Not-for-profit organizations are in some ways financed much like business organizations. Frequently, not-for-profit organizations borrow money and grant security interests in their property. They also may generate revenue by charging fees for their services, which may support the organization's operating expenses, but which also may be retained as internally generated capital. More frequently than for-profit organizations, not-for-profits may be supported by grants, government funding, and tax-exempt borrowing through state government agencies.
In some circumstances, not-for-profit organizations can also be financed by issuing memberships or, less commonly, shares, that can be resold to or redeemed by the organization. This paper addresses problems that such financing can create under securities laws and suggests how to avoid those problems.
New Hampshire Voluntary Corporation and Federal Tax Provisions.
RSA 292:8 authorizes New Hampshire voluntary corporations to generate funds through "issuance of membership certificates or stock certificates," dues, fees, and by accepting "contributions to capital." Charitable not-for-profit organizations, if qualified under Internal Revenue Code s.501(c)(3), are commonly supported by tax-deductible donations from supporters. Such donations do not "purchase" an interest in the charitable organization, will not be returned to members or shareholders, and upon dissolution, the organization must distribute any net assets to another 501(c)(3) organization. That is true even if the charitable organization provides for "membership" or issues membership certificates or stock in exchange for membership fees or dues.
Aside from the requirement that a s.501(c)(3) organization distribute assets to another s.501(c)(3) upon dissolution, can not-for-profit organizations return member or shareholder contributions as a means of financing?
The Internal Revenue Code prohibits most categories of s.503(c) tax-exempt organizations from allowing any part of their net earnings to inure to the benefit of any private shareholder or individual or require them to devote all net earnings to their tax-exempt purpose (except as a recipient of the services of the organization). However, the Code does not generally prohibit s.503(c) organizations from returning the contributions, membership purchase payments, or share purchase prices (in contrast to "net earnings") to members or shareholders.
Of course, not-for-profit organizations, including 501(c)(3) organizations, frequently borrow money and in exchange issue notes, bonds, and other evidences of indebtedness. As discussed below, those instruments are securities.
Under New Hampshire law, the only limitation contained in RSA 292 is found in 292:9 IV, which prohibits the distribution to a member or shareholder of amounts greater than the member's or shareholder's capital contributions of share purchase price upon dissolution of a non-for-profit corporation.
Though the prospect of financing any not-for-profit organization through refundable "equity" contributions could arise with any sort of not-for-profit venture, as a practical matter, the return of contributions or share purchase consideration rarely arises in connection with non-charitable non-for-profit corporations. The context in which it frequently arises is in the financing of recreational organizations (s.501(c)(7)), and it is here that there is an intersection of tax and securities law.
Financing Not-for-Profit Organizations and Redeemable Contributions.
A complication that will arise if an organization...