Q: Some members of our board are pushing to form a separate foundation. Their arguments include that such a move would ensure that more funds come into the organization, that those funds can be better managed by a dedicated entity, that such a move will protect the assets of the original 501c3 and that this would put us on par with the larger, more respected organizations in the community like the local hospital.
Other members of the board aren’t so sure. Our auditor – a national CPA firm – provided a written opinion stating that we would realize no additional tax advantages and, if we relied on a single management team and board as we were considering, such a move would not protect our assets. We’d like your opinion as well.
A: This must be the question of the hour. I have had three different organizations raise this within the last month. I will try to respond to each of the arguments presented above. However, my thoughts are necessarily general. Inasmuch as you have already spoken with your auditor, who understands your particular situation, I would go with your auditor’s advice before mine. For others reading this, I suggest you seek such individualized advice as well.
A separate foundation makes sense if you are looking for public contributions and your nonprofit has an IRS designation such as 501c4 that prohibits you from providing donors with tax deductions for their donations. This is because a foundation could help you facilitate such donations. Assuming this is not the case with your organization, let’s look at the individual arguments.
You will be able to bring more funds into the organization. I find this assertion questionable. Why would a foundation be more capable of raising funds than the organization itself? Is it because the foundation will have experienced staff and volunteers dedicated to this purpose? Why can’t your organization hire the same staff, find the same volunteers and provide the same resources to make them successful? And, if your organization already has a fund development department, your duplication of administrative expenses may wipe out any potential benefit.
I’ve heard people say that donors may be more motivated to give to a foundation than to the 501c3 with which it is affiliated because of a prestige factor. However, study after study shows that people are motivated to give when they can see the direct impact their gifts have made. A foundation is merely an investment mechanism. It can’t demonstrate direct impact. But, your organization can. With the right staff in place at your organization, you have an equal or better chance of raising the funds a foundation could raise and you keep your administrative costs down.
A separate foundation will better manage the funds. My response to this is similar to my response above. As long as you have a dedicated investment committee charged with managing your 501c3’s funds, that committee is made up of the same or same caliber of people that would work with the foundation and you have strong investment policies, your results will be the same as if you had a separate foundation. It’s the people not the legal entity that manages your funds.
Your organization’s assets will be protected if they are managed under a separate legal entity. Generally, board members are concerned with asset protection. This is a good thing. The organization could, after all, be wiped out if someone sues. However, while anyone can sue your organization for any reason, the chances of being sued and losing enough of your assets to force you to close or radically change what you do are fortunately slim. That is why you carry – or should carry – insurance. Besides, unless you create a totally separate foundation – one with its own staff and a unique board – you would be hard pressed to convince a determined lawyer or a jury that these are, in fact, distinct organizations where the assets of the foundation should not be tapped to pay for malfeasance on the part of the 501c3.
There is another critical consideration here though. If you should go the route of creating an independent entity, you risk the very real danger that at some point in the future the board of the foundation will decide that it doesn’t like a policy of, or a person associated with, the 501c3 and it will therefore withhold “its” money from the 501c3. Even though the bylaws of both organizations may make clear that the money held in the foundation belongs to the 501c3, it may require a court battle to free those funds under such circumstances. And to anyone who wonders – this happens. A lot! And you were concerned about asset protection….
This will put us on par with other, more prestigious organizations in town, like the hospital. We tend to forget that few hospitals today are still nonprofit. For-profit hospitals must incorporate nonprofit foundations if they wish to solicit contributions and hope to give donors a tax deduction for those contributions. Also, hospitals are unique in that they may actually require asset protection because a relatively simple mistake can result in death or permanent disability – a situation in which juries are more likely to award significant sums of money.
Does the argument still hold if we take away the example of the hospital and compare ourselves to other prestigious organizations in town? Not really. What makes an organization prestigious? I guarantee it is not the existence of a foundation. It is that these organizations positively impact the community, they are well run and they attract people who want to be associated with a winner. Any organization can achieve these three things without a foundation.
I would suggest that you would be incurring additional expense and bureaucracy for little real benefit if you succumb to the arguments of those on the board that want a separate foundation.