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Dropping Profit

07/18/2014

Inside Higher Ed. July 17, 2014.

These are hard days for most for-profit colleges. Declining revenues and an ongoing regulatory crackdown has led to speculation that some in the sector -- including one of the major, publicly traded companies -- will go nonprofit to get out of the crosshairs.

Yet that transition isn’t easy or practical for most for-profits. Just four have successfully changed their tax status in recent years, sources said. And those institutions appear to have made the jump mostly for reasons other than avoiding the Obama administration’s proposed “gainful employment” regulations or a current rule that for-profits can get no more than 90 percent of their revenue from federal sources.

The four for-profits that made the transition were all privately held and relatively small, at least compared to the dozen or so behemoths that dominate the public discourse about for-profit higher education. Keiser University, a Florida-based chain, is the most prominent of the group. Others include Stevens-Henager College and Remington College. (Inside Higher Ed wasn't able to learn the name of the fourth.)

Sources said four other privately held for-profits were also seeking to make the move. They did not name those institutions.

The main motivators for private for-profits to go nonprofit are typically to cut losses and get out of a struggling business or an unusual circumstance -- such as succession planning for a family operation, in Keiser’s case.

Neil Lefkowitz, a lawyer with Dickstein Shapiro, a firm based in Washington, D.C., described the conversion process at a 2012 meeting of the Association of Private Sector Colleges and Universities, which is the for-profit sector’s primary trade group.

Lefkowitz didn’t respond to a request for comment. But David Halperin, a Washington-based lawyer and frequent critic of the industry, posted a copy of Lefkowitz's 29-page presentation in The Huffington Post earlier this year.

The presentation lays out the advantages and disadvantages of going nonprofit, which has been common among health-care corporations. The benefits -- like being exempt from various taxes and regulation, as well as eligibility for state grants and private donations -- look tantalizing.

But Lefkowitz’s presentation includes many more potential drawbacks than advantages.

For example, colleges may face additional scrutiny from accreditors and state agencies. They may need to get new approval as a result having made a “substantial change” in their operations. And federal regulations aimed at for-profits, including the so-called “90/10” rule for federal revenue, are extended during the transition period -- for a year in some cases.

Perhaps most importantly, Lefkowitz showed how a former for-profit can no longer generate serious profits for its owners.

Managers are eligible for “very limited” and taxable payouts for the sale of a converted college, he said. “Owners lose control” of the institution, according to his presentation, and nonprofits generally face “more limited financing alternatives.”

Nonprofit or Public Benefit Corporation?

The primary way to make the transition is for the college to sell to an existing nonprofit. That’s what Keiser did in 2011, when it sold to Everglades University, a nonprofit Keiser had previously purchased.

Under Internal Revenue Service rules, an outside auditor must determine the “fair market value” of a for-profit’s assets. That was $521 million in Keiser’s case, according to federal tax forms. The for-profit loaned Everglades $300 million for the purchase, with the rest of the balance being a charitable contribution.

That scenario, however, would create extra hurdles for a publicly traded chain, experts said. And no such for-profit has tried it, at least in recent history.

Publicly traded companies are legally bound to shareholders. Ceding the pursuit of profit and selling off the institution’s name, intellectual property and real estate would result in a thicket of legal and regulatory red tape.

Just deciding what to sell would be difficult, said Dennis Cariello, a lawyer with DLA Piper, another Washington-based firm. It’s not clear that everything -- including the learning management system or senior administrators -- would be part of the deal.

“Sometimes, because of cost or other reasons, the only way to get a deal done would be to separate the institution from some of its parts,” he said in an email. “The key question then is what’s left behind.”

As a result, some lawyers said a more realistic option might be for major for-profits to follow the lead of Rasmussen College, a midsize privately held for-profit chain.

In January, the 24-campus Rasmussen became a Public Benefit Corporation, which means it will donate more employee and facility usage time to local groups. For example, the company’s employee benefits will now include up to eight hours of paid work time to volunteer at a nonprofit of their choice.

The change also allows Rasmussen to sharpen its focus on local work force development, according to the company. But its tax status remains for-profit.

One key aspect of becoming a Public Benefit Corporation, experts said, is that the college becomes somewhat insulated from shareholders when making moves that might reduce profits. Some predicted more for-profits might go that route, in part to signal to regulation-minded lawmakers and others that they are responsible companies.

Some Things Change

The move by Keiser to go nonprofit drew notice in part because of the university’s chancellor and co-founder, Art Keiser. He had played a visible role in pushing back on federal regulation of for-profits in his former side-gig as chair of the governing board of the Association of Private Sector Colleges and Universities, the sector’s primary trade group.

Critics of for-profits at the time asserted that the university had sought nonprofit status to avoid taxes and gainful employment. Keiser, however, says the change began well before the White House-led crackdown on the sector, and was originally about ensuring his family would have a continuing role in running the university he and his mother created in 1977.

“We built a significant institution,” he said. “Once we got it going, this was our life.”

Odds were another for-profit would buy the university after Keiser’s run as chancellor ended. Going nonprofit would prevent that. So he planted the seeds of the transition in 1998 with the university’s purchase of Everglades University.

Keiser converted Everglades, a former business college, into a nonprofit. Everglades sought regional accreditation, which it received in 2010.

“Then we went full speed ahead,” Keiser said, by moving all of the chain to nonprofit status.

There were several reasons other than succession planning behind the transition, he said.

The university has 18 campuses across Florida, two online divisions and campuses in China and Nicaragua. It issues associate, bachelor’s and graduate degrees. In recent years Keiser had ramped up graduate programs in STEM fields. But it’s harder to recruit faculty members with research chops to for-profits, which the federal government prohibits from receiving research grants.

After a couple years of being a nonprofit, Keiser said both faculty recruiting and landing research money have gotten easier.

“It accomplished what we wanted to accomplish,” he said.

Remington, which is also based in Florida, cited federal regulations when it made the change in 2011. The Chronicle of Higher Education reported at the time that the college’s founder, Jerry Barnett, said he looked forward to being free from the “unintended consequences” of operating under the 90/10 rule, the restriction on the sources of funds for for-profits.

Keiser said the threat of gainful employment and the federal-revenue limit were not factors in his university’s move.

The for-profit collected 74 percent of its revenue from federal sources prior to the change, he said. And the university’s relatively low tuition rates made gainful employment a non-issue.

“If we had known what the law was when we did it,” Keiser said, “it still wouldn’t have affected us.”

The university’s annual tuition and fees were $15,000 in 2011. They’ve held fairly steady as it became a nonprofit, now standing at about $16,300.

“Our costs are the same,” said Keiser.

The change, however, was expensive. Related legal fees in particular were brutal, Keiser said, citing $800-an-hour charges by D.C.-based lawyers.

Keiser had to pay “lots of lawyers on both sides” of the process, he said, “to make sure we did it right.”

For skeptics who think Keiser’s goal was to avoid federal regulation, the university’s co-founder said hiding out as a nonprofit is not a solution. That’s because he thinks performance-based funding and other accountability policies like gainful employment are coming to all of higher education.

Having become a nonprofit “just delayed its onset,” he said. “It’s going to spread.”