Impacts of financial decisions
Nonprofit Spin-Offs: Key Issues Related to Funding, Leadership, and Control
Sending a child off to college can be a trying time. Is he ready? Are you? Have you given Johnny enough stability and structure to stand on his own? Will he explore and find himself while staying true to the person you raised him to be?
Moving an effort or program out of your foundation and into a standalone entity can bring up the same mix of pride and anxiety. You have known the “innermost being” of the program since it was born. You have raised it, nurtured it, and instilled it with your values. While you don’t want it to live in your basement until it’s 25 years old, you also may not be entirely ready to cut the cord.
When considering how to go about spinning off a program in a way that sets it up for success, there are many variables at play, but at the end of the day, it comes down to issues of control: How much control should you assert on the new organization’s strategy, governance, and funding? You want it to be independent without straying too far from its original intent and purpose.
How you structure your funding and the influence you have over leadership are the two primary ways you can guide a new organization. Right from the start, decisions on both fronts have implications for the organization’s tax status and legal structure.
Funding the new organization
When sending your child off to college, there are a number of ways you might help him/her out financially, from giving him full access to a college savings account, to directly paying tuition or requiring him to apply for scholarships or work part-time to help fund his collegiate experience.
Likewise, there are a number of ways to lend financial support to a fledgling nonprofit.
- Endowment — If you send Johnny off to college with a large pot of money, financial aid and scholarship screeners may think he doesn’t need any other support, even though he can’t immediately use most of the cash. Endowing a new organization can be similar. It is restrictive, but also gives the nascent nonprofit a healthy balance sheet and revenue streams in perpetuity. The biggest downside is the lack of liquidity.
- Multi-year pledge — The offspring organization will probably like this option best; a multi-year pledge provides comfort in knowing that the support it needs will be there today and in the near future. It will also motivate the group to seek other resources in the interim and when the pledge expires.
- Annual grant — Doling out funds to the organization annually is a bit like helping Johnny with his college expenses each year, without a promise to keep helping in the future.
Your scholar has to continuously prove that he is spending your dollars wisely and keeping his grades up. With an annual grant arrangement there is no certainty that the foundation will help out again next year, which may motivate the spin-off to build up other sources of revenue from the start.
Governance and leadership
In addition to funding, the other major sources of control relate to leadership and governance. How much control can you have without being perceived as a “helicopter parent?”
A new organization can deploy a variety of options when creating its governance structure. The four listed here are in order of control from most to least.
- Mirror board — The new board is comprised of all or part of the parent organization’s governing body. This provides you with nearly complete control, but is generally not advisable as it may defeat the purpose of creating a new entity.
- Selecting the entire board — By seating the entire board of directors, you can indirectly steer and guide the strategy of the organization in the near term. However, the new organization may face challenges claiming independence as it relates to public perception and tax status.
- Selecting a portion of the board — You may identify a portion of the initial board and then allow board members to select their peers for the remaining seats.
- Designated seat on the board — One additional consideration is whether there should be a designated seat on the board to be filled (on an ongoing basis) by a staff or board member of the parent organization.
Regardless of how it is created, the new entity’s board will have total authority and responsibility for its success. It’s worth spending some time exploring how much influence you believe you will need to ensure success without inhibiting the entity’s ability to flourish and grow.
Evaluating and hiring the key staff leader (often the executive director) is generally one of the most important roles of a nonprofit board. In an ideal setting the new board would be formed and operational for at least a few months prior to undertaking a search-and-selection process. In reality, most start-ups don’t have the luxury of time. More than likely, inaugurating the board and starting a search (should you need it) for executive leadership will be happening simultaneously.
It is helpful to include individuals on the search committee who have these skills or experiences:
- Someone who really knows the work; this will often be a representative from the parent foundation
- Individuals with networks of potential candidates
- A subject matter expert
- A key partner or community representative
How funding and control impact tax status
Decisions about funding and governance/leadership control have an impact on the true independence of the new organization — both in the eyes of the public and the IRS (as it relates to charitable tax status). Assuming that the foundation is spinning off a program as a standalone nonprofit, the new organization will likely prefer to be structured as a 501(c)(3) public charity.
The primary federal requirement for public charity status is to pass the public support test — a series of metrics designed to ensure that a public charity receives a wide range of gifts and grants and is not being funded by one person or organization.
The ultimate goal: independence
While there are many ways for a foundation or other philanthropic entity to move a program out from “under your roof,” you should carefully consider the implications that funding and leadership choices have on the new organization’s ability to stand on its own and reach its potential. Like a parent waiting for a child to be handed a college diploma, it may take time, but the pride of knowing you helped make it happen makes it all worthwhile.