The Chan Zuckerberg Initiative

January 12, 2016       Mark Hrywna      

Is it a charity? Is it a foundation? Is it a private company? Or, could it be just a huge tax dodge? Whatever it is, it’s bigger than what Bill and Melinda Gates started their eponymous foundation with in 2000 and bigger than what Warren Buffett donated to the Gates’ foundation in 2006.

“It” is the Chan Zuckerberg Initiative (CZI). Facebook founder Mark Zuckerberg and his wife Priscilla Chan have gotten tongues wagging since the Dec. 1 announcement that they would be giving away 99 percent of their shares in Facebook (currently worth $45 billion) during their lifetime to establish the organization. They made the an­nouncement via Facebook on the occasion of the birth of their daughter, Max, outlining their intentions in a 2,246-word open letter to her. Max was born a week earlier, weighing 7 pounds, 8 ounces.

The fact that CZI was established as a limited liability corporation (LLC) and not a charitable trust or a foundation has ob­servers wondering about the next move. Zuckerberg said he plans to dispose of more than $1 billion of Facebook stock each year for the next three years, which will not impact his status as controlling stockholder of the social media Goliath. His role as chairman and CEO of Facebook also will not change. Their Face­book shares, or the net after-tax proceeds from the sale of shares, will be used to ad­vance the mission, and the couple will decide together how best to allocate funds.

“From what I can tell, the main question is whether the LLC is going to have a 501(c)(3) as a member. It appears that the LLC has no connection to any 501(c)(3) organization, meaning that all the Zuckerbergs have done is shift wealth from holding it directly to holding it through an LLC. This is a non-event from a philanthropy standpoint,” said Roger Colinvaux, professor of law and director of the Law and Public Policy Program at Catholic University’s Columbus School of Law in Washington, D.C.

If they create a foundation, the Zuckerbergs would be allowed a charitable deduction. The foundation would be subject to a 5-percent payout rule and could not hold too much of any one business, Facebook, for example. “Until they actually create or support a charity directly, it seems to me that there is no significant difference to the world of philanthropy pre and post his announcement, except for a statement of intent to give at some later date,” he said.

Phil Buchanan, executive director of the Center for Effective Philanthropy in Cam­bridge, Mass., expects Zuckerberg to use a range of tools to pursue his objectives, whether that’s grantmaking, policy advocacy, communications, or even investments in companies where the work contributes to progress in the areas he and Chan care about. He wouldn’t be surprised to see CZI create multiple entities over time, including a private foundation.

Said Buchanan: “If there’s one piece of advice I’d have for everyone who is watching this to play out, it would be to take a deep breath and take the long view. We know very little about what the Chan Zuckerberg Initiative will look like in 10 years, much less a year.”

The Chan Zuckerberg Initiative will be an organization with the mission to “advance human potential and promote equality.” The areas of focus initially will include:

  • Personalized learning;
  • Curing disease;
  • Connecting people; and,
  • Building strong communities.

The announcement described the couple’s commitment to investing for the next generation. “We must make long-term investments over 25, 50 or even 100 years. The greatest challenges require very long time horizons and cannot be solved by short-term thinking,” Zuckerberg wrote in the open letter to Max. “We don’t always collectively direct our resources at the biggest opportunities and problems your generation will face.

“Consider disease. Today we spend about 50 times more as a society treating people who are sick than we invest in research so you won’t get sick in the first place.

“Medicine has only been a real science for less than 100 years, and we’ve already seen complete cures for some diseases and good progress for others. As technology accelerates, we have a real shot at preventing, curing or managing all or most of the rest in the next 100 years.”

The organization will pursue its mission by funding nonprofits, making private investments and participating in policy debates. Profits from investments in companies will be used to fund additional work to advance the mission.

Zuckerberg is among the signers of the Giving Pledge, committing to give the majority of his wealth to philanthropic causes. Zuckerberg and Chan already have committed $1.6 billion to philanthropy, including a $100 million gift to the Newark, N.J. public school system in 2010. In recent years, he’s also donated about $1.5 billion to the Silicon Valley Community Foundation (SVCF) through a donor-advised fund (DAF).

“One hopeful sign is it seems that Zuckerberg has already taken some important lessons from Newark. That doesn’t make the failure to achieve the desired results there any less disappointing, but it is much better than the alternative of the donor who refuses to acknowledge and learn from mistakes,” Buchanan said.

