Not-For-Profits: Joint Ventures or Social Enterprises
Many charities and Not-for- profit organisations are asset rich and cash poor.
It is not uncommon for an entrepreneur to identify an asset owned by a Not-for-profit and approach the entity with a proposal to develop the asset so that a return can be realised in cash by the Not-for-profit.
What pitfalls lie ahead if the Not-for-profit agrees to participate?
- Possibility of prejudicing tax free status
This status should be a Not-for-profit’s most enviable asset. Its eligibility hinges on registration with the ACNC (if a charity) or tax exemption under Division 50 Income Tax Assessment Act, 1997 if otherwise.
In accordance with the case of Commissioner of Taxation of the Commonwealth of Australia v Word Investments Limited [2008] HCA 55 (3 December 2008), charities can operate for-profit enterprises, provided that the profit is given to the charity, and does not, for example, get distributed to private shareholders.
- A Not-for-profit’s Constitution
A close analysis of the constitution is recommended to ensure that any commercial enterprise is within the powers of the entity. If the entity has a body corporate status, then the body corporate will have all the powers of a natural person.
On the other hand, if the Not-for-profit is a trust, or an unincorporated entity with a set of rules, the venture must fit squarely within the terms of the governing document.
- Preservation of Existing Asset Base
A Not-for-profit holds its assets ‘in trust’ for its purpose. Directors owe a duty of care to beneficiaries of the purposes to use such assets for the purposes. Any chance that the assets are likely to be lost or exposed to deterioration in value, should be buffered by, for example, replacement assets of similar worth, or expectation of disproportionate increase in value over time as a consequence of the venture or a cash injection equivalent to lost asset value if, for example, assets are sold as part of the venture.
- Change in Direction
If a project results in a change in character, objects, or purposes for the Not-for-profit, its endorsements (tax exemption, DGR status, GST concession, FBT status) may alter.
- Exposure to Finance Covenants
Often, a venture requires borrowings. It is likely the Not-for-profit will be expected to use its assets as security against such borrowings. Even though personal covenants on borrowings will lie at first instance with the entrepreneur borrower, a financier will generally require third party ‘covenants’ from the Not-for-profit. That is akin to giving a personal guarantee and the Not-for-profit entity, cash poor, should resist that position.
- Determining if the Joint Venture is really a Social Enterprise
Increasingly, Not-for-profits wishing to pursue particular purposes, may engage in a ‘social enterprise’. A social enterprise usually involves the Not-for-profit operating a separate division of its structure, to generate profit, for example, to open a coffee shop.
The coffee shop might be staffed or used as a training ground for ‘beneficiaries’ of the Not-for-profit, but the expectation of the for-profit will be that the coffee shop become self-sustaining. The for-profit division would expect to cover wages, rent, utilities, supplies, and receive a return on its investment. That return can be retained by the Not-for-profit without tainting its tax free status.
If the for-profit is set up as a related entity to the Not-for-profit, then a suitable structure would be for the Not-for-profit to ‘own’ any shares issued by the for-profit, and collect surplus when dividend is declared. Again, there is no risk to the status of the not-for-profit.
- Risk of Conflicts or Disputes
Due to for-profit or Not-for-profit entities having essentially different objectives, unless the individuals on their boards are committed to the same outcome and have agreed the method of achieving that outcome, the potential for disagreement is high. The agreement between both entitles should be reduced to writing and contain a practical dispute resolution provision. Ideally, either party should be able to walk away if particular milestones are not reached during the course of the project.
It is recommended that two different sets of individuals hold positions on the boards of the for-profit and the Not-for-profit.
Josephine Heesh, Partner