OpenAI is considering transitioning 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 frees OpenAI to focus on profits will likely benefit Microsoft’s investment in the company,” said Sarah Kreps, director of the Technology Policy Institute at Cornell University’s Brooks School of Public Policy.
A reconfigured corporate structure would give Microsoft the opportunity to renegotiate its already generous earnings cap, as well as scrap a provision that denies Microsoft an interest in the artificial general intelligence (GAI) created by OpenAI, according to another observer.
“[OpenAI] “is clearly saying that the nonprofit will no longer have control, so presumably that means Microsoft and other investors will have more of a say in what OpenAI does,” said Rose Chan Loui, founding executive director of the Lowell Milken Center for the University of California, Los Angeles for Philanthropy and Nonprofit Organizations.
But there are potential downsides for Microsoft as OpenAI tries to shed its charitable cloak.
OpenAI’s huge valuation, labyrinth of for-profit subsidiaries and potentially risky technology make a for-profit shift legally and publicly complicated, and could draw opposition from regulators.
Still, OpenAI investors see many advantages. On Wednesday, the company announced it raised about $6.6 billion in its latest funding round, valuing the Sam Altman-led company at $157 billion. However, that valuation largely depends on OpenAI becoming a for-profit entity.
Whirlwind of change
OpenAI is in the midst of a whirlwind of change.
It is experiencing a prolonged executive exodus that includes, most recently, the departure of chief technology officer Mira Murati. It also faces increased competition from rivals such as Google (GOOG, GOOGL) and Amazon-backed Anthropic (AMZN).
Reclassification to a for-profit structure would be another seismic shift for OpenAI, upending the way it was established nearly a decade ago.
It began in 2015 as a nonprofit under the name OpenAI Inc., a nod to its mission of advancing humanity rather than seeking profit.
“The corporation is not organized for the private benefit of any person,” OpenAI’s certificate of incorporation said in its organizational documents, along with a promise to keep its technology open source for public benefit.
Things evolved in 2019 when OpenAI CEO Sam Altman and his team created a for-profit subsidiary to raise outside venture capital, including billions from Microsoft.
It was structured in such a way 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 its largest sponsor (Microsoft) He had no seats on the board of directors. and without voting power.
The inherent tension between these two parts of the company is what contributed to a dramatic boardroom clash in 2023, when Altman was ousted by the board and then reinstated five days later.
Microsoft subsequently took a non-voting observer position on OpenAI’s board of directors, only to resign from that position this year when both OpenAI and Microsoft came under increased regulatory scrutiny.
The idea of changing the current structure has already attracted the interest of US and European regulators and exacerbated an ideological divide between scientific and business leaders who warn that machine learning technologies like those developed by OpenAI must remain accessible to the public.
They argue that the technology represents an existential threat to humanity and should therefore be operated 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 into concerns that AI market consolidation is “distorting innovation and undermining fair competition.”
And there have been multiple calls for California’s attorney general to investigate the legality of OpenAI’s business structure. One came from Elon Musk, who co-founded OpenAI with Altman. It sued OpenAI, Altman, and 21 named OpenAI subsidiaries.
Musk said the defendants fraudulently promised that his $100 million in investments in OpenAI would be used for public benefit.
A transition of OpenAI to for-profit status could also attract the attention of the Internal Revenue Service, given that OpenAI was granted tax-exempt status as a charity.
‘Did they get fair market value?’
One unknown is the extent to which Microsoft will be able to directly profit from its investments.
By law, a nonprofit must use its assets only for its stated charitable purposes. And OpenAI’s assets, which include all of OpenAI’s subsidiaries, cannot be sold for less than fair market value.
The question regulators will want to confirm is: “Did they get fair market value for the asset at that time?” said Gene Takagi, principal at NEO Law Group.
Chan Loui added that regulators would require OpenAI to realistically value its assets, including residual interests. And he suspects that figure may exceed OpenAI’s latest valuation.
“I think the biggest sensitivity is probably the way they take control away from nonprofits,” he said. “And I think your best option to avoid conflicts related to restructuring is to sufficiently compensate the nonprofit,” Chan Loui said.
“I think that’s the best way to get the public on your side, the states on your side and the IRS on your side.”
What OpenAI is expected to do as part of its transition is register as a public benefit corporation.
These entities are like traditional corporations, but with more freedom to spend on civic initiatives, according to Rick Alexander, a veteran corporate structuring lawyer and founder of Shareholder Commons.
“It’s a permitting structure,” Alexander said.
Other public benefit corporations include Elon Musk’s xAI, Warby Parker (WRBY), Allbirds (BIRD), Lemonade (LMND), and Etsy (ETSY).
And building on the success of Musk’s xAI, OpenAI could benefit greatly from the change. In May, xAI raised $6 billion.
“This type of transition can quickly generate considerable investor interest,” Kreps said. “This is 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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