Sept. 30 (Bloomberg) -- Artificial intelligence research organization OpenAI Plans to transition tofor-profit companyThe goal is to simplify the corporate structure and operating model. However, the process of realizing this goal is extremely complex.
OpenAI, the developer of the popular chatbot ChatGPT, is raising $6.5 billion in funding from investors including Microsoft, NVIDIA, VCs, and a state-owned company in the UAE. A key provision in the negotiations is that OpenAI, which is currently run by a non-profit organization, must transform itself into a public benefit corporation within two years. This means that OpenAI needs to be profitable while creating social benefits. If it fails to do so, investors can withdraw their funds.
In order to achieve this goal.OpenAI will have to deal with regulatory requirements in at least two states to determine how to distribute equity in for-profit companies and split assets with continuing nonprofit entities.
"These types of transactions are extremely complex and involve a number of legal and regulatory hurdles that need to be overcome," said Karen Blackistone, general counsel at investment firm Hangar Management and an attorney specializing in technology and tax-exempt organizations.
An OpenAI spokesperson declined to comment.
What is the current architecture of OpenAI?
In 2015, OpenAI was founded as a nonprofit organization with the goal of safely developing artificial intelligence. Four years later, it created a for-profit subsidiary to help raise additional funds.
Currently, the board of directors of the nonprofit organization controls the for-profit subsidiary and has the authority to take actions that may be contrary to the interests of shareholders on the basis of advancing the humanitarian mission. According to tax filings, OpenAI has indicated that its divisions are legally obligated to carry out the nonprofit's mission, such as following the principles of security and broader interests in their research and deployment efforts, independent of the profit motive.
OpenAI says it will continue to operate a nonprofit organization, do charitable work, and hold shares in for-profit companies.
Why did you make this change?
The surprise ouster of CEO Sam Altman last fall lasted only a few days, but it began a push by investors to transform OpenAI into a more typical for-profit company. They worry that the current complex structure could lead to a repeat of the incident.
If OpenAI transforms into a for-profit company that is no longer governed by a nonprofit organization, it will be easier for investors to share in the company's success. Microsoft has already invested $13 billion in OpenAI's for-profit arm and is the company's largest outside shareholder. In addition, a number of companies have purchased shares of OpenAI employees in private transactions.
Technically speaking, current investors don't own OpenAI. They only own a portion of the future profits of the company, which still loses billions of dollars a year. A more direct equity structure would eliminate the profit cap imposed by the nonprofit.
OpenAI also needs to clarify how it will convert Microsoft's and other existing investors' share of profits into equity in the reorganization.
Regulators have scrutinized Microsoft's relationship with OpenAI, focusing on whether Microsoft actually controls the startup. Microsoft has argued that its investment only entitles it to a share of potential profits. However, if Microsoft takes an equity stake in OpenAI in the new structure, it could raise further antitrust concerns.
What is involved in the transition? Who approves it?
OpenAI is a Delaware-incorporated company, so it will need to legally change its structure in accordance with the state's laws. Jill Horwitz, a law professor at the University of California, Los Angeles, noted that Delaware's legal system is pro-business, so the change in structure itself should be a relatively easy step.
Even more complicated is what to do with OpenAI's assets. By law, a nonprofit organization cannot simply transfer assets to a for-profit corporation. Ultimately, the nonprofit must ensure that the assets it owns (including cash or securities) are equivalent to the assets it hands over to the for-profit company. As a result, OpenAI's business may be sold to the restructured for-profit company or its investors, with the nonprofit organization retaining the proceeds.
According to Alexander Reid, a partner at BakerHostetler, "Assets previously donated to the public interest cannot be repurposed for private benefit without compensation."
It's uncertain how many assets the nonprofit will receive in the deal. Considering that OpenAI is expected to be valued at around $150 billion, the figure could be quite significant.
This process is particularly complicated because the nonprofit may own some of OpenAI's AI patents, which will also need to be valued during the restructuring process.
Because the majority of OpenAI's operations are in California, the California Attorney General has the authority to ensure that charitable assets are properly protected.
What will the transformed nonprofit do?
OpenAI has not yet clarified how the non-profit organization that will continue to exist after the transition will operate. According to its official website, the current nonprofit supports research for a universal basic income program and provides philanthropic funding for technical and social equity.The reorganized nonprofit organization could continue to fund similar efforts, using its holdings in for-profit companies as a source of income.
A key question OpenAI needs to address is what rights nonprofit organizations will have over AI technologies developed by new companies.
What are some of the challenges OpenAI still needs to overcome to make this transition?
OpenAI's board of directors has said it is considering granting Altman a stake in the new company. The size of its stake could raise public concern.
In addition, OpenAI will need to decide whether the nonprofit's board of directors will continue to manage the for-profit corporation and, if so, who will manage the remaining nonprofits.
OpenAI is also facing a lawsuit filed by Elon Musk. In August, Musk filed a lawsuit against OpenAI, claiming that he was misled into believing that OpenAI would remain a nonprofit when he co-founded the company and provided seed money.
OpenAI refuted Musk's claims in response.
Musk parted ways with Altman and the other co-founders in 2018, in part because they wanted to bring in outside investors and commercialize the technology. in 2019, Musk founded his own competing company, xAI.