Stabilizing Exempt Organizations through Fiscal Sponsorship - Tools for a COVID World
Why work with established organizations?
Lend a stabilizing hand to organizations struggling with the economic impacts of the pandemic or other challenges.
Provide a strategic strengthening and capacity building hand to organizations poised for growth and/or pivot.
Grow and diversify your community of projects (“portfolio”) as a fiscal sponsor: collective capacity building affords strength in numbers.
Provide a platform for transformation or wind-down, preserving valuable resources that may continue to benefit communities.
The economic and social repercussions of the COVID-19 pandemic are destabilizing the nonprofit sector. Of the nearly one million nonprofits nationwide, 88% operate below $500,000 and according to the Nonprofit Finance Fund’s annual survey, 50% had no more than 30 days of cash on hand--and that was before the pandemic. Candid, a nonprofit data firm, estimates that at least 11% of all nonprofits will go out of business, and 13% of all nonprofit staff were laid off by the end of July. But these organizations, despite being the most vulnerable, do the lion’s share of the work for our sector and represent the most local reach and greatest diversity in mission and communities served.
We may be only beginning to feel the impact of pandemic, which will likely set in more acutely as 2020 winds to a close. The federal Payroll Protection Program (PPP) expired in July, just over two months ago. And smaller organizations are often slow to declare a state of emergency. For better and for worse, the operation of smaller organizations remains predominantly driven by passionate people, who work tirelessly for meagre (frequently below-market) compensation, owing to the cash-strapped nature of the sector. This tremendous human drive is a strength: nonprofit workers likely contribute as much or more value in sweat equity than all philanthropic giving combined. As long as there is someone willing to get up in the morning and carry the flag for one more day, the work goes on, regardless whether there is money in the till. Grassroots initiatives and smaller nonprofits don’t fail when they run out of money. They fail when they run out of will. This economic reality allows organizations to hold on longer than they should in the face of economic challenges. Often, when the alarm sounds, it is too late for a rescue or the cost of recovery is simply too dear.
Fiscal sponsors can help our sector restructure for greater resilience and sustainability. While it’s not a new practice for fiscal sponsors, in particular Model “A” providers, to share their infrastructure with established nonprofits, it’s not exactly a widespread practice or well understood. Moreover, our sector is still focused on conventional mergers and acquisitions (“M&A”) between single-mission nonprofits as the approach to restructuring; fiscal sponsors are rarely included in the repositioning conversation. M&A may be a great solution for two or more larger organizations, say above $5 to $10 million in budget. But for smaller organizations, the emotional and financial costs, as well as the burden of the process may be prohibitive, in particular in a state of diminished capacity. As our community confronts the economic fallout of COVID, it’s time to re-examine the role that fiscal sponsors can play in providing structures for greater resilience and impact, focused on the 88% of organizations operating at small but impactful scale.
Fiscal sponsors have a number of ways in which they can support the needs of established, tax-exempt organizations in uncertain times, offering the same backbone support that they provide to “informal” projects that have never incorporated or sought their own tax exemption. These shared services include accounting, financial management, insurances, compliance, risk management, legal, HR, project management, and other capacity building support, such as marketing and fundraising.
The Models
Following Gregory Colvin’s taxonomy, the approaches best suited for supporting exempt organizations span Models “A”, “L”, and “F”, (and variations thereon), as well as a “new” Model “O”, described below. Though different in nature, structure, and impetus, these four models have a common value proposition for organizations: they are means of sharing critical back-office support. Below is a brief overview of these four models and how they can be used to provide shared resources to nonprofits. More details on the specific structures, as well as pros and cons of each model and what might drive the choice of one over another will be the subject of a forthcoming primer from Social Impact Commons, “Working with Exempt Organizations: A Field Guide for Fiscal Sponsors”. An overview deck with more details and schematics of the models described below is available for download here.
