Tax Law Allows Nonprofit/For-Profit Joint Ventures but The Market Will Not Abide Charity

I feel so violated.  Because when I first heard about OpenAI (c)(3)'s joint venture with Microsoft, I said "wait a minute, this can't possibly work!"  But they had some good lawyers who understood Revenue Ruling 98-15 and I thought "wait a minute, this might work!"  And then when Microsoft starting doling out stock options to the workers who subsequently helped engineer Sam Altman's reinstallation as OpenAI (c)(3)'s profit strongman, I thought to myself, "wait a minute, can this ever really work?!"  It can't work and even OpenAI (c)(3) is admitting it.

More and more media are reporting that Sam Altman and his band of effective altruists have decided that by the end of next year, OpenAI will have converted to a public benefit corporation, if not something else taxable and even less in pursuit of public benefit other than by the pursuit of private profit. 

I gave a talk at UCI Law about a year ago when I was in my "this might work" stage.  Omri Marian, who sat in along with Vic Fleischer and a bunch of LLM students, pretty openly scoffed at the whole idea. I was right legally, I still am.  The OpenAI structure adheres to Revenue Ruling 98-15's structural mandate and the effective altruists say the right things about a charitable mission. It's just that Marian was much "righter" economically. This can't ever work.

Revenue Ruling 98-15 describes a Utopia, where capitalists and charitalists co-exist, and capitalists seek public benefit before private profit.  Only now do I understand Marian's sentiment. The market doesn't give a rat's ass about "charity" and will not subordinate profit making to such nonsense. What's said on paper hardly even matters.  I don't mind intellectual honesty, by the way.  And I'm paraphrasing because Marian hardly even bothered explaining.  But its increasingly obvious that human nature will not tolerate the subordination of profit-making. To anything.  It's almost a violation of natural law.  

I am in the process of writing an after-action report on OpenAI's joint venture for publication next spring.  My thesis is that the structure mandated by Revenue Ruling 98-15 is easily achievable but can't ever really work in economic reality.  Profiteers will not tolerate it.  We can stab them with our steely knives but we just can't kill the beast.  Which is to say that capitalism will not tolerate a mixed entity by which profit is subordinated to public benefit.  Public benefit corporations and whole hospital joint ventures, notwithstanding. I think the same is true in the health care industry, by the way but nonprofit hospitals have never been as arrogant about it as OpenAI (c)(3) is today. The only way OpenAI (c)(3) is still getting away with all this is that its board is filled with influential folks with White House access, including a super-capitalist former Treasury Secretary and a retired high ranking cyberwarrior. I am not exaggerating about White House access but I think its more about national security than taxes.  

Meanwhile, this from Reuters:

OpenAI's new financing round is expected to come in the form of convertible notes, according to sources with direct knowledge of the matter, who said its $150 billion valuation will be contingent on whether the ChatGPT-maker can upend its corporate structure and remove a profit cap for investors.  The details of the conditions of the $6.5 billion funding, which have not been previously reported, show how far OpenAI, the most valuable AI startup in the world, has come from a research-based non-profit, and the structural changes it's willing to make to attract ever more investment to fund its expensive pursuit of artificial general intelligence (AGI), or AI that surpasses human intelligence.

 

The outsized funding round has seen strong investor demand and could be finalized in the next two weeks, given the rapid growth of OpenAI's revenue, sources added.  Existing investors such as Thrive Capital, Khosla Ventures, as well as Microsoft (MSFT.O) are expected to participate. New investors including Nvidia (NVDA.O) and Apple (AAPL.O) also plan to invest. Sequoia Capital is also in talks to come back as a returning investor

 

Can a nonprofit that is half for-profit issue convertible debt? Debt one step from private ownership?  This can't possibly work, at least not with tax exemption too.  OpenAI (c)(3) admits it, though Sam still asserts a charitable mission.  And just to put a final point on the matter, here is part of a Tech Crunch article entitled "Investors are souring on OpenAI's nonprofit governance model:"

 

OpenAI was never quite like other generative AI startups — or other startups period, for that matter. Its governance structure is unique and what ultimately led to the abrupt ousting of CEO Sam Altman on Friday. Even after it transitioned from a nonprofit to a “capped-profit” company in 2019, OpenAI retained an unusual structure that laid out in no uncertain terms what investors could — and couldn’t — expect from the startup’s leadership.

For example, OpenAI backers’ returns are limited to 100x of a first-round investment. That means that if an investor puts in $1, for example, they’re capped to $100 in total returned profit. OpenAI investors also agree — in theory, at least — to abide by the mission of the nonprofit guiding OpenAI’s commercial endeavors. That mission is to attain artificial general intelligence (AGI), or AI that can “outperform humans at most economically valuable work” — but not necessarily generating a profit while or after attaining it. Determining exactly when OpenAI has achieved AGI is at the board’s sole discretion, and this AGI — whatever form it takes — is exempted from the commercial licensing agreements OpenAI has in place with its current customers.

The prescient article is nearly a year old, by the way. It was written in the immediate wake of Altman's ouster last year for being too solicitous to profit.  We should have known then that "investor dissatisfaction" meant the end of charity more than profit.  Those who sought to pursue charity are gone.  Altman is still there.  And the investors are quite explicit that they want the same unlimited profit potential they can get from for-profit competitors.  Profit capped at 100x investment is not enough.  Here is a little more from Reuters:

 

It is unclear if such fundamental corporate structural changes could happen. The removal of the profit cap, which put a limit on investors' potential returns in OpenAI's for-profit subsidiary, would hand early investors an even bigger win. It could also raise questions about OpenAI's governance and departure from its non-profit mission. OpenAI has said the cap was put in place to "incentivize them to research, develop, and deploy AGI in a way that balances commerciality with safety and sustainability, rather than focusing on pure profit-maximization."

 

The San Francisco-based AI lab, founded in 2015 as a nonprofit research project, with the goal of building AI for the benefit of humanity, is currently controlled by a non-profit parent organization.  It has accelerated its commercialization efforts by selling subscription-based services like ChatGPT to consumers and enterprises, which now boasts over 200 million users.  Existing investors are beholden to a capped limit to their return on investment, with any additional returns to be routed to the non-profit.  Returns were capped at 100x the investment for investors in OpenAI’s first round of financing. “We expect this multiple to be lower for future rounds,” the company said in a 2019 blog post detailing the structure. OpenAI used this model to raise more than $10 billion in recent years, with the majority coming from Microsoft. It was last valued at $80 billion in February in a tender offer deal where the company sold existing shares led by Thrive Capital.

darryll k. jones