Nonprofit Law Blog

Joining Forces in the Back Office - Management Service Organizations

2009-07-16T14:39:25-07:00

Sharing Administrative Services, Part III: Joining Forces in the Back Office - Management Service Organizations

Management Service Organization: MACC CommonWealth

MACC CommonWealth is an MSO that was created in January 2007 by five social services groups to provide finance, human resources, and technology. With a 20 employee staff comprised of the administrative employees of the five charities, MACC now provides administrative services for 13 groups (fees based on total revenue). MACC President Stan Birbaum discussed the following benefits of their MSO:

Improving Quality of Services and Reducing Risks. Birbaum explains the founding organizations of MACC were typically weak in one area (e.g., IT) but acceptable in another (e.g., HR). Birbaum states the biggest benefit resulting from MACC was an opportunity for all the organizations to have solid back room services across “the whole gamut” by giving the necessary quality at costs equal to or less than their historic costs so as to drive out risk at the same time. For example, a basic strategy to minimize financial risk is to separate the individuals in receivables from those in payable. Smaller members (which at best have one accountant or a part-time accountant) could not afford to implement this strategy: everything across the whole spectrum was managed by one person. And even the largest members “couldn’t get [it] right… [I]f they were fortunate enough to have two accountants or three accountants, [when] somebody was gone on vacation, somebody else did back up.” In contrast, MACC has a finance staff of 14 that not only separates the receivables from payables but also uses a third group responsible for review and release of statements, touching neither the receivables nor payables.

Economies of Scale and Purchasing Sophistication. Birbaum expressed a surprising and significant saving occurred for members one step removed from the service itself through economies of scale and purchasing sophistication. Birbaum states if the person or team involved in purchasing the benefits has a “deeper expertise in how purchase of benefits works, how the channels behave, and what the opportunities are, how to negotiate the contracts, how you work with the brokers, you have a chance of having lower costs for your organization.”

Challenges for the Member Organizations. Besides turf and ego issues, Birbaum discusses two other critical challenges. He states the first challenge is addressing service design issues to reach a standardized way of doing the work (e.g., MACC has a common auditor appointed by multiple boards at the same time, single approach to employee handbooks, and single chart of accounts): “Scale can save you some dollars; it can also cost you some dollars if you take on some complexity… [S]o our theme was always to reduce the complexity; variance we knew would increase costs.” The second challenge is this cannot be accomplished without high commitment from both the CEOs and the boards. Specifically, Birbaum says CEO mindset is a “make or break issue”: CEOs must think less about the greatest good for their organization and more about the greatest good for the collaboration, the common good; CEOs cannot compete for maximum organizational gain. Birbaum states that “[t]he critical groundwork of trust for MACC was built when the founding CEOs met every other week for 10 months before doing anything formal” and MACC continues to meet with their CEOs every quarter to address the common benefit and reinforce the spirit of working together. He credits much of MACC’s success to the “commitment of those CEOs and their personal and professional decisions to really keep faith with that collaborative covenant.”

Advice to Organizations Interested in Creating a MSO. Birbaum first advises organizations to be realistic about their expectations and what the outcome might be. For example, none of the founding MACC organizations had significant inefficiencies that could be driven out for easy “financial wins.” And while cost reduction was a hope, Birbaum states it was not the primary reason for forming MACC. Second, in order to foster a collaboration that will build a sustained success, he advises organizations to pay attention to organizational structure, governance, and more importantly, the culture and rules of engagement among the collaborators.

Capital. While establishing an MSO may create efficiencies in the long-run, it has initial costs that may take time to fund or recoup. Accordingly, organizations in financial distress may not be in a position to create an MSO. Birbaum explained MACC ran a capital fund drive to help to cover the $800,000 - $900,000 needed to create MACC. It received tremendous support from local foundation interest and importantly, Birbaum credits the members’ prior relationships with these foundations as a main reason for the foundations’ willingness to take on the risk and have confidence in MACC.
Additionally, the individual annual campaigns have benefited as well from MACC. Birbaum states the foundations that helped organize MACC place high regard on organizations that are MACC members. The membership “is short of a ‘seal of approval,’ but it helps funders have confidence in the quality of back office services and the financial stewardship of those organizations.”

To read more about the history of MACC, please view Jean Butzen’s article, "Management Service Organizations" and the Humphrey Institute's paper, “Trust as an Asset: The MACC Alliance for Connected Communities (B).”

