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Should You Set Up a For-Profit?

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In today’s environment (e.g. declining memberships and increased scrutiny by the CRA) associations need to be more and more creative with respect to their operations and structure.  This has led to a growing trend of associations looking for alternative structures to meet their objectives and goals – including the creation of revenue-generating for-profit structures.  A 2014 CSAE Trillium Chapter PDX session provided attendees with insight into these structures,  addressing why an association would consider them, and some of the pros and cons of creating such a structure.This article recaps the learnings of that session.

A National Trade Association Creates a For-Profit Corporation

Bob Ramsey, CAE, President of the Motorcycle and Moped Industry Council (MMIC) shared the detailed steps his organization followed to incorporate a new organization: Power Sport Services.  

Prior to setting up this new enterprise, MMIC built seven successful annual Motorcycle and OHV shows across Canada.   They had also established a group insurance program administered through a Contractual Agreement with the underwriters and in partnership with a financial management company. 

Both programs were specifically designed in line with the purposes of the association, to serve the members and were budgeted to operate on a break-even basis.

However by 2009, both programs were generating unanticipated excess revenue over expenses.  At around the same time the Canada Revenue Agency began to show a renewed interest in the not for profit sector.

In a technical interpretation (“TI”) 2009-0337311E5 dated November 5, 2009, the CRA was asked to consider a number of questions including:

  1. Can an organization earn a profit and continue to be exempt from tax under paragraph 149(1)(l) of the Act? And
  2. Can an organization intentionally earn a profit and still be exempt from tax under 149(1)(l), as long as that profit is used solely for the purpose of supporting its objectives?

The CRA responded and I quote “In our view, the use of the word “exclusively” indicates that while an organization may have many purposes, none of those purposes may be to earn a profit. Thus, where an organization intends, at any time, to earn a profit, it will not be exempt from tax under paragraph 149(1)(l) even if it expects to use or actually uses that profit to support its not-for-profit objectives.”  The CRA accepted that earning a profit, in and of itself, does not prevent an organization from being a not for profit entity. However, the profit should generally be unanticipated and incidental to the purpose or purposes of the organization.

As a direct consideration, over the next two years MMIC, and its sister association, COHV began reviewing and analyzing various options with regard to two fundamental questions: 

  1. What is the best organizational structure to serve our member companies? and
  2. How do we best safeguard the not for profit status of the MMIC and COHV through which we had spent decades building trust, credibility and positive relations with governments and the public service across Canada? 

The Process

First, MMIC staff developed a list of options including the status quo. Then they consulted with corporate lawyers and corporate auditors about the various options. With their professional counsels, they reviewed the financial implications of each option.

They reviewed the legal implications of each option. They prepared a series of recommendations including incorporating a for-profit subsidiary for the Board of Directors of the two associations.  This took a period of six months of detailed onerous work.  When they presented the recommendation to the Board they struck out.   So they repeated the process but got even more detailed information, did even more financial forecasts and projections, drafted a USA (Unanimous Shareholders Agreement) and reviewed everything with lawyers and auditors. 

Then then made a second pitch to the Boards of Directors and in early 2011 were successful.  But then came all the preparation and cost of incorporating the for-profit business – it is neither inexpensive nor quick.  Three years later, on January 1, 2012, Power Sport Services officially came into existence. 

The Benefits

As much as legally possible, MMIC worked to ensure and protect the not-for-profit status of their two national trade associations.  There is no additional legal or financial risk to their member companies or industry partners.  The for-profit business has been incorporated to limit the legal and financial risks to the two associations. There are no additional fees or dues required from the member companies. 

There are substantial opportunities to generate significant profits through the for-profit subsidiary that can then be re-invested in the industry, and there are substantial opportunities for cost savings for the two associations and the member companies of the associations. 

Restaurants Canada Creates For-Profit Alliances

Sheryl Ross, CFO of Restaurants Canada shared that her organization was established in 1944 to promote and further the common interests of people in the restaurant and foodservice industry, and represent the industry’s interests to all levels of government.

Over the years, activities specific to the industry were added to the general operations of the Association, including affinity programs, training programs, a resource centre and trade shows.

In order to comply with CRA regulations related to not-for-profit organizations, all the activities were restricted to members and the industry; the general public was prohibited from participating.

In addition to the internal revenue streams, in 1996, Restaurants Canada acquired a 50% stake in a for-profit company named Groupex, which provided a Group Buying Program for Independent Restaurants in Western Canada; the remaining 50% stake was acquired in 2001. Today, Groupex remains a wholly owned, for-profit subsidiary.

