On October 1, 2009, I joined two esteemed exempt organization attorneys, Greg Colvin and Jill Dodd, in a panel discussion on fiscal sponsorship for the National Network of Fiscal Sponsors (NNFS) Annual Gathering. This is a fascinating area that holds great promise for philanthropy and social entrepreneurs, but first there are hurdles for the field to overcome.
Fiscal sponsorship: a poorly defined term.
Fiscal sponsorship is not a legally defined term and describes a number of varying contractual relationships that have through custom and practice developed between “sponsors” and “projects.” There is, however, a prevailing myth that fiscal sponsorship is just financial management. See BTW Report (referenced below). And by using definitions that seek to simplify or market fiscal sponsorship to potential projects, the field has not done a good job of dispelling this myth.
NNFS, in its Guidelines for Fiscal Sponsors, provides the following definition: “Fiscal sponsorship means a nonprofit organization – a ‘fiscal sponsor’ – assumes legal and financial responsibility for the activities of groups or individuals engaged in work that furthers the fiscal sponsor’s mission and their own respective purposes.” While the definition appears slightly awkward, it does not omit the critical fact of the sponsor’s responsibility, not necessarily limited to financial management. In the most common form of fiscal sponsorship, Colvin’s Model A or Direct Project model, the sponsor has ultimate responsibility for the project’s legal, financial, and programmatic activities.
Lack of understanding and expertise of many organizations that act as sponsors.
The Tides Center Field Scan (referenced below) revealed some troubling data. Regarding challenges of being a fiscal sponsor, the Field Scan reported: “On average, fiscal sponsors do not rate any of the issues we presented to be challenging.” The most challenging issues on a scale of 1-5 (not challenging to most challenging): orienting new projects and staying current with the law (each scoring 2.6). Next most challenging: risk management (2.4). But in a self-assessment of their own knowledge, fiscal sponsors did not consider themselves to be knowledgeable about the legal and regulatory requirements of being a fiscal sponsor (2.8). So, fiscal sponsors on average don’t feel they’re knowledgeable but aren’t too worried about compliance or risk management.
Failure to emphasize importance of monitoring a project’s programmatic impact.
The BTW Report provides that “an effective and responsible fiscal sponsor monitors program impact as a first order priority in meeting its legal obligations.” Yet the Field Scan reported that only 55 percent of sponsors require documentation of programmatic accomplishments for all projects. And the NNFS Guidelines do not explicitly refer to programmatic oversight or to programmatic reporting to the sponsor.
Evaluating programmatic impact is an extremely challenging task for many nonprofits and beyond the scope of this post. Nevertheless, it is a critical component for increasing the effectiveness and efficiency of charitable programs and for making it possible to take a successful program to scale. But an important consideration for sponsors (and foundations): failures of innovative and/or experimental projects may be important and valuable lessons for the field (i.e., a programmatic failure may be an advancement of the charitable purpose). Reporting failures may be just as valuable as reporting successes.
Evidence of the Problem
The BTW Report noted that the firm’s interviews with foundation executives and philanthropy thought leaders “revealed a combination of ambivalence, misapprehension and misunderstanding about the nature and value of fiscal sponsorship.” Further, “[d]espite the [nonprofit] sector’s vigorous growth in the past few decades, changes in nonprofit standards and higher public expectations of charitable organizations, there has been little examination of the role that fiscal sponsorship has played and could play in this changed environment.”
Other Issues Raised During the Panel Discussion
The selection of suitable projects is a critical task for fiscal sponsors. Mission alignment is essential, but certainly not the sole criterion. Sponsors must also account for their own internal capacity and desire to further the project’s mission as well as the project leaders’ capacity to implement their projects, understand the fiscal sponsorship relationship, and work cooperatively with their sponsors.
An attendee asked about the appropriate level of due diligence in monitoring projects. This is a difficult question to answer as the law does not provide one set of clear guidance and any answer would depend on the particular facts and circumstances of the sponsor, the project, the activities, the contract, the leaders involved, and the relationships. But we can say that monitoring financial activities and legal compliance is not enough. Sponsors must also monitor programmatic activities. And it would be prudent for a sponsor to incorporate termination procedures for dormant projects.
The redesigned Form 990 contains several new sections that should be noted by fiscal sponsors. The Statement of Program Service Accomplishments now requires a description of achievements for the filer’s three largest program services by expenses. The governance policies referenced by the Form (e.g., conflict of interest, document retention/destruction, whistleblower, executive compensation, gift acceptance, joint venture) have been controversial and a major action item for many filers. And there are new schedules requiring additional disclosures related to donor advised funds, foreign activities, and noncash contributions. Further, Colvin noted that sponsors should not input fiscal sponsorship information on Schedule D, Part IV (Trust, Escrow, and Custodial Arrangements).
