A New Model: Foundation-owned Social Enterprise

Print Share on LinkedIn More


October 7, 2014;GrantCraft (via Alliance Magazine)

Gradian Health Systems provides access to a unique anesthesia machine that requires no power source or compressed oxygen to function. That makes the Universal Anesthesia Machine (UAM), as it is called, perfect for many poor and underserved countries around the world. Although clearly a wonderful tool, that’s not what makes this unusual. The fact that Gradian is a Limited Liability Corporation (LLC) wholly owned by a private foundation is.

The Nick Simons Foundation, based in New York City, has a mission to “improve health and medical care, especially for rural and remote communities in Nepal.” This is not a small foundation. Its assets were listed as more than $56 million in the most recent IRS Form 990 available on GuideStar. The website for the foundation is intriguingly short, at a single page, and clearly states that it does not accept unsolicited requests for grants because “the Foundation’s main grantees are the Nick Simons Institute (NSI) and Gradian Health Systems.”

Gradian’s relationship to the Foundation is a lot more than simple grantee and was recently described as “both a program-related investment of the foundation and a commercial subsidiary of it. We have taken to calling this structure Foundation-owned Social Enterprise (or FOSE).” The way this works is that Gradian was created as a nonprofit LLC with a single member. The single member is the Nick Simons Foundation. In other words, Gradian is a wholly owned subsidiary of the Foundation.

There appear to be a number of benefits to this relationship:

  • By providing the UAM to hospitals in needy communities around the country, Gradian is helping to fulfill the foundation’s mission.
  • Because it is a single member LLC, Gradian is considered by the IRS to be a “disregarded entity,” which means, in the long run, that its financials are to be reflected on the tax filings of the owner, which in this case is the Foundation. This removes the burden of having to file annually with the IRS.
  • Because of the philanthropic work it does, Gradian represents a tax-free investment vehicle, so the Foundation’s investment can still be considered towards its annual requirement to spend five percent of its endowment.
  • Meanwhile, hospitals and clinics around the world can buy the UAM at cost and are provided free training.
  • Gradian also gets access to the hard assets (office space, etc.) and some soft assets (knowledge and contacts) that the foundation can offer.

An examination of the Foundation’s 990 reveals that it does make quite a number of gifts (other than those listed on the website) to Gradian and an institute that provides training and support to doctors in Nepal. In fact, the foundation gives quite a number of gifts to clinics around the world, many of which are for exactly the same amount of money. All of these grants, which are generally of $10 or $11 thousand each, are “to provide universal anesthesia inventory parts for use in hospitals in rural regions.” It appears that the Foundation is either helping purchase or providing support for the maintenance of the UAM machines Gradian sells.

This represents the second example of a foundation adopting a new and intriguing relationship to its grantees. Recently, NPQ reported about a foundation that does not invest in Wall Street to earn income that is later distributed in the form of grants. Instead, the Hutton Parker Foundation has invested in quite a bit of commercial property, which it leases to nonprofit organizations. The profits from its management of these facilities then become the basis for some cash grants to other nonprofits.

Before running ahead with the model that has been adopted by the Nick Simons Foundation, there are some issues that should be considered. Some are legal in nature, and some are in the area of conflict of interest.

The legal questions revolve around the concept of the single-member LLC. Apparently, only some states allow an LLC to have nonprofit status. The nonprofit status allows the LLC to represent a tax-exempt investment for the Foundation. According to the IRS, when calculating taxes, the LLC as a disregarded entity is treated as part of the owner for some taxes, but not all, including employment tax when the disregarded entity is considered separate.

The questions regarding conflict of interest regard how closely tied the two organizations are. As a nonprofit, Gradian does have a board of directors, three of whom are also listed as being on the board of the Foundation. This is not necessarily an issue, although the two boards are getting quite close, especially since one organization, Gradian, is a grantee of the other. In many cases, foundations do not allow staff or board to serve on the board of a grantee to avoid any issues of duality of conflict of interest and the directors’ duty of loyalty. More troubling is that the CEO of Gradian, who is listed as earning in excess of $300,000, is listed as a director of both boards.

As Woods Bowman, NPQ’s Nonprofit Ethicist, has said, something people do things for good reasons that look odd to outsiders. That is likely the case here: The barriers between these two organizations are minimal to nonexistent, so it looks like the structure is a ruse allowing the parties involved the benefits listed above. We would love to hear from others about this unusual model.—Rob Meiksins

  • Allen Bromberger

    This is a great structure, but there is nothing really new here. Foundations have been making PRI’s to social ventures and owning for-profit subsidiaries for a long time. As long as you can deal with self-dealing issues, conflicts of interest, UBIT, and private benefit issues, there is no reason why these can’t be done exactly as described. The more difficult issues tend to arise when the venture needs outside investment and/or when a liquidity event is contemplated.

  • Clary Castrission

    The 40K Group is an Australian organisation that runs a FOSE. The 40K Foundation Australia is a non-profit company limited by guarantee under the Australian Corporations Act. It has tax-deductibility status as an authorised overseas aid funds. The funds it collects funds the development of its education social business in India- delivering high-quality English and Maths through tablet technology.

    The FOSE is a business called 40K Globe. It trains Australian university students in how to build social businesses in India. The profits from the business are channeled into the 40K Foundation Australia. It’s controlling share is held by the CEO/COO of the 40K Foundation, but the profit share is controlled by the 40K Foundation Australia, meaning that the CEO/COO cannot be paid dividends, nor can they sell their controlling interest, without a special majority of the 40K Foundation Australia board (of which they cannot be members).

    We would be more than happy to share further information about the model to give you an international perspective to this important article.