- Emily Chan

Joining Forces in the Back Office - Administrative Collaboration and Consolidation

2009-07-15T15:49:02-07:00

Sharing Administrative Services, Part II: Joining Forces in the Back Office - Administrative Collaboration and Consolidation

On June 3, 2009, The Chronicle of Philanthropy presented the webinar, “Joining Forces in the Back Office: How Collaboration Can Help Your Organization,” moderated by Nicole Wallace, Senior Writer at The Chronicle of Philanthropy, with three panelists, Robert A. Kret, Director at the Hunter Museum of American Art; Stan Birbaum, President of MACC CommonWealth Services; and Lois Savage, President of Lodestar.

As mentioned in the previous post,"Sharing Administrative Services, Part I: Administrative Consolidations and Management Service Organizations,” administrative partnerships can be thought of to fall into four categories: an administrative collaboration, administrative consolidation, management service organization (MSO), or external provider. According to La Piana Associates, Inc., an administrative collaboration is an informal, not necessarily enduring, arrangement to share services or expertise while each organization retains its individual decision-making power; an administrative consolidation is a more formal agreement that involves shared decision making (without changing the corporate structure) and the sharing of specific functions; an MSO is a newly created organization for the purpose of integrating administrative functions; and an external service providerinvolves the outsourcing of certain administrative elements. Although the webinar did not discuss the three organizations according to these categories, applying the La Piana framework to the panelists’ experiences helps to better illustrate examples of administrative collaborations and consolidations, and MSOs.

Administrative Collaboration and Consolidation: The Hunter Museum of American Art

The Hunter Museum of American Artis part of the Chattanooga Museums Collaboration (hereinafter referred to as “CMC”), a back-office partnership formalized in 2001 between the Hunter Museum, Tennessee Aquarium, and Creative Discovery Museum. Using a fee-for-service agreement, the Tennessee Aquarium is currently responsible for the finances, human resources, information technology (IT), and some marketing for the two smaller nearby institutions. It is important to note that the Tennessee Aquarium is not an MSO; although it provides most of the administrative services for CMC, this is not its primary purpose.

Prior to CMC, the Hunter Museum was facing a steep administrative hill – it only accomplished basic bookkeeping and most things were out of date such as the personnel policy, job descriptions, (few) employee benefits, appraisal system, and unsophisticated, limited dial-up computer network. Kret states the CMC relationship originally started with sharing back-office but has since evolved into much more, and while they work closely together, “[the] organizations haven’t merged and [have] actually worked very hard to maintain their separate identities.”

While Kret believes the biggest benefit of CMC has been allowing the Creative Discovery Museum and Hunter Museum to focus on their mission, the Hunter Museum has also improved productivity, generated additional income, and saved money.

Improving Productivity.The Hunter Museum improved productivity through administrative collaborations such as joint-staff training for areas such as security and first-aid, using the area expertise from other staff (e.g., early child development), and having active participation from the Tennessee Aquarium and Creative Discovery Museum in strategic planning. The Hunter Museum also benefits from administrative consolidations such as having a standardized HR managed by the Tennessee Aquarium; joining the Tennessee Aquarium’s retirement plan to get improved benefits; and having the same CFO for the three entities. Kret highlights that because of the CFO’s unique position, the CFO has intimate knowledge of each organization from which they can pull expertise, an informed third party opinion, and valuable business consulting.
Generating Additional Income.Importantly, Kret notes that CMC was more than just a defensive measure to fix administrative problems; it also allowed the entities “to play a little offense.” For example, CMC led the 21st Century Waterfront Plan, a joint capital campaign that raised $120 million with the city of Chattanooga – $40 million of which was raised through 75 fundraising meetings held by CMC with private foundations and individuals within a 6-week time period. Kret primarily credits the CMC administrative relationship already in place as building the foundation for this joint capital campaign.
Saving Money.Kret explains that at the outset, the Tennessee Aquarium saved the Hunter Museum money by charging half of Hunter’s previous administrative expenses (which accomplished just bookkeeping functions). Ultimately, because the Tennessee Aquarium added HR and IT, the Hunter Museum receives three times the services for about half the expense. CMC created additional savings through administrative consolidations such as joint purchasing for computer hardware and software, liability insurance, etc. More specifically, CMC bundles liability insurance – but keeps the insurance products separate – and “shop[s] it out every three years so it’s a bigger piece of business [and thus] the individual underwriters have really sharpened their pencils.” CMC also uses their partnership to save money through joint exhibitions and public programs. Overall, since CMC was formed in 2001, the Hunter Museum has saved about $1.7M, the Creative Discovery Museum has saved almost $2M, all while the Tennessee Aquarium has generated roughly over $1M in income.

Although the “immediate reaction is that it’s the smaller guys who are getting the benefit,” Kret corrects this misconception stating that through CMC, the Tennessee Aquarium benefits as well by generating revenue from typically nonrevenue places like accounting, increasing retention by offering key employees a higher level of compensation, and offering their employees a much more rewarding and challenging work environment.

