OpenAI is considering its transition from a nonprofit to a for-profit company, and its deep-pocketed benefactor Microsoft (MSFT) has a lot to gain if the ChatGPT developer gets the green light to act more like a startup.
“Anything that gives OpenAI room to focus on profits is likely to benefit Microsoft’s investment in the company,” said Sarah Kreps, director of the Tech Policy Institute at the Brooks School of Public Policy at Cornell University.
A reconfigured corporate structure would give Microsoft the chance to renegotiate its already generous profit cap, and to set aside a provision that Microsoft denies an interest made in OpenAI general artificial intelligence (GAI), according to another observer.
“[OpenAI] clearly says the nonprofit will no longer be in control, so presumably that means Microsoft and other investors will have more say in what OpenAI does,” said Rose Chan Loui, founder and executive director of the University’s Lowell Milken Center of California Los Angeles. Philanthropy and Nonprofits.
But there are potential problems for Microsoft as OpenAI tries to shed its charitable mantle.
OpenAI’s enormous valuation, its labyrinth of for-profit subsidiaries, and its potentially risky technology make a for-profit move legally and publicly complicated — and could prompt backlash from regulators.
Still, OpenAI’s investors see a lot of upside potential. On Wednesday, the company announced it had raised about $6.6 billion in its latest funding round, valuing the Sam Altman-backed company at $157 billion. However, that valuation is largely dependent on OpenAI becoming a for-profit entity.
Whirlwind of change
OpenAI is in the midst of a whirlwind of change.
The country is experiencing a prolonged management exodus, including most recently the departure of Chief Technology Officer Mira Murati. It also faces increasing competition from rivals including Google (GOOG, GOOGL) and Amazon-backed (AMZN) Anthropic.
The reclassification to a for-profit structure would be yet another seismic shift for OpenAI, upending the way it was founded nearly a decade ago.
It started in 2015 as a nonprofit organization under the name OpenAI Inc., a nod to its mission to advance humanity rather than pursue profit.
“The company is not organized for the private benefit of anyone,” OpenAI’s certificate of incorporation reads in the organizational documents, along with a pledge to keep its technology open source for public benefit.
Things evolved in 2019 when Sam Altman, CEO of OpenAI, and his team established a for-profit subsidiary to attract external venture capital, including billions from Microsoft.
It was structured so that the for-profit subsidiary, technically owned by a holding company owned by OpenAI employees and investors, remained under the control of the nonprofit and its board of directors, while the largest funder (Microsoft) was denied board seats . and no voting rights.
The inherent tension between these two parts of the business contributed to a dramatic boardroom clash in 2023, when Altman was ousted by the board and brought back five days later.
In the aftermath, Microsoft took a non-voting observer position on OpenAI’s board, only to relinquish that seat this year as both OpenAI and Microsoft came under increased regulatory scrutiny.
The idea of overturning the current structure has already attracted the attention of US and European regulators and exacerbated an ideological divide between scientific and business leaders who warn that machine learning technologies such as those developed by OpenAI should remain accessible to the public.
The technology, they argue, poses an existential threat to humanity and should therefore be used in a way that is subject to public scrutiny.
OpenAI and Microsoft are also part of an ongoing investigation by the US Federal Trade Commission about concerns that AI market consolidation “distorts innovation and undermines fair competition.”
And several to call to action were created for the California Attorney General to investigate the legality of OpenAI’s corporate structure. One came from Elon Musk, who co-founded OpenAI with Altman. He sued OpenAI, Altman and 21 named OpenAI subsidiaries.
Musk said the defendants fraudulently promised that his $100 million in OpenAI investments would be used for public benefit.
A transition of OpenAI to for-profit status could also draw the attention of the Internal Revenue Service, as OpenAI has been granted tax-exempt status as a charitable organization.
“Did they get fair market value?”
An unknown question is to what extent Microsoft will be able to generate immediate profits from its investments.
By law, a nonprofit organization may use its assets only for stated charitable purposes. And OpenAI’s assets, including all OpenAI subsidiaries, may not be sold for less than fair market value.
The question regulators will want to answer is, “Did they get a fair market value for the asset at the time?” said Gene Takagi, principal at NEO Law Group.
Chan Loui added that regulators would require OpenAI to realistically value its assets, including residual interest. And she suspects this figure may be higher than OpenAI’s last valuation.
“I think the biggest sensitivity is probably in the way they take control away from the nonprofit,” she said. “And I think their best chance to avoid conflict around restructuring is to adequately compensate the nonprofit,” Chan Loui said.
“I think this is the best way for them to get the public on their side, the states on their side and the IRS on their side.”
What OpenAI is expected to do as part of the transition is register as a public benefit corporation.
Such entities resemble traditional corporations but have more freedom to spend money on grassroots initiatives, said Rick Alexander, an experienced corporate structuring attorney and founder of the Shareholder Commons.
“It’s a consent structure,” Alexander said.
Other public organizations include Elon Musk’s xAI, Warby Parker (WRBY), Allbirds (BIRD), Lemonade (LMND), and Etsy (ETSY).
And based on the success of Musk’s xAI, OpenAI could benefit significantly from the change. In May, xAI raised $6 billion.
“This type of transition can quickly generate significant investor interest,” Kreps said. “This is such a capital-intensive industry, so anything OpenAI can do to attract investment will act as a positive feedback loop and accelerate its benefits.”
Alexis Keenan is a legal reporter for Yahoo Finance. Follow Alexis on X @alexiskweed.
Email Daniel Howley at dhowley@yahoofinance.com. Follow him on Twitter at @DanielHowley.
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