Ben's Way Funds Generators leverage the power of compounding over centuries to grow a legacy gift to a significant repeating size. What form of enterprise organization equips us best to deliver our future charitable gifts over such long periods?
Our choice of business formation structure (e.g. charity, trust, corporation, etc.) is an important building block for centuries-long resilience. From the many choices for the business structure of a Funds Generator, donors want the optimal arrangement so their contribution to the future will be:
significant (grows ten times larger in real growth per century),
sound (operates legally in all respects),
strong (resistant to interference), and
flexible (adaptable to change).
By process of elimination, our current best choice is a non-tax deductible For-Profit Corporation (FPC) with its voting shares held in a Perpetual Purpose Trust (PPT).
An FPC held in a PPT structure can grow and deliver scheduled payouts of ever-larger funds to charities chosen by seed funders in perpetuity. But why this approach, and why not one of many other possibilities? What about donor tax receipts?
This article focuses on how and why we choose a particular business structure. We discuss why a particular form may seem ideal and identify the drawbacks. I am not an expert, so I will depend on lawyers and accountants to confirm this proposed approach.
Open to ideas: While this structure is currently our best choice, this is not to say alternative better structures may exist. Let me know if you have a suggestion.
Making a business structure selection
Here are the basic forms I considered candidates for being a Funds Generator.
Charities
Charitable Foundations and Donor Advised Funds
Non-Profits and Associations
For-Profit Corporations and Co-operatives
Trusts
Perpetual Purpose Trusts
Charities
My first thought when I began the journey to create a Funds Generator was to ask charities to invest my money over time and, when significant growth occurs, say every 25 years, to donate a portion and re-invest the rest for the next payout date.
A huge benefit of using charities for our Ben's Way business structure is the ability to issue tax receipts to reduce donors' taxes and that the charity itself does not pay tax on its investment earnings.
But here is the problem: the Canada Revenue Agency (CRA) requires charities to spend at least 5% of invested assets each year, a measure called the 'Disbursement Quota' (DQ).
The DQ delays the seed funds' growth by huge, unacceptably long periods, as shown in Table 1 below. To wait one hundred years to grow by a factor of ten is long enough. Waiting three to four hundred years to augment by a factor of ten is unworkable, it is just too long to build significant gifts. The longer funds take to grow, the more risk of delivering the payouts applies and the lower the appeal to charities and donors.
To express this in today's dollar terms, the 7% example growth rate approximates the average expected portfolio growth of 10% less 3% inflation.
The 2% example takes the DQ 5% away from the 7%, effectively representing the real growth rate for investment funds held within a charity.
Target growth of seed fund contribution | Outside of charities Time to reach target - 7 % example | Inside of charities Time to reach target - 2 % example |
Ten times bigger | 100 years | 350 years |
One hundred times bigger | 200 years | 700 years |
One thousand times bigger | 300 years | 1,050 years |
Table 1 - Years to grow seed funds by factors of 10
Charitable Foundations and Donor Advised Funds
Both charitable foundations and donor advised funds are designed to invest funds received to grow and spread eventual use as donations over time. Could this approach be the answer?
The same CRA 5% DQ rule applies, so using foundations for this business structure won't work because of fund growth delays.
Note that some Donor Advised Funds Providers currently can allow individual DAF accounts to grow and avoid the DQ since the overall DQ reaches the required level. This subterfuge works only on a small scale but won't be workable when the overall fund size becomes huge, especially if several DAFs want this. The government may curb this loophole as it already sees, with the rapid growth of DAFs, how charities increasingly want the tax-incented money spent now, not later.
Donor tax deductions
Charities and Foundations are the only organization structures able to issue a receipt to save donors on tax. An unfortunate effect of using a non-charity business structure is that seed fund contributions will not be deductible.
Charitable tax incentives can be approximated as a 'two for the price of one' marketing ploy. However, Ben's Way Funds Generators seed funders eventually get 'ten for the price of one' (within one century), with many more gifts to come. Who gets the better deal? Who may make a bigger impact?
Even with two-for-one deals, a donor must pay for one. If tax deductibility is a show-stopper issue, ask the donor to give half of what they wanted. Effectively this is an 'instant tax-back' donation. And the eventual donations are just as big after just one doubling of the growth of the funds, a mere 15 years later.
Non-Profits
Non-profit organizations provide a social or charitable benefit to the community. They usually offer a service or program to the public for free or at a low cost. They usually do not pay taxes on their income and reinvest their surplus in their mission or cause.
No one 'owns' a non-profit enabling a stability of purpose for the long term.
While a non-profit business structure seems suitable for seed fund contributions, the issue is that they are not allowed to accumulate large amounts of capital. A non-profit can have a surplus in a given period if it is used for the organization’s purpose and not for the personal benefit of its members, directors, or officers.
As the Ben's Way Funds Generator intends to amass large capital funds over centuries, a Non-Profit business structure is officially not appropriate. I say 'officially' because once the Funds Generator operates sustainably, annual surpluses can be added back to the mission of the growing fund portfolio, as a non-profit would do.
Associations
Associations are groups of people who share a common interest, goal, or cause. They are usually not for profit and do not distribute any surplus to their members.
Similar to non-profits, associations seem quite suitable for seed fund contributions. They support their community. However, this form is also not allowed to accumulate large amounts of capital, and the capital must be for the benefit of the association, not other charities.
