Did you know that OpenAI, the company behind ChatGPT, is structured as a nonprofit? On a recent episode of The Accounting Podcast, I shared how this setup may cost OpenAI's founders and investors billions to fix.

At the top, we have OpenAI Inc., a Delaware 501(c)(3) nonprofit, which controls OpenAI GP LLC—the general partner managing the for-profit entities OpenAI LP and OpenAI Global LLC.

Microsoft's initial $13 billion investment went into OpenAI Global LLC, giving them 49% ownership but with a catch: a profit cap limiting returns to 100 times their investment.

So, a $10 million investment could return a maximum of $1 billion—not chump change, but potentially just a fraction of what's possible given OpenAI's groundbreaking AI technologies.

The most recent $6.6 billion investment went into OpenAI LP, which also carries the same 100x profit cap. Investors and founders are eyeing the limitless potential beyond this cap, and that's pushing OpenAI to consider moving away from their nonprofit roots.

My co-host David Leary joked that you could "drag the circle" representing the nonprofit control out of the diagram to solve the issue. If only it were that simple. Rules exist to prevent organizations from dodging taxes by flipping between nonprofit and for-profit statuses.

That's where it gets tricky. Transferring assets from a nonprofit to a for-profit isn't straightforward. The law requires for-profit entities to pay fair market value (FMV) for those assets.

So, what is the FMV? That's a good question. It should include the value of the nonprofit's control over the for-profit entities and the expected future cash flows of any profits in excess of the 100x profit cap in the for-profit entities.

Investors in the recent $6.6 billion fundraising are valuing OpenAI at $157 billion. Should $157B be the FMV? That would be a lot to pay to unlock the profit cap!

It's more complicated because OpenAI reportedly loses about $5 billion per year. So, if this deal is contingent on tens of billions going to the nonprofit, it could take investors a long time to see any benefits.

OpenAI's initial entity structure, meant to align with altruistic goals, is now a significant hurdle as it scales. The investors have no control due to the nonprofit's overarching authority, and unlocking the company's full profit potential requires navigating complex legal and financial obstacles.

It's a wild situation that highlights how crucial entity structuring is from the start.

So next time you have a client who made a basic entity selection mistake, you can help them feel better by pointing out that they're better off than OpenAI's founders.