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OpenAI’s plan to convert to a for-profit company is meant to simplify the world’s leading artificial-intelligence startup. Making that happen will be enormously complex.
The ChatGPT maker is in the midst of raising $6.5 billion from backers including Microsoft MSFT -0.76%decrease; red down pointing triangle and Nvidia, along with venture-capital firms and a United Arab Emirates state-backed company. An essential provision of talks is that OpenAI, currently governed by a charitable nonprofit, must within two years become a public-benefit corporation. That means its mission is to earn a profit while creating social good. If it doesn’t, investors could take back their money.
To get there, it will have to deal with regulatory requirements in at least two states, determine how to award equity in the for-profit company, and split assets with the nonprofit entity, which will continue to exist.
“This kind of transaction is incredibly complex and would involve a large number of legal and regulatory hurdles that would need to be navigated,” said Karen Blackistone, general counsel at the investment firm Hangar Management and an attorney specializing in technology and tax-exempt organizations.
An OpenAI spokeswoman declined to comment. The Wall Street Journal’s owner, News Corp, has a content-licensing partnership with OpenAI.
How is OpenAI currently set up?
OpenAI was founded in 2015 as a nonprofit with the goal of safely developing artificial intelligence. It created a for-profit subsidiary four years later to help it raise more money.
The nonprofit’s board of directors currently controls the subsidiary and has the right to act against shareholder interests for reasons that further its humanitarian mission. In tax filings, OpenAI notes that each of its various arms is legally bound to pursue the nonprofit’s mission, “such as following uncompromised principles of safety and broad benefit in its research and deployment efforts, unencumbered by profit incentives.”
OpenAI has said it would continue to operate a nonprofit that would do charitable work and own a stake in the for-profit company.
Why is it making this change?
After the surprise ouster of Chief Executive Sam Altman as CEO last fall, which lasted just a few days, investors began pushing OpenAI to turn into a more typical company. They feared that the esoteric structure made it more likely that such a disruption could happen again.
Operating as a for-profit company that isn’t governed by a nonprofit will make it simpler and easier for investors to share in OpenAI’s success. Microsoft has put $13 billion into OpenAI’s for-profit division and is the company’s largest outside stakeholder. Other firms have bought stakes from employees in private transactions.
Current investors don’t technically own equity in OpenAI. Instead, they own a share of any future profits of the company, which currently loses billions of dollars a year. More straightforward equity would eliminate a cap on investors’ profits, which the nonprofit currently imposes.
OpenAI would have to figure out how to translate the profit stakes of Microsoft and other existing investors into equity in the restructured company.
Regulators have already scrutinized Microsoft’s relationship with OpenAI and whether it effectively controls the startup. The tech giant has argued that its investment only entitles it to a share of potential profits, but a new structure under which Microsoft has an equity stake in OpenAI could invite further antitrust attention.
What is involved in the conversion and who would have to approve it?
OpenAI is a Delaware-based corporation and would need to change its structure legally under that state’s law. Given Delaware’s business-friendly legal regime, making that change should be the easiest part of the process, said Jill Horwitz, a law professor and founding faculty director of the Lowell Milken Center for Philanthropy and Nonprofits at the University of California, Los Angeles.
The more complicated part is what would happen to OpenAI’s assets. When such a conversion takes place, it can’t simply shift assets from a nonprofit to a for-profit. The nonprofit is legally required to end up with assets, including any cash and securities, at least as valuable as those it turns over to the for-profit. In effect, OpenAI’s operations would likely be sold to the for-profit company or its investors, with the charity retaining the proceeds.
Assets “previously donated to the public benefit cannot be repurposed to private benefit without compensating the public for the loss,” said Alexander Reid, a partner at the law firm BakerHostetler.
It couldn’t be determined how much the remaining nonprofit would receive in such a transaction. Given that OpenAI is expected to be valued at around $150 billion after the current fundraising round, the amount could be immense.
That determination is particularly complicated because the nonprofit might own some of OpenAI’s patents on AI technology, which would need to be valued in the conversion.
Because most of OpenAI’s operations are in California, that state’s attorney general would have jurisdiction to ensure its charitable assets were protected, according to legal experts.
What would the nonprofit do after the conversion?
OpenAI hasn’t said what the continuing nonprofit would do once a profit-seeking company takes over all of its operations.
The current nonprofit has supported research on universal basic income programs and made charitable grants focused on technology and social equality, according to its website. It could continue to fund such work in the future, using its stake in the for-profit OpenAI as a source of income.
One important issue OpenAI will have to resolve in the conversion is what rights the nonprofit will have to AI technology that the new company develops.
What other challenges will OpenAI have to overcome to make this switch?
OpenAI’s board has said it is thinking about giving Altman equity in the new company. The size of his stake would likely invite public scrutiny.
OpenAI will also have to determine whether the board of directors at the nonprofit will run the for-profit company and, if so, who would govern the remaining nonprofit.
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In addition, OpenAI will still have to contend with a lawsuit filed by Elon Musk. The complaint, filed in August—a revised version of an earlier suit that he dropped—argues that he was fraudulently manipulated into believing OpenAI would remain a nonprofit when he co-founded it and provided seed money.
OpenAI has disputed Musk’s version of events and his claims.
Musk split from Altman and the other co-founders in 2018 partly over their desire to take on outside investors and commercialize the technology. In 2019, he founded a rival private company, xAI.
Write to Theo Francis at theo.francis@wsj.com, Berber Jin at berber.jin@wsj.com and Tom Dotan at tom.dotan@wsj.com
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