Hybrid Business Models: Possibilities and Pitfalls
Today’s NY Times features a sloppy article on the “snags” associated with non-profit/for-profit hybrid business models. I’m thrilled that the mainstream media is talking about this stuff, since it’s been a favorite subject of mine for years, but the reporting is rife with factual errors and dubious conclusions.
First, call me a nitpicker, but I’m really tired of people referring to the L3C as the “LC3″. I realize people are getting their wires crossed because of an impulse to establish a parallel to the the 501(c)(3), but enough is enough. L3C stands for Low-Profit Limited Liability Company. There are 3 Ls and 1 C. This isn’t rocket surgery, folks. If you’re writing an article about hybrid for-profit/non-profit business models, it’s a good idea to get the name right for the most important, highly publicized hybrid business form to emerge in years, if not ever.
More substantively, the article erroneously reports that the Freelancers Insurance Company is owned by members of the non-profit Freelancers Union. It took me a single Google search to confirm my instinct that the the insurance company is actually a wholly owned subsidiary of the Freelancers Union itself. This is a non-trivial distinction, since members of the Freelancers Union don’t have any meaningful control or ownership over either the non-profit parent or the for-profit subsidiary. (I’m not saying they necessarily *should* have such control or ownership, but it’s a little goofy that the reporter’s one example of a successful hybrid model is predicated on factual inaccuracies.)
But my real beef is that the article seems to imply that the prominent failure it cites - GlobalGiving and ManyFutures Inc. - was somehow a function of the hybrid structure itself. I don’t claim to know what happened behind the scenes in that particular case, but check this out:
[GlobalGiving] sent approximately $10 million in payments and loans that were never repaid to a company, ManyFutures Inc., that was largely owned by GlobalGiving’s founders, Mari Kuraishi and Dennis Whittle, former World Bank executives turned social entrepreneurs.
ManyFutures provided the technology platform on which the GlobalGiving Web site operated, and which it hoped to sell to others. But the company never broke even, even though it paid nothing for the platform, which had been donated to ManyFutures. In late 2008, GlobalGiving converted its loans into ownership of the company, paying Ms. Kuraishi and Mr. Whittle just $12,000 for their stakes.
They had invested $1.4 million. “I lost a large majority of my net worth doing this,” Mr. Whittle said. “It’s been personally very painful.”
Excuse me?? I’m sorry, but that reeks of either fraud, incompetence, or both. Possibility #1 is that the owners were effectively embezzling millions of dollars (perhaps by simply being grossly overpaid for their work on behalf of ManyFutures), in which case the Board of GlobalGiving failed colossally in its fiduciary duties. Possibility #2 is that everyone involved was so clueless that despite an abundance of resources they still managed to drive the enterprise into the ground. Either way, the hybrid structure appears to be a total red herring.
Look, I’m not saying this stuff is simple. Hybrid models are complex - legally, financially, and ethically. Those of us advocating for such approaches need to be candid and transparent about our own experiences. Fractured Atlas formed a for-profit subsidiary in 2003. The company - Gemini SBS - was formed primarily to leverage Fractured Atlas’s expertise in web-based software development by offering those services to other non-profits and government agencies. There was also a strategic benefit in having such a close relationship with - and an ownership stake in - a software development subcontractor. Fractured Atlas has done a ton of software development over the years, and Gemini SBS has allowed us to ramp up and scale back capacity as needed without having to go through the expensive and time-consuming process of hiring and firing programmers every few months. (When Fractured Atlas’s demand for software engineering ebbs, Gemini SBS simply shifts focus to its other clients, like the US Department of Education.) In addition, having a meaningful ownership stake in our biggest vendor means that Fractured Atlas gets some of its money back when Gemini SBS distributes profits to its shareholders.
Have we run into pitfalls and complications with this arrangement? Absolutely! One of the trickiest problems we’ve faced was when it became clear that Gemini SBS was having trouble attracting and retaining top-notch talent when it had to compete against a bunch of start-ups that could offer equity and stock options to their hires. We went through an excruciatingly complex process that resulted in Fractured Atlas exchanging 60% of its ownership stake in Gemini SBS for a large amount of debt from the company. That 60% was then purchased by three key Gemini SBS employees at something approximating fair market value (full disclosure: I’m one of the three). To be certain that everything was absolutely ethical and beyond reproach, we erred on the side of overpaying for our shares.
Fractured Atlas’s complex relationship with Gemini SBS - and the delicate ethical issues that stem from my insider status as both companies - requires that our Board exercise due diligence in monitoring that relationship over time. We also need to be totally transparent with our funders when some portion of grant funds will end up being paid to Gemini SBS for its work on a project. But the point is that these are solvable problems!
I would never for a minute claim that hybrid models are a panacea or that they remove the burden of managerial competence. Please don’t create 6 interconnected organizations when you only need 1. However, when there are compelling benefits to realize from a complex structure under common oversight, then we as a field can’t afford to be scared off by uninformed fear mongering like that NY Times article.