The success of an administrative partnership like CMC is neither guaranteed nor easy. However, this should not necessarily be taken as a deterrent. Organizations can reap great benefits from such a partnership so long as they are committed to the time and effort necessary not only to establish a solid plan going into the partnership but also to maintain a continued “upkeep” of the partnership. Kret alludes to an overarching concern that the right attitude must be in place to overcome certain obstacles and challenges that may occur in opposition to a successful partnership such as conflicting priorities and turf battles.

Avoiding Conflict of Interests Among Institutions.To avoid conflicting priorities among the institutions, Kret advises partnerships to have good communication, common sense, and courtesy and respect for one another (i.e., an understanding that you might not get something right away). For example, CMC’s inter-office computer system (e.g., setting up meetings through Outlook) and physically close proximity (all institutions within three blocks) helps facilitate its good communication. CMC also helps inter-functioning by using different fiscal years to spread out the audits and auditors’ workload.
Overcoming Challenges to Successful Partnerships.Kret emphasizes critical factors for success are a positive attitude and an understanding the partnership is about relationships between people. It important to get over “traditional turf battles” and to recognize “that each of the CEOs at the organizations have different leadership styles.
Advice to Organizations Interested in Administrative Collaborations and Consolidations.Kret says as a preliminary matter, “people need to understand it’s not necessarily going to be something that solves all of the problems an institution may be confronted with.” Kret also says that the need for a strong spirit of cooperation and leadership by the board cannot be underscored enough – “sometimes it’s not enough for the CEOs to be interested in doing something like this, I think there needs to be active participation by the board.” The attitude cannot be “we’ve always done it this way” – the organizations must open their thinking to being “more imaginative, creative, and inspired.”

To read more about the Chattanooga Museum Collaboration, please view the “About us” article written by Heather DeGaetano, developement director at the Tennessee Aquarium, on the Hunter Museum website.

- Emily Chan

Board Attendance: Expect More and Strengthen Your Organization

2009-07-12T11:17:58-07:00

Previously published in Nonprofit Conversation (June 8, 2009).

A board of directors is charged with providing ultimate oversight over the activities and affairs of its organization. Each director must discharge such duties in good faith, in a manner the director believes to be in the best interests of the organization, and with due care. Failure to regularly attend board meetings likely signals a director's inability or unwillingness to meet the director's fiduciary duties to the organization and its mission.

The most important factor in encouraging board attendance is to ensure that meetings are productive and valuable to the organization. Directors are more likely to attend meetings at which they believe their participation will be constructive. While I save a more comprehensive discussion of holding effective meetings for another post, here are some keys:

Have a capable chair who can effectively preside over the meeting and elicit the participation of the directors.
Have basic rules in place that are consistent with the organization's core values (but be careful of adopting formalized procedures like Robert's Rules without a full understanding of all of the procedures).
Predetermine the goals of the meeting (and be mission-focused).
Develop and distribute at least several days in advance a detailed agenda for the meeting, including the actions required to be taken, and supporting materials.
Provide opportunities for each director to contribute relevant information to the organization and the board with respect to major issues, opportunities and threats (this may be collected and distributed in advance of the meeting -- the chair may then choose to focus on important and/or recurring issues at the meeting).
Manage time appropriately and respectfully.
Evaluate the effectiveness of meetings.

A nonprofit's bylaws may contain provisions to encourage board attendance. Quorum requirements may be established to ensure that board meetings can only take place with the participation a majority or supermajority of directors. If the quorum requirements are set too low, a small percentage of directors may be able to take important actions without the input and vote of a majority of the directors. For example, in the case of a board with 12 directors and a quorum requirement of 40%, five directors may hold a meeting, and an affirmative vote of three may constitute a board action. By increasing the quorum requirement to a simple majority (i.e., >50%), seven directors would be required to hold a meeting, and four votes for an action. If a quorum is defined as 60%, eight directors would be required for a meeting, and five votes for an action. The higher quorum requirements would (1) send a signal to directors, prospective directors, and others that regular board attendance is expected; and (2) ensure that a very small percentage of the board could not pass actions that impact the organization. However, boards must be careful not to set its quorum requirements so high as to jeopardize the board's ability to take important actions in a timely manner.

