The big winner if OpenAI becomes a profitable business? Microsoft.

OpenAI is considering transitioning from a nonprofit to a for-profit company, and its benefactor, Microsoft ( MSFT ), has a lot to gain if developer ChatGPT gets the green light to behave more like a startup.

“Anything that frees up OpenAI to focus on profit is likely to benefit from 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 business structure would give Microsoft the opportunity to renegotiate its already generous profit cap, as well as waive a provision denying Microsoft an interest in general artificial intelligence (GAI) created by OpenAI, according to another observer .

“(OpenAI) makes it clear that the nonprofit will no longer be in control, so that probably means Microsoft and other investors will have more of a say in what OpenAI does,” said Rose Chan Loui, founding executive director of the University of California Los Angeles. Lowell Milken Center for Philanthropy and Nonprofit Organizations.

But there are potential pitfalls for Microsoft as OpenAI tries to shed its charitable garb.

OpenAI’s huge valuation, maze of for-profit subsidiaries and potentially risky technology make a for-profit switch legally and publicly complicated — and could invite pushback from regulators.

Still, OpenAI investors see plenty of upside. On Wednesday, the company announced it had raised about $6.6 billion in its latest funding round, valuing the Sam Altman-backed firm at $157 billion. However, this valuation is highly dependent on OpenAI becoming a for-profit entity.

Whirlwind of change

OpenAI is in the middle of a whirlwind of change.

It is facing a widespread executive exodus, including most recently the departure of chief technology officer Mira Murati. It also faces increased competition from rivals including Google ( GOOG , GOOGL ) and Amazon-backed Anthropic ( AMZN ).

The reclassification to a for-profit structure would be yet another seismic shift for OpenAI, changing the way it was founded nearly a decade ago.

It started in 2015 as a nonprofit organization under the name OpenAI Inc., a sign of its mission to advance humanity instead of chasing profits.

“The corporation is not organized for the private gain of any person,” OpenAI’s certificate of incorporation stated in its organizational documents, along with a promise to keep its technology open source for the public benefit.

Things took a turn in 2019, when OpenAI CEO Sam Altman and his team created a for-profit subsidiary to raise outside venture capital — including billions from Microsoft.

The story continues

It was structured so 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 biggest backer (Microsoft) does not give any seat on the board. and without voting power.

It is the inherent tension between these two parts of the enterprise that contributed to a dramatic boardroom clash in 2023, when Altman was ousted from the board and then brought back five days later.

Microsoft later took a non-voting observer position on OpenAI’s board, only to relinquish that seat this year as both OpenAI and Microsoft came under closer regulatory scrutiny.

The idea of ​​changing the current structure has already drawn interest from regulators in the US and Europe and exacerbated an ideological divide between science and business leaders who warn that machine learning technologies like those developed by OpenAI should remain publicly available .

Technology, they argue, poses 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 strengthening the AI ​​market “distorts innovation and undermines fair competition.”

And several calls have been made to California’s attorney general to investigate the legality of OpenAI’s business structure. One came from Elon Musk, who co-founded OpenAI with Altman. He sued OpenAI, Altman and 21 affiliates named OpenAI.

Musk said the defendants fraudulently promised that his $100 million investment 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 has received tax-exempt status as a charitable organization.

— Did they get a fair market value?

An unknown question is to what extent Microsoft will be able to directly extract returns from its investments.

By law, a nonprofit must use its assets only for stated charitable purposes. And OpenAI’s assets, which include all OpenAI subsidiaries, cannot be sold for anything less than fair market value.

The question regulators will want to confirm is, “Did they obtain fair market value for the asset at the time?” said Gene Takagi, principal at NEO Law Group.

Chan Loui added that regulators would require OpenAI to realistically value its assets, including residual interest. And she suspects that figure may surpass OpenAI’s most recent assessment.

“I think the biggest sensitivity is probably how it takes away control of the nonprofit,” she said. “And I think the best solution to avoid restructuring conflicts is to sufficiently compensate the nonprofit,” Chan Loui said.

“I think this is the best way for them to get the public on their side, the states on their side and the IRS on their side.”

What OpenAI is expected to do as part of its transition is to register as a public interest corporation.

Such entities are like traditional corporations, but with more freedom to spend on civic-minded initiatives, according to Rick Alexander, a veteran corporate structuring attorney and founder of Shareholder Commons.

“It’s a permission structure,” Alexander said.

Other public interest corporations include Elon Musk’s xAI, Warby Parker (WRBY), Allbirds (BIRD), Lemonade (LMND), and Etsy (ETSY).

And based 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 such 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 [email protected]. Follow him on Twitter at @DanielHowley.

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