Hybrid Structures: A Tale of Two Entities

In recent years, there has been a lot of discussion in the socially responsible world about “hybrid” structures.  “Hybrid structures” are organizations made up of a for-profit entity and a nonprofit entity that have complementary organizational missions and some overlap in the founding group.   Embrace, for example, is considered a classic example hybrid structure in that it includes the Embrace – a 501(c)(3) nonprofit – and Embrace Innovations – a for-profit social enterprise (the popular browser, Firefox, is also a great example of a hybrid structure).

A recent article in the Financial Times reminds us of the importance of designing and managing these kinds of hybrid structures in compliance with applicable federal and state law.   One of the biggest risks with these structures is that the relevant regulatory agency finds that the nonprofit is operating to provide a special benefit to the for-profit entity rather than to the benefit the general public. The technical term for this is “private inurement”.

Private inurement risks legal action and serious penalties. The Pearson Foundation was founded to promote literacy and learning alongside Pearson PLC, its for-profit cousin, the largest education company and book publisher in the world. Earlier this December, the Foundation entered into a $7.7M settlement with the New York State Attorney General’s Office because it was alleged that the Foundation improperly supported one of Pearson’s for profit businesses.

So, take note, entrepreneurs, and please make sure that you engage a competent legal advisor to help navigate the tricky issues in this area.  At the very least, you will want to ensure that the non-profit board is comprised of a majority of independent directors and that any commercial relationship between the two entities is documented and on arms-length terms. A failure to do so could be costly to the entire organization and to the mission, however noble, that both entities seek to serve.