The bylaws may also provide for an automatic removal (or deemed resignation) of directors who either miss a specified number of meetings or fail to attend a specified number of meetings. A board may have the right to remove a director with or without cause under state law and the organization's bylaws, but such actions may be highly sensitive, politically charged, and not seen as a viable option except in extreme circumstances of director misconduct. An automatic removal provision linked to attendance may allow for the pruning of absentee directors without an affirmative board action for removal and loss of face of the removed director. However, as nonprofit attorney Don Kramer points out in Nonprofit Issues, such provisions may not be enforceable, particularly if poorly drafted. One key to a valid automatic removal provision is not to tie the removal to a number of "unexcused" absences because without written evidence to the contrary, it may be argued that the board excuses every absence. Instead, the removal provision can provide for board discretion to waive the automatic removal provision under certain defined circumstances.

A nonprofit may also adopt a board attendance policy outside of its bylaws which explicitly defines the organization's expectations of its directors. Such policy may be included in the director's job description and given to each director and prospective director. Carter McNamara provides a sample board attendance policy in the Free Management Library.

Board attendance is directly correlated to board participation and thereby to the success of the organization in furthering its mission. Creating and maintaining a board culture that expects the participation of its directors in productive meetings will increase the engagement of the board. And an engaged board is one of a nonprofit's most valuable assets.

Administrative Consolidations and Management Service Organizations

2009-06-29T04:59:00-07:00

Sharing Administrative Services, Part I: Administrative Consolidations and Management Service Organizations

In January 2009, San Francisco Mayor Gavin Newsom created the San Francisco Community-Based Organizations Task Force, co-chaired by Dr. Sandra Hernandez, chief executive officer of the San Francisco Foundation, and City Attorney Dennis Herrera, to devise a strategy between the City and nonprofits in light of San Francisco’s projected $438 million budget deficit. In the Task Force’s April 2009 Report, “Partnering with Nonprofits in Tough Times,” one of its six recommendations was for San Francisco to “identify and incentivize opportunities for nonprofits to use management services organizations (MSOs) and consolidate back office functions.” The Task Force hopes this recommendation will lessen costs such as the estimated $58 million spent by San Francisco on nonprofit indirect costs in the fiscal year 2007-08. The Task Force believes MSOs offer an opportunity to capture economies of scale and when combined with administrative consolidations, nonprofits can further benefit from “the potential to standardize and improve the quality of administrative services” as well as provide San Francisco with “increased notification and oversight of performance issues.”

Especially with the current economy, there has been increasing interest in and attention on partnerships for strategic restructuring across the nonprofit sector. While MSOs and administrative consolidations are both forms of sharing administrative services, the two should not be confused as one and the same. Bill Coy and Vance Yoshida, Senior Associates at La Piana Associatesset the framework for these discussions in their article, “Administrative Collaborations, Consolidations, and MSOs,” by first defining nonprofit administration as human resources (e.g., recruiting, personnel policies, and compensation), finance (e.g., accounts payable/receivable, cash management, and forecasting), information technology (e.g., software, database administration, and website management), and other areas (e.g., marketing, office space, and grant-writing). From a macro viewpoint, organizations focus on these functions at three levels: transactional, managerial, and strategic. Coy and Yoshida state organizations seeking to share administrative services have four options available: an administrative collaboration, administrative consolidation, MSO, or external service provider.

Administrative Consolidation

Coy and Yoshida describe an administrative consolidation as a more formal agreement than a collaboration that “involves the sharing of specific functions to increase administrative efficiency.” It is a “commitment to continue, for the foreseeable future, shared decision-making power” but does not, however, change the corporate structure of the organizations. Examples may include standardized human resources practices and training, shared accounting systems, shared IT professional and other key staff, or shared marketing/development staff such as a grant writer.

They suggest a consolidation is best used when:

Nonprofits operate in similar programs in the same or adjacent communities
Good relations exist among the parties
Expansion is not necessary

A benefit of this form is that the consolidation of simple functions can be inexpensive with quick results. Drawbacks include a potential distraction from the organization’s mission because of the time and resources needed for administration of the consolidation, costs, and conflicts due to shared-decision making.

Management Service Organizations

MSOs in particular are receiving increasing attention lately by the nonprofit sector due to calls for restructuring in light of the economy, but this concept has been around for quite some time (although often a harder concept to grasp, in part, because they are historically less common than, for example, administrative consolidations).

The definition of an MSO seems to vary slightly across the sector but all center on the idea that an MSO is an organization that primarily exists to provide administrative services. For example, the Task Force defines MSOs as “independent organizations that provide management and administrative services (e.g., financial and legal services, human resources and payroll/benefits management, grants and contract management, bulk purchasing, risk management, real estate consulting, insurance) to multiple organizations, while allowing those organizations to maintain separate identities, governance structures, and programmatic independence.” Coy and Yoshida define an MSO as “a new organization created to integrate administrative functions, and thereby to increase the participating organizations’ efficiency.”