Sponsors should consider whether project managers may fall under the definition of key employees. Form 990 now requires that sponsors disclose whether they require key employees to disclose potential conflicts of interest. In general, a key employee (1) had reportable annual compensation exceeding $150,000, (2) had or shared organizational control or influence comparable to a director or officer or had authority or control over at least 10% of the organization’s activities, and (3) were within the group of the top twenty compensated employees.
The assets associated with a particular project might be reachable by general creditors of its sponsor in a bankruptcy. Joshua Sattely of Third Sector New England reminded me that this is another reason why projects must be careful about selection of a sponsor. Charitable trust doctrines might protect restricted assets from uses other than those intended, and Colvin noted that this argument appeared to have been accepted in New York, but it is unknown how States like California would treat this issue.
Dodd commented on the importance of insurance to protect fiscal sponsors. Insurance carriers should be made aware of all of the sponsor’s projects and special note should be made of particular projects with greater risk profiles.
Single members limited liability companies may be used by some sponsors as a risk management tool to protect the sponsor, but we haven’t seen much of this yet in large part due to the administrative burdens of ensuring that there is proper separation between the sponsor and its subsidiary LLC both from an organizational and operational perspective. Single member LLCs may be tax-exempt as disregarded entities if the sole member is tax-exempt. Alternatively, the LLC may apply for and obtain its own 501(c)(3) status, but the IRS discourages applicants from choosing this form (despite its guidance to LLCs on how to obtain tax-exempt status).
Colvin remarked that there had been a rumor that an IRS representative was going to lead an initiative targeting organizations serving as fiscal sponsors. He said that IRS Exempt Organizations Director Lois Lerner quickly responded to his inquiry by stating that no such initiative had been authorized.
Colvin also raised the possibility that certain fiscal sponsorship accounts could also fall under the definition of a donor advised fund. His excellent memo on this topic is available here.
Dodd raised the issue of unrelated business income tax and Model C (Pre-approved Grant Relationship) fiscal sponsorships where other back office services are provided for fee to the project. She referred to a recent Private Letter Ruling regarding administrative and clerical services provided by a community foundation to other charitable organizations. You can read an article from Simpson Thacher & Bartlett about the PLR 200832027 here.
Also regarding Model C relationships, Colvin cautioned against sponsors paying bills directly on behalf of their projects without a disclaimer to the project’s creditors that payments were being made by the sponsor as a convenience to the project and were not, and were not intended to be, an acceptance or assumption of any obligations by the sponsor.
I commented on two frequently used terms that I did not particularly like and thought should be replaced in our professional vernacular:
- “Advisory Committees” that are delegated with management duties and that sign the fiscal sponsorship agreement have more than advisory responsibilities. Another name should be used to describe such bodies (e.g., “Project Committees”), and they should be differentiated from the entities (often also referred to as Advisory Committees) that entered into the fiscal sponsorship agreement with the fiscal sponsor. The committees delegated with management duties pursuant to a Model A (also referred to as comprehensive) fiscal sponsorship are internal bodies of the fiscal sponsor and not separate legal entities that can enter into a binding contract. So, there are often two separate committees involved in a Model A fiscal sponsorship: (i) a legally distinct committee that enters into the fiscal sponsorship agreement, and (ii) an internal project committee that manages or provides intermediate level oversight with respect to the project.
- “Memorandum of Understanding” (or MOU) is not an appropriate term to describe a binding agreement or contract. An MOU commonly refers a nonbinding letter of intent containing agreed upon terms while other terms get negotiated. It certainly sounds more friendly than a “contract,” but when we’re creating fiscal sponsorship relationships, we need to treat and identify them more seriously.
Some Closing Thoughts
The formation of NNFS is a strong step towards greater advocacy, education, and self-regulation related to appropriate fiscal sponsorship relationships and the benefits to be reaped from utilization of this powerful vehicle. But it’s only when the field has become more uniformly professionalized that it will be widely accepted by private foundations and social entrepreneurs. How the field chooses to self-regulate the practice will be key to its evolution and growth.
Fiscal Sponsorship, Nonprofit Law Blog
BTW Informing Change, More than Money: Fiscal Sponsorship’s Unrealized Potential (2007), Jill Blair & Tina Cheplick
National Network of Fiscal Sponsors, Guidelines for Fiscal Sponsors
Tides Center Whitepaper, Fiscal Sponsorship Field Scan: Understanding Current Needs and Practices (2006)
Third Sector New England, A White Paper: On Comprehensive Fiscal Sponsorship (September 2009), Joshua Sattely
Fiscal Sponsorship 6 Ways to Do It Right (2nd ed. 2006), Greg Colvin.