Last year, Restaurants Canada decided to wind down its BC trade show and join forces with two other associations to produce a new trade show. While it was clear that they would need to set up a new legal entity for this joint venture, we needed to determine if we would incorporate a for-profit or not-for-profit corporation.

The British Columbia Hotel Association (BCHA) and the Alliance of Beverage Licensees (ABLE) had previously joined together to produce an annual event under a separate for-profit corporation; Hospitality Trade Expositions (HTE).

In reviewing options for the structure of the new joint venture corporation, management reached out to both legal advisors and auditors to understand the pros, cons and risks of for-profit versus not-for-profit. They opted to go the for-profit route, which was not a difficult decision; deciding factors were as follows;

  • There would be no restrictions or qualifiers as to whether or not attendees were industry related; while the industries are related, this could pose a problem
  • There was no risk to the parent organizations’ not-for-profit status
  • Internal Management Fees and charge backs for expenses/office usage would allocate the majority of the future income, and any residual profit would fall under the small business rate.

Following these case history presentations, Bob Ramsay, CAE and Sheryl Ross were joined by Sophie Doukas, Principal at Grant Thornton LLP and Susan Manwaring, Partner at Miller Thompson and National Chair of her firm’s Charities and Not-for-Profit. Dale Varney, a Partner of Grant Thornton LLP moderated the panel that worked with the following key questions.

Structural and pre-operational considerations 

What planning issues should be considered when establishing a social enterprise?

  • What is the fundamental purpose?
  • How should the entity be structured?
  • How will the structure be financed?
    • Start-up versus ongoing
    • External versus internal financing
  • Will it be self-sustaining?
  • What is the business plan?
  • What are the implications of failure on the organization?

How should the Board think about business risks?

  • Internal
  • External
  • Management and staffing issues
  • Input and operational costs
  • Market environment
  • General economic conditions
  • Financing risk
  • Regulatory environment

Structural and pre-operational considerations

How can a social enterprise be structured?
Pros and cons of each.

Structures

  • Charity
  • NPO
  • For profit
  • Hybrid – social enterprise Considerations
  • The need for flexibility
  • Financing requirements
  • Value of preferential tax treatment
  • Public perception

What tax compliance risks must be considered?

What are some of the challenges faced by social enterprise?

  • Multiple objectives/tension in organization culture
  • Multiple stakeholders with competing priorities
  • Tension between parent non-profit and subsidiary

How can/should a social enterprise be controlled?

  • Subsidiary or stand-alone organization – Pros/cons
  • Share capital versus non share capital corporations – Pros/cons

Post-implementation guidance

  • What are the fiduciary duties of the Board in the context of a social enterprise?
  • Are the duties of care different for a for profit entity, a not-for-profit entity, a charitable organization, a social enterprise entity or trust?
  • What qualifications or skills should Board members have?
  • Or put another way, do the qualifications or skills need to be different if an alternative structure is established (be it a for-profit, charitable organization, trust, social enterprise or even another NPO)?
  • Paid vs. volunteer staff? Pros/cons: Volunteer staff (less costly; may be more committed to the cause); Paid staff (greater accountability; can purchase expertise; have more control over them)
  • What training should a social enterprise provide to Board members and employees? Or put another way, is the training any different than it would be for the association’s board? Are there unique considerations if the new organization is a for-profit, charitable organization, social enterprise or trust?
  • How can an organization measure the success of a social enterprise? • Return on investment • Return to the association’s goals and objectives
  • How can an organization ensure that the social enterprise maintain its focus • Clear objectives which are reviewed regularly
  • Board recruitment and orientation
  • Cross board participation
  • Control by the association
  • What are the reporting requirements? For-profit Charitable organization Social enterprise Trust
  • How should the social enterprise be communicated to the organization’s stakeholders?)
  • Communication is critical – How, when and how often?
  • Why and how it will benefit the membership?
  • Transparency and accountability critical

Resources: 20 Questions Directors of NPO’s Should Ask About Social Enterprise?

Paulette Vinette, CAE, FASAE is President of solutionstudioinc.com which offers strategic consulting to not-for-profit organization leaders.  As a bilingual professional, she strives to do purposeful work that helps advance her client associations’ missions through business strategy, management consulting, strategic planning, and organizational development and reviews. Follow Paulette on Twitter @wwwsolutionstud

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