Coy and Yoshida suggest that MSOs are best used when:

This will be the entity’s sole business
Existing systems need minimal migration
Systems are easily scalable
Funders will support start-up

Benefits include an opportunity to create systems that meet the organizations’ service needs, expansion possibilities, and an integrate service model. Drawbacks include the high costs to create a new system, initial large investment of time, and potential inability to customize services.

Examples of MSOs currently operating in California help to illustrate the MSO concept:

CompassPoint is a San Francisco based MSO that works with over 300 nonprofits a year, offering consulting, research, training, and conferences in order to provide the management tools, strategies, and resources “to lead change in their communities.”
The Center for Excellence in San Jose is an MSO that provides consulting, programs, in-depth leadership development, and resources to the nonprofit community of Santa Clara and San Mateo counties.
The Valley Nonprofits Resources (VNR) is “designed to serve executive directors, staff and board members of nonprofits, plus leaders of volunteer groups and of smaller foundations” in the San Fernando Valley. VNR calls itself a “virtual MSO” because most services are provided on-line, over the phone, or in the facilities of partner organizations, thereby making it “a management support organization that takes advantage of modern technology and multiple partners.”
The Long Beach Nonprofit Partnership (LBNP) is an MSO currently serving over 1,000 community-based organizations in the greater Long Beach area. LBNP offers services such as information and referral, capacity development consulting, networking opportunities, a prized Philanthropy and Research Library, and year-round educational seminars and workshops.

Generally speaking, Coy and Yoshida advise four steps to a nonprofit considering an administrative partnership:

Step 1 – Document your existing administrative structure in order to determine where efficiencies can be created.
Step 2 – Define the improvements that would bring the organization’s administration to its desired state.
Step 3 – Identify potential partners.
Step 4 – Begin to explore potential partnerships.

“Partnering with Nonprofits in Tough Times” by the San Francisco Community-Based Organizations Task Force is available here.

“Administrative Collaborations, Consolidations, and MSOs” by Bill Coy and Vance Yoshida, Senior Associates at La Piana Associates, Inc. (2006) is available here.

- Emily Chan

The Impact of Giving Circles

2009-06-25T08:43:47-07:00

According to a May 2009 study, “The Impact of Giving Together: Giving Circles’ Influence on Members’ Philanthropic and Civic Behaviors, Knowledge and Attitudes,” conducted by the University of Nebraska at Omaha, the Forum of Regional Associations of Grantmakers, and the Center on Philanthropy at Indiana University, giving circles contribute more and act more strategically. The principle investigators were Dr. Angela M. Eikenberry, an assistant professor in the School of Public Administration at the University of Nebraska at Omaha, and Jessica Bearman, an independent consultant focusing on philanthropic and nonprofit organizations; with research assistance from Hao Han and Melissa Brown, Center on Philanthropy at Indiana University, and Courtney Jensen, University of Nebraska at Omaha.

Eikenberry and Bearman explain that giving circles are a relatively “new philanthropy” – most starting in the last five to ten years, with indication that many more exist and continue to be created. Giving circles, as Bearman estimates, account for more than $100 million in giving and have engaged at least 12,000 people; however, Eikenberry and Bearman state, of the little broad-based research on giving circles that exists, the studies have been “largely exploratory” because of its newness and “dynamic, grassroots features.” Their study aims to broaden the understanding of giving circles - “to illuminate changes in how much individuals give, how they give, and how they think about their giving.”

The study analyzed data from a survey of 341 current and past members from 26 giving circles and a control group of 246 donors and public service graduate students and practitioners; semi-structured interviews with 30 giving circle members and past members from 11 giving circles; and participant observations of four giving circles, in order to answer questions such as:

Has participation in a giving circle changed members’ behavior related to giving, volunteering, and civic engagement?
Has participation in a giving circle changed members’ knowledge or awareness about philanthropy, nonprofits and community issues?
Has participation in a giving circle changed members' attitudes or perceptions about philanthropy, community issues, political and social values, and government or nonprofit roles and responsibilities?

Highlights from the study’s findings include:

The members of giving circles give more, on average, than the donors not in a giving circle. Additionally, the giving is higher for giving circle members who are more engaged, have a longer membership history, or are members of multiple giving circles; amount of giving among members furthermore differs in relation to the type of participation in the giving circle – e.g., members who mainly participate in deciding funding decisions versus members who mainly volunteer or attend social events or educational sessions.
The members of giving circles think more strategically about giving than the control group, for example, by conducting research or using factors such as organizational data performance in making decisions, and in considering options such as supporting operation expenses or giving multi-year gifts.
The giving circles reach a wider audience than the control group, giving not only to a larger number of organizations but also showing more likely to give to organizations that support women, ethnic, and minority groups, the arts, culture, or ethnic awareness, and “other” (e.g., environment) – with the caveat that they are less likely to support federated or combined giving funds (e.g., the United Way) and religious organizations.
The length of membership in a giving circle has a positive correlation with an individual’s sense of civic responsibility, within and outside the giving circle; the findings did not, however, show a major correlation with political activism.
Participation in a giving circle increases knowledge about philanthropy and awareness of the nonprofit sector on a local and international level, even among members with a “heightened awareness” prior to their participation in a giving circle.
While giving circle members are more likely than the control group, among other things, to believe in the positive impact of giving on a community’s health, as the size of a giving circle increases, the amount of time volunteering decreases and the less members believe that giving and volunteering have a positive impact on the health of a community.