In a follow-up post days after the initial announcement, Zuckerberg explained that the initiative is structured as an LLC rather than a traditional foundation to enable them to pursue their mission by funding nonprofits, making private investments and participating in policy debates. “In each case with the goal of generating a positive impact in areas of great need,” he wrote.

By using an LLC rather than a foundation, he said they receive no tax benefit from transferring shares to the initiative but gain flexibility in executing the mission. If the shares were transferred to a traditional foundation, they would have received an immediate tax benefit, he added, and they will pay capital gains taxes when the shares are sold by the LLC.

“What’s most important to us is the flexibility to give to the organizations that will do the best work – regardless of how they’re structured,” Zuckerberg wrote.

The Chan Zuckerberg Initiative is not with­out precedent. The Omidyar Network was established in 2004, with an LLC and foundation. It has distributed or invested almost $1 billion ($400 million in for-profit investments and $479 million in nonprofit grants). A foundation that predated the network has since been dissolved.

There was a level of cynicism and confusion when the Omidyar Network was established but the Chan Zuckerberg Initiative is on a whole different level, given the numbers and publicity, said Will Fitzpatrick, general counsel for the Omidyar Network. Soon after eBay went public, he worked with founder Pierre Omidyar and his wife, Pam, who committed to giving away most of their fortune during their lifetime. “If he’d gone out to try to fund a nonprofit to do poverty remediation or create jobs, it never would have had the scale that eBay had,” Fitzpatrick said. “The idea that this for-profit business could have massive social impact was just in his bones,” he said of Omidyar.

With an LLC, Omidyar Network can invest in initiatives even if they don’t match the strict eligibility of IRS rules on foundations, according to Fitzpatrick.

There’s been an acceleration in the number of foundations trying to figure out how to start and expand their program-related investments (PRIs) during the past five years, he said. New and high-net-worth individuals are entering the philanthropic world and want an expanded toolkit.

The Gates Foundation is a good example, according to Fitzpatrick, which always did some PRI but it was fairly small. When dealing with such a major landscape, something like eradicating polio globally, it will take more than grants to nonprofits. It will need to involve for-profits. “It’s not a way to build a robust market if it’s just nonprofit involved,” Fitzpatrick said.

Zuckerberg is trying to determine how he can accomplish as much as he can during his lifetime, Fitzpatrick said. “It’s not going to let the tax tail wag the dog,” he said. Omidyar, for instance, took a very big tax hit in creating the LLC. “It’s possible that we’ll get rid of the foundation. We really like the hybrid approach,” Fitzpatrick said.

To the extent that you know giving money to nonprofits is compatible with IRS regulations, it really becomes the public’s money. An LLC is effectively private money with a commitment to use it for the good of society but it’s no different than any other investment fund in a way, Fitzpatrick said. It continues to be private money until it’s granted to a nonprofit.

There are not many models of social enterprise — the notion to balance profit and social good — that have proven to work so far, according to Ken Berger, former president and CEO of Charity Navigator and now managing director at Algorhythm. The Phila­delphia, Pa.-based company works with nonprofits and social businesses. “Certainly it will propel that area of social enterprise forward since so much money is involved. Whether that’s good or bad, I’m not sure,” he said.

Sometimes when the super-wealthy announce they’ll use their wealth for good, everyone gets excited, but the possibility exists that it could cause problems, setting bad precedents, such as a lack of openness and transparency, Berger said, “which an LLC traditionally has.” The sector has suffered from the need for more transparency and accountability, he said. “This could take us in the wrong direction.”

There are more questions than answers at this point. “It seems this is relatively uncharted territory because it’s not a nonprofit and it’s not what you’d expect more typically from a social enterprise,” he said. “It’s not a B-Corp, it’s not an L3C [Low-profit Limited Liability Company]; it’s a garden variety LLC.”

Among the questions are how it will operate, whether it fits into the mode of a social enterprise, as well as how much political activity will be involved or organizational transparency.

“B-corps and LC3s make a commitment to certain clear standards of transparency, accountability, low-profit. So far, I don’t see any of that. I think this is a really big question mark,” Berger said. “The commitment they’ve expressed, that it’s going to be used for good, sounds good, but the devil is in the details, and we don’t have any.”  E