruistic endeavors but incentivizing them to do good work with a share of the charity's "monetary upside" is that what you are saying? Yes? Ok so owners of start-up equity in companies like Uber, WeWrok and Casper with market value upwards of $50 million have pledged up to 1 percent of their equity to Charity: Water as charitable contributions. When those companies go public, the charity cashes in (big time, no doubt) on the one percent pledge of equity and distributes up to 20% of the [ahem] "monetary upside" to the employees, including the CEO no doubt.
Yeeaaaaaaa -- No! If that ain't private inurement, per se there is no such thing.
Darryll K. Jones