Business Operations

Reevaluating Legal Structures

What should you do if your legal structure is preventing growth?

 

About CHP and Solutions SF

Founded in 1990, Community Housing Partnership (CHP) is an award-winning San Francisco nonprofit dedicated to helping homeless people secure housing and become self-sufficient.  By providing high-quality housing together with comprehensive services, CHP empowers formerly homeless individuals and families to rebuild their lives.  CHP currently owns, manages and/or provides support services in 16 buildings in San Francisco, housing more than 1,500 formerly homeless individuals.

CHP’s social enterprise, Solutions SF, was founded in 2007 to provide supportive employment to its tenants as a next step beyond their existing job training programs.  By providing a “stepping stone” between job training and a market-rate job with no support, Solutions SF’s main goal is to help formerly homeless individuals more successfully get employed, and stay employed, in career-path jobs.

Currently, Solutions SF hires formerly homeless individuals who have graduated from their job training program into 15-month transitional jobs as desk clerks, staffing the front desks of multi-unit affordable housing buildings in San Francisco.  Included with the job are support services and assistance finding permanent jobs.

Social mission has always been the primary goal and driver for Solutions SF, so the decision was made in the beginning to keep the social enterprise as a program of the parent nonprofit, rather than a separate entity.  Laurie Bernstein, CHP’s Director of Social Enterprise and Workforce Services, notes that “without the social mission, Solutions SF would not exist.”  From a management standpoint, CHP also did not want the hassle and cost of managing a separate entity when the business model itself was not yet proven.

Luckily, the business was more successful than they imagined.  Solutions SF is now a thriving business with $2 million in annual sales, and receives excellent reviews from satisfied customers.  Perhaps more importantly, Solutions SF has trained and employed hundreds of formerly homeless individuals since its inception.  Many have since found permanent employment in property management and other related careers.  In fact, customers often love their Solutions SF desk clerks so much that they are hired away as permanent employees before they complete their 15-month term as a Solutions SF employee.

 

Situation:  Growing Pains and Contract Negotiations

Solutions SF’s growth and success did not come without challenges.  Early customers of Solutions SF were often smaller-scale peer nonprofits, offering contracts with straightforward terms requiring little if any negotiation.  However, the next stage of growth involved larger contracts of 10 to 20 buildings, often managed by professional property management entities with very different requirements and ways of working.

In 2014, Solutions SF found itself reconsidering its legal structure due to contract issues.  At stake were large contracts with two different national property management entities, each with the potential to create dozens of jobs.  Unfortunately, contract negotiations had reached an impasse with both due to liability language.

Customer #1 wanted Solutions SF to accept extremely broad liability language related to negligence, even beyond potential incidents that could be controlled by the front desk clerk).  CHP was not willing to accept such broad liability, and the customer was not willing to budge.  There was much at stake – as a supportive housing developer and manager, CHP itself owns and manages millions of dollars of property across San Francisco.

Customer #2 also had concerns about liability language.  CHP had a good relationship with the local affiliate, who very much wanted the contract to proceed and was willing to negotiate, but legal counsel at the national office pushed back against any contract language modifications.

In both cases, Solutions SF wanted to strike the right balance between protecting CHP’s assets and winning the contracts.  According to Bernstein, “we wanted to grow and create more jobs, but not at the cost of putting all of CHP at risk.”

 

Options and Tradeoffs

In order to move the negotiations forward, Solutions SF considered both contractual and restructuring options.

Contractual options

Contractual options involved negotiating changes in contract language to be mutually agreeable to both parties.  The easiest option: imposing a cap on the liability, or making the liability mutual – that is, if the customer would agree to it.  A more expensive option would require Solutions SF to carry liability or other insurance beyond what they already have.  However, it was unclear whether it was even possible to cover the full extent of the assets potentially at risk.

Restructuring options

Restructuring options would have involved separating Solutions SF as a distinct legal entity from CHP, but still wholly owned by CHP.  The only legal structure option seriously considered by CHP was an LLC (limited liability company).  By definition, LLCs are intended to protect owners’ personal assets from business liability, thus providing flexibility for the business to take needed risks.  No other legal structures were considered by Solutions SF at the time, given that the LLC structure seemed to be the most obvious fit for their needs.

 

So what happened?

In the end, CHP senior management decided that Solutions SF should remain a nonprofit program of CHP (and not form a separate LLC) for several reasons:

Liability protection

CHP senior management was not convinced that an LLC structure would provide full protection from a very litigious customer.  Even if an LLC were to increase their likelihood of winning a lawsuit, the win would come at a high cost to CHP in terms of legal fees and time.

Cost and complexity

Given the above, CHP management did not have the appetite for taking on the significant additional complexity of governance and costs associated with creating and maintaining a separate LLC.

Social enterprise business model

Separating Solutions SF as a distinct entity from CHP could be detrimental both to Solutions SF’s business and its social mission, as well as to CHP.  According to Bernstein, “the desk clerk training program, which is subsidized by CHP, is now very intertwined with Solutions SF’s desk clerk staffing business.  We redesigned the training program specifically to meet the needs of the business as well as the employees. Operationally and financially, Solutions SF would not survive in its current form if it legally separated from CHP.”

Relationship with CHP

Programmatically, CHP depends on and has benefitted from Solutions SF in many ways.  Bernstein notes that “Solutions SF is now the main component of CHP’s workforce development strategy, and many of CHP’s workforce innovations have come from Solutions SF.”

In the end, both contract negotiations came to a conclusion before a restructuring was even possible.

Ultimately Solutions SF was not able to reach an agreement with Customer #1, who was unwilling to accept any changes to its liability language. Instead, the contract was awarded to a local mom-and-pop administrative training and staffing company structured as an LLC.  “Unlike CHP, they had no problems assuming such broad liability since they had no real assets,” noted Bernstein.  “The customer would have no reason to sue them, since they would have nothing to gain.”  However, in a twist of fate, Solutions SF is back in the picture.  The mom-and-pop company, facing a shortage of qualified trainees for the contract, has now partnered to hire Solutions-trained desk clerks.  This arrangement doesn’t necessarily help Solutions SF’s business bottom line, but it very much aligns with their social mission.

In the case of Customer #2, Solutions SF benefitted from its relationship with CHP. In a separate transaction unrelated to this contract, CHP hired Customer #2 to manage some of their own properties.  Wanting to maintain a good relationship with CHP, Customer #2’s senior management ultimately decided to meet Solutions SF halfway on contract language, and move forward with the contract.  The end result?  Jobs for dozens of desk clerks, and a happy and satisfied customer.

 

What’s next?

Is there a scenario where CHP would ever consider a different legal structure for Solutions SF in the future?  “Yes, but not right now” says Bernstein.  “Right now, our biggest issue is not lack of contracts, but lack of people power. Since the economy has picked up, we are having a harder time finding and keeping trained people for the desk clerk jobs, which is great for the employees but not for us.  And we’re not the only ones.  Our customers are also having the same issue, which is why they call us!”  As a result, Solutions SF has had its choice of customers willing to work with them on their terms.

But this could change in the future.  If the economy took a downturn, and contracts again became the constraint to growth, Solutions SF may be open to considering a different structure if it helped win more contracts – as long as it could be done without compromising their business model and, more importantly, their social mission.

 

REDF would like to thank Esther Kim of Esther Kim Consulting for leading the research and development of this case study.

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