I guess "mom-and-pop businesses" are probably not started as charities in the first place in most cases so I don't really get what you are trying to say.
He’s making a (valid) point having to do with tax avoidance.
Want to open a bakery in your small town? Start it as a 501(3)(c) and promise it’s a charitable endeavor for the local community. Then invest your $500k into the bakery maybe even from your local community (it’s a tax deductible donation!) to get the bakery up and running.
Then once it’s turning a profit, ditch the original 501(3)c and replace it with a LLC, S-Corp or C-corp and start paying taxes. (And hope you don’t get sued or audited)
His point is mom and pop bakeries aren’t typically sophisticated enough to pull of schemes like this, even if it would save tens of thousands on taxes.
In general the the 501(3)c isn't replaced by a for-profit corp though. The 501(3)c remains and a new for-profit corp is established under its ownership.
IANAL but I think the tax issue would likely hinge on how well that $500k was isolated from the for-profit side. If the non-profit has no substantial operations and is just a shell for the for-profit, I could see getting in trouble for trying to deduct that as a donation. But if there's an audit trail showing that the money is staying on the non-profit side, it would likely be fine.
Yes if the for-profit was the entire operation, I think you could definitely have issues with the IRS. It would ultimately depend on your ability to convince either the IRS or a judge that there is some purpose to the nonprofit apart from giving investors in the for-profit side tax deductions.