Overall, Eikenberry and Bearman suggest the level of engagement, length of engagement, and size of the giving circle are the most important factors to understanding giving circles’ effects on members. Based on these findings, the researchers give four key recommendations for giving circles (explained in more detail in the study publication(s)):

Invest in engaging and keeping members for the long-term,
Consider how a giving circle’s size may affect its impact,
Don’t worry about shifting funding away from existing priorities, and
Use giving circles to increase awareness about community and policy.

The study, “The Impact of Giving Together: Giving Circles’ Influence on Members’ Philanthropic and Civic Behaviors, Knowledge and Attitudes,” in its entirety is available here.

The summary of the study, “The Impact of Giving Together: A Snapshot of a Study on Giving Circles’ Influence on Philanthropic and Civic Behaviors, Knowledge, and Attitudes” is available here.

The 2006 study, “More Giving Together: The Growth and Impact of Giving Circles and Shared Giving,” researched and written by Jessica Bearman for the Forum of Regional Associations of Grantmakers is available here.

For information on giving circles generally, please view the previous post, “Giving Circles.”

Additional resources on giving circles are available on the Forum of Regional Associations of Grantmaker website, in the “Giving Circle Knowledge Center”.

- Emily Chan

Selecting the State of Incorporation

2009-06-11T10:30:49-07:00

Founders of to-be-formed nonprofit corporations may be confused about selecting an appropriate state of incorporation. The general rule of thumb is to incorporate in the state in which the nonprofit will operate. This may substantially reduce the nonprofit’s reporting requirements and associated burdens. If the nonprofit is incorporated elsewhere, it may be required to qualify to do business as a foreign corporation in the state in which it is operating. In addition, the nonprofit may need to register to engage in charitable solicitations, obtain state tax exemption, file several regular information returns, and maintain an agent for service of process, in both the state of incorporation and the state of operations.

However, there are other factors to consider in deciding on the state of incorporation, particularly if the nonprofit will be operating in multiple states. State corporation and tax laws may be more favorable in some states than in others. For example, nonprofits may be concerned about the presence or absence of state income taxes, the amount and types of regulations that would impact their operations, restrictions on compensated directors, and filing burdens.

The following are some of the considerations for groups considering incorporating in California:

Form FTB 3500A. California has a state tax exemption application separate from the 501(c)(3) tax-exempt status process with the IRS. Prior to 2008, there was only one option: a multi-page form FTB 3500. As a result, states without taxes, such as Nevada, could leverage the appeal of no such additional filing requirement. However, beginning January 1, 2008, the California tax exemption process was streamlined for organizations that have already received federal 501(c)(3) determination with the introduction of form FTB 3500A, Submission of Exemption Request. Form FTB 3500A is only a one page form submitted with a copy of the 501(c)(3) determination letter, thereby greatly diminishing the effort involved to obtain California tax exemption.

Default Rules. The California Corporations Code has a section specifically dedicated to nonprofits that also contains a myriad of default rules. Not every state shares these characteristics. For example, Delaware has a much less comprehensive code dedicated to nonprofit corporation law. States such as Delaware that allow great flexibility in constructing bylaws may be more desirable for nonprofits that intend to or already have comprehensive bylaws. California, on the other hand, is better able to “fill-in” the gaps for more simple bylaws due to its default rules. California’s default rules should not, however, deter nonprofit corporations with detailed bylaws as many of the default rules only apply if not otherwise indicated in the organization’s articles or bylaws.

49% Limitation on Interested Directors. California imposes a 49% limitation on interested directors. Calif. Corp. Code § 5227. Other states, such as Delaware, have no such limitation. In one respect, no limitation on the number of interested directors makes it easier for a nonprofit to incorporate simply because it is one less rule to follow. However, the 49% limitation rule is considered a best practice in the nonprofit sector and therefore, it may be a beneficial rule the nonprofit wants to have in place.

