Introducing a New Startup Financing Model for Social Ventures: Net Income Participation Certificates

Social Entrepreneurship has shown that there is a middle way between outright profit seeking, and outright shunning of service revenue models of many nonprofits. Many U.S. social entrepreneurs may wish to start their venture as a 501(c)(3) so they can focus on the mission of their work ahead of the money. But, nonprofits have much more difficulty getting startup capital. While for-profit corporations can float equity as stocks in their business, nonprofits are usually public benefit corporations that have no actual owners, and hence no equity to sell. And getting loans is risky for both the borrower and the lender. And it again forces the nonprofit to focus on money first, to pay back the loan.

What if there could be a model for gaining startup funding that was equity-esque? This would be a model where there could be investment into the nonprofit corporation for returns on investment, but not an ownership of the nonprofit, since that is illegal.

This is the conundrum I've been diligently working to solve over the past several months, and now I have found the answer: Net Income Participation Certificates. These are modeled after the Swiss Participation Certificate, where investors can purchase future profit of a company, without having any votes or say in how the company is ran, nor any actual equity in the company. Net Income Participation Certificates (NIPCs) would do the same, when purchased, they would give the holder the rights to a percentage of the net income of the non-profit organization, based upon a ratio of how much they paid for the NIPC, compared to the total valuation of the nonprofit corporation.

There are of course important pitfalls to avoid with these. First, Private Inurement must be avoided, so no one who has any control or influence on the nonprofit could purchase the NIPCs. Also, there is an important question about ensuring that gain by the NIPCs is for charitable purposes.

Further, it would be important that those who direct the nonprofit, do not game the system to lower net income to try and pay less in the future on these, and thus the net income must be calculated excluding the pay of those who have control over the nonprofit, and excluding saving money in rainy day funds.

As a case study, I plan to have TutorONE gain much of its startup capital through NIPCs. The venture has a good business model that will ultimately generate net income, but it also needs to have the flexibility to not worry about paying back loans in the first few years of operation. NIPCs will fit this need well. Further, they will be a good fit for investment from Individual Retirement Accounts (IRAs), because they give the opportunity for lifelong revenue generation, and because there is no control endowed by the NIPC, it will not break any IRA rules. Further, with the stock market and other investments going haywire, this could be safer and more financially beneficial in the long-term, while also providing the investor with the knowledge that it is also an impact investment that is doing good for the world.

Note: This article has been modified from the original publishing, to update to current circumstances, based on current knowledge.

#Nonprofit #Innovation #ImpactInvesting #FinancialEngineering #NIPC