Nonprofit Conversions
Nonprofit Valuations: Transactions Requiring an Accurate Valuation of Your Nonprofit
From today’s Bloomberg Law:
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What is sometimes nevertheless labeled a “nonprofit conversion” is different. A nonprofit conversion, such as what OpenAI is attempting, imprecisely refers to a contraction or termination that alters beneficial ownership.
This can only happen by selling some or all assets held in trust by a nonprofit fiduciary, followed by redeployment of those assets in the buyer’s profit-making business. But even when a nonprofit sells, the proceeds inherit the charitable immortality previously attached to the sold assets.
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Trustees may decide for business or regulatory reasons that their work might be better accomplished under a different legal statute through which successors acquire both legal and beneficial ownership. To carry out that sort of conversion, the successors must purchase the nonprofit’s assets. This is true even if the successors were former trustees. Their prior status as trustees affords them no rights to simply appropriate the assets to their profit-making endeavors because they never owned the assets in the first place. They must fairly purchase the assets from the taxpayers.
Trustees who seek beneficial ownership become both sellers and potential buyers regarding publicly owned assets. As public fiduciaries, trustees are legally obliged to negotiate on behalf of taxpayers for the best price. But in their private roles, trustees are naturally motivated to pay the least amount possible for the assets. Clearly, the public can’t be sanguine if the buyers are also the sellers’ agent. The conflict is clear—yet it would be bad policy to entirely prohibit such transactions, so the law imposes guardrails.
Both process and price for a nonprofit conversion—a sale of all or some of the assets—must fairly protect the real owners’ financial interest. State and federal tax laws determine what is fair. To be substantively fair, the sale price must at least equal fair market value, a concept easily articulated but difficult to determine. To be procedurally fair, the negotiation process must negate the impact of the trustees’ irredeemable conflict. Fair price and process are generally though not invariably symbiotic. A sale price will typically be considered fair, with no other required proof, if the process is fair.
A process will be considered fair if the resulting price is within a provable range of comparable prices, but the latter correlation may vary. In Smith v. Van Gorkum, for example, the beneficial owners sold stock for a premium, and yet the Delaware Supreme Court found that directors violated their fiduciary duties because of an unfair process. When trustees are both buyers and sellers, the transaction must be negotiated by substitute trustees free of financial conflict who comply with the same fiduciary duties applicable to the conflicted trustees. The practical and legal requirements are codified in Reg. 53.4958-6.
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darryll k. jones