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Before jumping into becoming a nonprofit institution, proprietary colleges and universities should consider the short- and long-term ramifications.

Preparing for transition

Higher Education: Five Things to Know About Converting to a Nonprofit

  • 5/1/2014

There has been a resurgence in proprietary schools considering converting to nonprofit status as the U.S. Department of Education’s “gainful employment regulation” awaits finalization. At first this may seem like one of the few options available to schools facing potentially punitive government performance standards, but there are some broad considerations you should explore before making a decision.

The gainful employment regulations propose to measure the quality of an educational program based on the debt load of its students relative to the student's earnings and the student loan default rates. The idea is to better prepare students for gainful employment without saddling them with debt. Any school not meeting the standard would lose access to federal grants and loans for students. The regulations would be applied to all programs meeting the criteria at proprietary schools, colleges, and universities, and certificate programs meeting the criteria at private, nonprofit, and public colleges and universities.

The Education Department expects that the regulations, as currently drafted, could adversely affect about 29 percent of the programs they cover, with the bulk of these programs at proprietary schools. But before jumping headlong into becoming a nonprofit institution, proprietary colleges and universities should consider some of the short- and long-term ramifications.

1. It’s not a quick and easy process

The first thing to know is that converting is not an easy or short process. The transition could be made by either filing Form 1023 to create a new 501(c)(3) organization, which could take 16 months or more to get approved, or by finding an existing nonprofit organization to acquire the assets of your school. In either case, you have to consider the approvals by everyone from the Education Department to the selling institution’s accrediting body.

Life will be much easier if you have already identified an existing, accredited nonprofit higher education institution as the buyer. If you have not, there are a whole host of other things to consider as you search for a partner.

2. Acquisition by a nonprofit is rare

It is uncommon, although not unheard of, for a nonprofit organization to acquire the ownership interests of a for-profit organization. Generally, a nonprofit would only acquire the assets of a for-profit entity. In the case of a school, that would mean hard assets and intangibles (programs and curriculum, people, intellectual property). A school's Office of Postsecondary Education (OPE) identification number (which makes it eligible to participate in Title IV programs) and accreditation would transfer through a change of ownership process.

Therefore, if the nonprofit buyer is not an existing, accredited, Title IV-eligible educational institution, there are significant steps to complete the transaction, which will increase the time it will take to become a nonprofit organization. In addition, if the nonprofit acquires assets using a long-term note, it may need to obtain a letter of credit since long-term debt would adversely affect the composite score (a measure of financial health required by the Education Department) of the nonprofit.

3. Nonprofits must be very transparent

Nonprofit organizations are required to operate in a very open and transparent environment. By law, financial information and tax returns are available to the public. Such scrutiny is generally foreign to proprietary institutions and would take some getting used to.

4. Being nonprofit means giving up control

Nonprofits are governed by an independent board that is hand-picked at start-up but that will change over time through elections and appointments. Once an organization becomes a nonprofit, the board takes over control of many decisions, such as hiring the chief executive or determining mission and purpose. 

5. Compensation rules are strict

Fairly stringent rules govern compensation for services in a nonprofit organization. These rules generally require that compensation be reasonable and fair and, where necessary, based on independent data such as salary surveys. Any compensation that is considered unreasonable may be subject to an excise tax and, in severe cases, can jeopardize the organization’s tax-exempt status.

These are just five broad considerations and there are many more. These points are not given to discourage proprietary schools from converting to a nonprofit, but rather to give some insight into the practical realities of conversion and operation as a nonprofit. As we await the final regulation, schools considering conversion should engage financial and legal advice to assist them in weighing the pros and cons.