Agent for service of process. A nonprofit must have an agent for service of process with a physical address located in the state of incorporation. The government may send official documents (e.g., tax notices and annual reports) to the agent’s address and the agent is also responsible for accepting lawsuit papers on behalf of the nonprofit. Therefore, a nonprofit that operates and is incorporated in California will benefit from having a domestic agent for service of process, which may be more readily accessible and available, such as an officer of the nonprofit. If a nonprofit operating in California incorporates in a foreign jurisdiction, it will have to appoint an agent for service of process in that foreign jurisdiction of incorporation as well as qualify to operate in California with the California Secretary of State.

Lawsuits in Court. A nonprofit risks the possibility of being hailed into a court in the state of its incorporation. Therefore, incorporating in the same state of the nonprofit’s operation may present fewer hurdles for individual(s) required to appear in a court in the state of incorporation.

California Nonprofit Integrity Act 2004. The California Nonprofit Integrity Act applies to most nonprofits operating in California. The Act requires compliance with provisions such as an annual financial statements audit by an independent certified public accountant for charitable corporations with gross revenues of $2 million or more. Therefore, even if a nonprofit is incorporated in another state, it cannot evade these requirements if it is operating in California.

A previous post on Form 3500A, “Form 3500A – Affirmation of 501(c)(3)” is viewable here. California’s Franchise Tax Board also has a frequently asked questions section regarding the differences between form FTB 3500 and form FTB 3500A as well as tax news section discussing the updated process.

A summary of the key provisions of the California Nonprofit Integrity Act 2004 is available here.

- Emily Chan

Conversions Between a For-Profit Corporation and Nonprofit Public Benefit Corporation

2009-06-08T19:00:48-07:00

California allows a for-profit corporation to convert into a nonprofit public benefit corporation and vice versa provided that certain steps are followed for each respective process.

For-profit corporation to Nonprofit corporation

Generally, a for-profit corporation can convert to a nonprofit public benefit corporation by amending of its articles of incorporation. See Calif. Corp. Code § 911(a). If no shares have been issued, Section 911(b) requires that the amendment of the articles shall:

Revise the statement of purpose
Delete the authorization for shares and any other provisions relating to authorized or issued shares, and
Make such other changes as may be necessary or desired.

The California Corporations Code imposes additional requirements on a corporation that has any shares issued. For example:

The amendment shall also “provide either for the cancellation of those shares or for the conversion of those shares to memberships of the nonprofit corporation.” Calif. Corp. Code § 911(b)
The amendment must “be approved by all of the outstanding shares of all classes regardless of limitations or restrictions on the voting rights thereof and an amendment to convert to a cooperative corporation shall be approved by the outstanding shares [] of each class regardless of limitations or restrictions on the voting rights thereof.” Calif. Corp. Code § 911(c).

A key element to remember is that a nonprofit public benefit corporation holds its assets in a charitable trust. Therefore, upon this conversion, the assets will be “locked in” for the nonprofit’s charitable purposes only.

Nonprofit corporation to For-profit corporation

Generally, a nonprofit public benefit corporation without assets can convert to a for-profit corporation by amending its articles of incorporation and providing a copy of the amendment to the Attorney General at least 20 days prior to its filing. See Calif. Corp. Code § 5813.5(a), (b). However, a nonprofit public benefit corporation with any assets cannot convert into a for-profit corporation through an amendment to its articles unless the amendment has received prior written consent of the Attorney General. Calif. Corp. Code § 5813.5(b). According to the California Attorney General’s publication, “Nonprofit Transactions Requiring Notice or Attorney General Approval,” certification that all charitable assets of the nonprofit will be transferred to another charity is required for consent. Furthermore, the publication states that applications should include:

A letter signed by an attorney or a director of the corporation setting forth a description of the proposed action and the material facts concerning the proposed action; authorizing the proposed action, and board meeting minutes reflecting discussion of the proposed action;
A copy of the corporation’s current financial statement;
A copy of the corporation’s articles of incorporation (if not already on file with the Registry of Charitable Trusts) and the articles of incorporation of any other corporation that is a party to the proposed action;
Any independent appraisals of the value of the public benefit corporation that are available. (In complex transactions involving conversion of a large public benefit corporation, the Attorney General usually requires independent valuation appraisals or other evidence that the transaction is fair and reasonable to the public benefit corporation.);
A statement of the plan for distribution of the assets of the public benefit corporation to a qualified charitable organization, or for payment by the directors or purchasers of the public benefit corporation of the fair market value of the corporation to a qualified charitable organization.

While the Attorney General’s approval is not expressly required before a nonprofit public benefit corporation without assets converts to a for-profit corporation, it is possible for the Attorney General to hold up the conversion by asking for information to verify the nonprofit public benefit corporation does not have assets. Accordingly, to help avoid this delay, it may be beneficial to include a letter from the CEO stating the nonprofit public benefit corporation has no assets in the notice to the Attorney General.