Model “F” Technical Assistance Relationship is an arm’s-length relationship between sponsor and sponsee in which any number and amount of services may be delivered to the organization (sponsee) by the sponsor for a fee. Both organizations remain completely independent, with a basic service agreement defining the relationship. This is of course a widespread service arrangement and not unique to fiscal sponsorship. In this relationship the both organizations maintain separate insurances, HR, and compliance obligations.
Model “A” Comprehensive or Direct Project Relationship entails the operations of an organization being transferred, in whole or in part, into the sponsor and then run as a project of the sponsor. The organization’s legacy entity (its original legal formation) may be left in place in a minimal operating state (filing an IRS Form 990-N), and thus carries little to no compliance or insurance costs, allowing all of these expenses to be assumed and managed by the sponsor. A percent of revenue or expense is allocated by the sponsor to the new “project” to cover the costs of core back office support, including such things as insurances, compliance, etc. In this structure the insurance, compliance and all back office staff supports are the responsibility of the sponsor, just as in any Model “A” relationship.
Model “L” Disregarded Entity or Sole Member LLC Relationship entails the operations of an organization being transferred, in whole or in part, into a wholly owned subsidiary LLC (“disregarded entity) under sponsor and then run as a project of the sponsor. The legacy entity can be treated in a similar fashion to the Model “A” case above. In most cases, the service suite and financial (cost allocations) mirror those of Model “A”, leading this model to sometimes be called Model “A-L”: it’s Model “A”, just with the project housed in a separate entity under the sponsor. This structure is useful for segregating liabilities and transactional relationships, and other benefits, but still taking advantage of the share compliance, insurance, and HR infrastructure. The LLC’s finances are operated separately, but consolidated into the sponsor from a reporting and compliance standpoint.
Model “O” Sole Member Organization Relationship entails a very similar structure and concept to Model “L” above. Except instead of using a sole-member LLC and having to transfer assets from the legacy nonprofit into a new LLC controlled by the sponsor, the entire legacy nonprofit corporation is simply brought under the sponsor by adjusting the bylaws and corporate articles to allow sole or majority member control by the sponsor. This is a change in legal (governance) control, not a transfer of assets. This model, which is relatively new and not part of Colvin’s current taxonomy, is being practiced increasingly in the healthcare field, as it has undergone great consolidation in recent years. Like Model “L”, the services and “business” arrangement are often essentially that of Model “A”, so one could also call this Model “A-O”.
Important Considerations
Establish sound due diligence, risk assessment, and a clear strategic framework for wanting to work with established organizations.
Assess your internal capacity as well as the readiness of your team, key partners, and vendors before entering into this work.
Define a clear stance on how equity considerations will influence the choice of which organizations to work with and how to structure the relationship.
Develop a strategy for what kinds of organization cases you want/can take on: i.e., stabilization may be more labor intensive than strategic growth.
Despite the practical utility of these approaches as triage responses to a crisis, there are substantial considerations and perils when one considers the needs of culturally specific and BIPOC organizations. These are especially critical considerations, if the origins and majority leadership/constituent base of the sponsor are not of the community being served. Such considerations include:
Maintain community “ownership” and control while satisfying legal and practical needs to share authorities as part of sharing resources. Perhaps the most critical potential barrier for BIPOC organizations in working with fiscal sponsors is the importance of independent formation and exemption for many organizations of color. Even though there is no nonprofit concept of “ownership” in the private sense, forming and receiving exemption for a nonprofit organization is often imbued with particular meaning for founders of color: it marks a moment of triumph over a system that is largely stacked against them. And if the organization holds any major assets: real estate, equipment, intellectual property, there may be strong hesitation to transfer these just to enter into a fiscal sponsorship relationship.