For Profit Corporations
For-profit organizations are businesses that aim to earn income and profit for their owners, shareholders, or employees. They usually provide a product or service to customers and charge a price for it. They pay taxes on their income and distribute their profits according to their ownership structure.
A for-profit structure is allowed to accumulate capital, which is encouraging. Also positive is that corporations can exist for a perpetual period. However, a concern in our growth projections is that investment income received by a corporation is taxed at the highest rates.
Most concerning is that voting shareholders control the disposition of For-Profit Corporations. Conceivably a Funds Generator's shareholders could liquidate the company and pocket the proceeds. This cannot happen!
Co-operatives
Cooperatives are businesses that are owned and controlled by their members, who use the products or services of the cooperative. They are usually for-profit and distribute their surplus to their members based on their patronage or participation.
Cooperatives are allowed to accumulate capital, but if the accumulation of capital becomes more important than the satisfaction of members' needs and interests, members may insist that it be liquidated. The bylaws of a cooperative may insist all capital grow until scheduled charity payouts occur. Still, if members can alter the bylaws, then a method and incentive exist for members to cash in the funds.
Trusts
Trusts are a legal concept that originated in medieval England and evolved into a common and versatile way of managing property and assets for various purposes.
Trusts are based on the idea that one person (the settlor) can transfer the legal ownership of property or assets to another person (the trustee) who is obliged to use them for the benefit of a third person (the beneficiary) or a specific goal (the purpose). Trusts often provide more flexibility in defining charitable objectives and may have fewer reporting and compliance requirements.
Once assets are transferred into the trust, they become irrevocable, meaning the donor relinquishes control over them. The trustee controls the assets and ensures they are used for designated charitable purposes. The trust's beneficiaries are the charitable causes specified in the trust's governing documents.
Conceptually a trust seems a good potential host for Ben's Way Funds Generator. A trust's purpose can be the payouts by the trust to the charities chosen by seed contributors (who are the 'settlors'). The trustee can be held to account by both the settlor while alive and the charities as beneficiaries after the settlor dies.
However, in many jurisdictions, the 'law against perpetuities' applies. The rule states that the trust must have a definite end date or a condition that will terminate the trust within a reasonable period, often 21 years. The rule aims to prevent the creation of perpetual trusts that would tie up property and assets indefinitely and prevent their use by future generations.
Canadian tax requirements add a "deemed' disposition, which effectively requires a trust to pay tax on all unrealized capital gains every 21 years. The effect of this tax payment is to reduce the amount of funds in the portfolio, thereby reducing the annual compound growth. This lower growth lengthens the years to grow to a significant size.
Some jurisdictions, such as the State of Delaware in the US, permit perpetual trusts and do not impose a deemed disposition tax.
Perpetual Purpose Trusts
Perpetual Purpose Trusts (PPTs) are established as trusts where assets are held by a trustee for the benefit of specific charitable purposes indefinitely or for an extended period.
PPTs are a relatively new and innovative legal form that can be used to create shared ownership models for businesses, real estate, land, and other assets. They can help protect the mission and values of an organization from external pressures or changes in ownership.
The Patagonia Example
Patagonia is a well-known outdoor clothing and gear company that was founded by Yvon Chouinard in 1973. Patagonia is strongly committed to environmental and social responsibility and the quality and durability of its products. Patagonia’s mission statement is: "We’re in business to save our home planet."
In 2022, Chouinard announced that he had transferred the ownership and control of Patagonia to a perpetual purpose trust. The purpose of the Patagonia Perpetual Purpose Trust is to protect and preserve the company’s purpose, values, and independence and to support its environmental and social initiatives. The trust holds all the voting shares of Patagonia, but none of the economic shares, which means that it can make decisions about the company’s strategy and governance but not receive any dividends or profits from it.
The economic shares of Patagonia are held by a non-profit organization called the Holdfast Collective, which was also established by Chouinard. The Holdfast Collective receives all of Patagonia's distributed profits, estimated to be around $100 million per year. The Holdfast Collective uses these funds to support various causes and projects related to climate change and land conservation worldwide. The Holdfast Collective also has the power to appoint and remove members of the trust stewardship committee, which is the group of people who manage and oversee the Patagonia Perpetual Purpose Trust.
By using a perpetual purpose trust to establish a long-term ownership plan for Patagonia, Chouinard has ensured that his vision and legacy for the company will continue even after his death or retirement. He has also prevented any potential takeover or sale of the company by external investors or competitors, who might compromise or dilute its mission and values. He has also empowered his employees and customers to participate and benefit from the company’s success and impact. He has also created a model and inspiration for other businesses that want to pursue a purpose-driven approach to their operations
Conclusion:
The drawbacks of each basic structure lead this author to speculate the best approach to the Ben's Way Funds Generator is for some hybrid form, such as the road taken by Patagonia.
At this moment, I foresee a for-profit corporation doing the fundraising, investing and payouts, with a trust holding their voting shares. A for-profit can accumulate capital, avoid the 5% DQ, enter into contracts, and exist perpetually. A perpetual purpose trust holding the shares can prevent the risk of a for-profit being sold to abscond with the funds.
Many more details need to be addressed, but I remain optimistic this interaction of the two entities can ensure the significant, sound, strong, and flexible business structure required.
Time will tell what the actual form of business structure will prevail.
Notes:
A prior article, 'Designing for Security, Trust, Resilience and Flexibility (STRF),' addresses the overall functioning of such an enterprise.
Photo by Bermix Studio on Unsplash