For-profit charity offers new way to combat poverty

John Horak

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By John Horak

Connecticut is blessed with many charitable foundations, the principal activities of which are to make grants to support various charitable objectives. They can be specific — such as a grant to fund research or to pay for childhood vaccinations — or (my topic) grants to operating nonprofits conducting activities and programs designed to ameliorate the myriad “social justice” problems that plague parts of the state. Poverty is, generally speaking, the nucleus around which problems orbit.

On Dec. 15 of last year, the Connecticut Council for Philanthropy (CCP) issued its 2015 “Giving in Connecticut” report, which asks poignant questions about foundation grant makers. Here are a few: With $4.66 billion invested by individuals and foundations in our communities … have we made a difference? Why do we feel comfortable funding the same organizations when no impact has been seen? Why is life not better for children and families in Connecticut?

On Dec. 1, 2015, Facebook founder Mark Zuckerberg turned the philanthropic world on its ear when he announced that he would “donate” 99 percent of his Facebook shares to “charity.” However, his $45 billion commitment did not create a stir so much for its size (as significant as it is), but because he committed his wealth to a newly formed limited liability company (LLC), and not to an IRS-approved, tax-exempt foundation of the type discussed in CCP's report. In other words, he pledged his money to the type of legal entity that the owner of a local dry cleaner might use to organize his business.

Zuckerberg's move is both a rejection of the traditional philanthropic foundation model, and a $45 billion bet that better results for children, families and communities can be achieved by a for-profit business entity operating with their interests in mind. A step this bold by someone of his stature presents an interesting question: Is the traditional grant-making approach to these issues subject to the type of creative disruption that Amazon has hoisted upon retailers or Uber upon the taxi industry? There are legal and philosophical reasons to believe this is the case.

First, the tax law (which affords deductible donations and exempt income) severely restricts what foundations can do — limiting the types of investments and grants they can make and prohibiting a controlling interest in a business enterprise. These are a form of cement shoes into which Zuckerberg does not want to place his entrepreneurial feet. LLCs have no burdens of this type, and can be managed as creatively as necessary to pursue Zuckerberg's goals — they can make a grant to a charity, own and operate a business, and make whatever investments will bring the best results. If their property and income is taxable, well, they pay the tax.

Second, the IRS has issued rulings that pave the way for using LLCs in a variety of creative settings. Singularly or in tandem with other LLCs or other types of nonprofit organizations they can be assembled, like Lego blocks, into new creative structures — something I am sure Zuckerberg's lawyers have told him. For example, a donor can make a tax-deductible contribution to a LLC that is 100 percent owned by an operating nonprofit; and, similarly, the nonprofits could co-own a LLC with for-profit investors from which both the nonprofit and private interests will derive financial benefit — such as a new or existing business, healthcare facilities, or investment real estate. There is IRS guidance, which would support giving employees an incentive equity interest in a LLC owned by a nonprofit.

Third, from a philosophical perspective Zuckerberg's decision appears to be a fundamental shift in thinking about how available resources should be used to address social issues. Contrast these two stories about efforts to revive Michigan's cities. First, in the Jan. 4 issue of the New Yorker, the story “What Money Can Buy” discusses the Ford Foundation's goal of conquering inequality. It said “grant makers know that many of their ideas will not work, and that even those which do will only go so far.” The Dec. 28 Wall Street Journal included a piece about downtrodden Pontiac, Mich., which seems to be lifting itself from a bottom thanks to entrepreneurs and developers returning to, and investing in, the city. LLCs are a perfect vehicle to undertake what appears to be happening in Pontiac.

A few years ago I was retained by a Connecticut grant-funded nonprofit with a mission of combatting poverty. It did this by teaching people about available public benefits and helping them apply for them. I walked away from the project thinking that the organization was really a poverty perpetuation agency, as I had thought that a better way to fight poverty would be to invest in, or help create wealth and job-creating enterprises — which seems to be what Zuckerberg has in mind.

Finally, for some time now the term “social entrepreneurship” has been bandied about as a means of combining for-profit operations with traditional nonprofit goals — though the term is ill defined and has generated more motion than traction. Having said that, Zuckerberg has, at least, made a big move in this direction and established LLCs as the entity of choice for those venturing onto this turf. Connecticut's philanthropic foundations and social entrepreneurs should take note.

John M. Horak has practiced law at Reid and Riege P.C. in Hartford since 1980.

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