So to ask a founder of color to entertain sharing any authority or responsibility over what they’ve built, as in the case of Models “A”, “L”, or “O” (moreso than Model “F”), may understandably be a non-starter. But there are ways to address these concerns in the cases of Models “A”, “L”, and “O”, such as carefully balancing authorities, approvals, and exit provisions in sponsorship agreements, such that organizations do not cede too much control. Using trust forms (in the legal sense) as opposed to corporate forms to house program activities can take advantage of unique capabilities in trust law that provide for more control by the project than corporate law affords. Finally, allowing for retention of the organization’s legacy formation and exemption (or providing for clear legal detachment of the corporation under Model “O”) while under fiscal sponsorship provides a path to exit. Maintaining the legacy organization, while having programs operate under the fiscal sponsors allows certain assets (real estate, collections, or intellectual property) and liabilities to remain in the legacy formation and thus not under the direct control of the sponsor.
Be open to concepts of “capacity building” that may not be core to fiscal sponsorship or conventional management practices. Understanding that many conventions of management are Western and adopted from for-profit, corporate culture. These may not often translate into the immediate needs of nonprofits working in communities of color, which may be struggling with very specific traumas of disenfranchisement or culturally specific capacity needs beyond “business” interests defined by Western management practices.
Build trust and honor different cultural practices and values while working to ensure compliance with historically white systems and institutions. If imbued with sufficient trust and understanding, fiscal sponsor relationships can be “translators” of culturally specific organizational practices that may not be seen as “best” or even compliant with Western notions of management--allowing an organization to meet funder, legal, or other demands and accessing resources while not relinquishing identity or values. For example, the frequent importance of family relationships and involvement in the leadership of organizations of color can run afoul of conflict of interest laws if not managed carefully. A fiscal sponsor can help navigate such issues without requiring the organization to give up an essential cultural approach to management or deeming that approach “incorrect” or “inappropriate”.
Finally, there are a number of operational considerations in using any of the above models to support established organizations. Chief among them is capacity to deliver. Established organizations often come with greater (or different) complexity and capacity demands than start-up or younger initiatives. And the transition into supporting an existing organization may require a significant increase in staff and capacity needs for the sponsor. Closely allied with this is added legal complexity and acumen, as well as the risk management due diligence required to restructure and co-manage nonprofit assets, if you are working with Models “A”, “L”, or “O”.
In closing, there are caveats that we should offer, as we encourage closer consideration of the role that fiscal sponsors can play in stabilizing our sector amidst the tumult of our times.
Restructuring to stave off failure is a moral and practical imperative, not necessarily a best practice. We would be remiss if we didn’t point out that highlighting this opportunity for fiscal sponsors does not necessarily mean we’re defining a “best practice”, but rather a practical response to a likely and unfortunate period of crisis in the sector. We have observed that smaller nonprofits consider repositioning (mergers/acquisitions, joint ventures, and other solutions) most often in the face of some looming failure or organizational weakness. It is a way out of trouble. In contrast, larger nonprofits and the for-profit sector view repositioning more as a strategic response to opportunity--a way to augment impact, market share, or positioning. It is far more constructive and healthy to view restructuring in this way, instead of as a path of last resort. Fiscal sponsors need to be realistic and set clear criteria in helping to stabilize other organizations in their community; we can’t save everything.
We must challenge and decry the Darwinian “thin the nonprofit herd” response to economic moments like this. In every moment of crisis, as we witnessed the wake of the 2008 market crash, many leaders in our sector (in particular funders) are quick to point out that times of trouble present great opportunities to “thin the herd”. The weak will fall away and the strong will prevail. The application of this biological metaphor, describing a tough but ultimately “healthy” practice, is not just wrong, but profoundly oppressive, if you consider the full implications of our national reckoning with social injustice. BIPOC organizations may be strong in will and vision, but are more likely to be financially weak, owing to decades of neglect, disinvestment, and systemic racism, largely on the part of the institutions and systems that support nonprofits. To invoke Darwin today in the nonprofit sector is an unabashed gesture of racism and white supremacy. Stabilization must be rendered through the lens of equity.
In the end, our sector will make it through this crisis. We always do, but at what cost? The vast ecosystem of small organizations that drive our sector are both resilient and vulnerable. We will need to bring as many resources to bear as we can in the coming months to ensure that resilience prevails and our sector continues to grow as a force for social change in our country.