After my team made the decision to convert our legal status from a nonprofit to a for-profit, the next thing we needed to figure out was how. We navigated the internet for hours and realized there was a dearth of information out there on the subject.
The reason is because few organizations have navigated the conversion successfully. It is very easy to go from a for-profit to a nonprofit. Going the other way is not. After having gone through the process, I completely understand why. In making the conversion happen, there is a huge element of luck. The timing matters. Most of the founders that I spoke to that had attempted the conversion and failed after the fact, it was because they didn’t find product-market fit. They anticipated that their service or product could be a for-profit business and they jumped to make the conversion before they gained full acceptance of their product or service. However, if they waited until the business was too mature, then the cost of converting the business may outweigh the benefits.
Assuming you have the timing right, which is subjective and will vary across businesses, below are the three most popular options. I've also listed the pros and cons for every one of these options.
Licensing, leasing, or renting the assets
This would require you to set up a new legal entity that you can incorporate in any structure you wanted. Then you’d work with the board of the nonprofit to draft an agreement that would allow you to rent, license or lease the assets that you need for the new company.
Pros: This is quick and easy. It provides you with immediate access to the assets that you need to do business.
Cons: You manage multiple entities. You do not own the assets outright. The board of the nonprofit can change its mind and terminate its agreement with you, which could put you out of business.
Complete asset purchase
This is the direction my team decided to go. This requires you to set up a new legal entity that you can incorporate in any structure you want. Then you have to hire counsel to represent the management team (buyer) and counsel to represent the board (seller). Once the counsel is in place, then you have to hire an accounting firm to provide what they believe to be a fair market value of the assets. The value is determined based on conversations with the board, an evaluation of the balance sheet and any hard assets that are being transferred. The management team then has to raise the money to purchase the assets. The board must approve the asset sale. Finally, the last approval must come from the Attorney General in the state where the transaction is taking place.
Pros: You own the assets once the process is approved.
Cons: This is the costliest of the different routes. This route also takes the longest of the three to accomplish.
During the process of the asset purchase, I wished several times that I had gone down this route. This route requires you to start a new entity and start over. It means walking away from what you built. Nonetheless, the most valuable piece of the experience is what you learned. Sometimes that chance to start over means you could probably do it even better. This option is only available for companies that are providing a service. Most states have loose non-compete laws. That means that anyone can start a competing business that copies exactly what you’re doing without any penalty unless you have a patent. It would require you to change the name and the branding, but those things shouldn’t be that valuable at the time of your conversion -- otherwise you’ve probably waited too long to make the switch.
Pros: This is the cheapest route to undertake. You do not need to hire any counsel and can pretty much walk away from what you had built to date.
Cons: The perception that you used donor assets to build something, get traction and then use it with a profit motive is poor. However, if you’re genuinely doing it for the greater good of the mission, you shouldn’t care too much about that.
When my team and I made the decision to make our conversion, we only really knew of the first two options. We also managed to receive pro bono counsel to support the nonprofit board. Otherwise, the costs of making the conversion might have sank our company. The intricacies of making this conversion happen are complicated. Though you may not need counsel to go through the entire process, depending on the route you choose to go, you should consult counsel at the start of the process to evaluate if there are any other options for you to consider that may be specific to your business.