The California Corporations Code is available here.

The California Attorney General’s publication, “Nonprofit Transactions Requiring Notice or Attorney General Approval,” is available here.

Forms and instructions for amending articles of incorporation for both for-profit corporations and nonprofit public benefit corporations are available on the California Secretary of State website.

For more information on charitable trusts, please view a prior post, “Charitable Trust Doctrine.”

- Emily Chan

You've Gotta Have Heart

2009-06-04T05:33:00-07:00

I recently skimmed You've Gotta Have Heart: achieving purpose beyond profit in the social sector by Cass Wheeler, former CEO of the American Heart Association (1997-2008). Wheeler's stated goal of writing the book: "to increase your organization's or your operation's effectiveness by 5 percent (or better) over your current projections."
Here are some of the many helpful takeaways, supported in the book by real-life examples:

A mission statement is not the same as a true sense of mission. Nonprofit organizations must have a pervasive sense of mission. Without a cause that resonates with volunteers and donors, nonprofits will ultimately fail and die off.

Good intentions are no longer enough. Nonprofit organizations must apply some businesslike, bottom-line mentalities to maintain their credibility with increasingly skeptical and results-oriented donors.

Determine core values and stick to them. Your organization's core values are your ethical standards: what is important to your organization and how you will do business.

Every nonprofit needs a strategic driving force. A driving force is "the primary determinant of the products and services an organization will and will not offer the the market ... it will and will not serve."

Know your business model and change it if necessary. ... Your business model is the process by which you acquire financial resources and how (and by whom) those resources are expended. Be aware of how it helps or hinders you in achieving your mission.

Every nonprofit needs a breakthrough goal. It provides accountability and allows you to make difficult decisions about the allocation of limited resources. It provides excitement among your employees, volunteer, board members, donors, and the public.

A bold goal is meaningless without rock-solid execution. ... When you set a breakthrough goal, you have to be willing to hold your organization's feet to the fire.

Shout your goal from the rooftops.

Marketing is not a dirty word. As long as a nonprofit organization's marketing is effective in boosting image, driving mission, extending reach, and increasing revenue, not only is it acceptable for a nonprofit, it is essential.

Any marketing effort must link to your organization's mission and strategic driving force.

Incorporate diversity into your efforts. Your organization must reflect the diversity of your constituents to serve them most effectively. Look to partnerships, local networking opportunities, supplier diversity, and affinity groups to learn about best practices and ensure equal service and opportunities for all."

Remember to declutter. The only way to have room for innovation is to let go of programs, activities, and products that no longer produce a return on investment.

You must have a people strategy. Developing your staff is not a program to implement; it is a way of being.

Make deposits in people's emotional trust accounts. Think of positive acts of leadership and management as making deposits into an emotional account with each person on your team. The more goodwill you have in your trust account, the better positioned you are if you ever need to make a withdrawal, such as asking for a favor or forgiveness for a mistake.

Implement best practices with your board.

Advocacy and lobbying should be considered by nonprofits large and small. We have a responsibility to speak out on issues that affect our constituents and advocate for better public policies.

Develop a specific and realistic strategic alliance value proposition. This is a simple statement that defines: (1) what you bring to the table in a partnership and (2) what your organization expects to receive from partner organizations.

Personal alliances drive professional alliances.

Wheeler combines strong business acumen and integrity with an appreciation of nonprofit organizational cultures. Moreover, You've Gotta Have Heart is accessible, insightful, and widely applicable. It's a book that I'll sit down and read more thoroughly soon.

California Attorney General Sues Charities, Directors & Fundraisers

2009-06-02T21:51:11-07:00

From a May 29, 2009 news release from the Office of the Attorney General:

As part of a nationwide crackdown on fraudulent charities, Attorney General Edmund G. Brown Jr. is filing today eight lawsuits against 53 individuals, 17 telemarketers and 12 charities that "shamelessly exploited" people's generosity and squandered millions of dollars of donations intended to help police, firefighters and veterans.
Brown's suits are intended to permanently stop the charities' deceptive practices and require the repayment of all funds raised under false pretenses. Brown is seeking involuntary dissolution of eight of the charities.
"These individuals shamelessly exploited the goodwill of decent citizens trying to help police, firefighters and veterans," Brown said. "In point of fact, a shockingly small portion of donations went to those in need, while millions went to pay for aggressive telemarketing and bloated overhead - and in one case - to purchase a 30-foot sailboat." Brown filed these suits in conjunction with the Federal Trade Commission and 48 other states as part of a nationwide sweep called "Operation False Charity."

See more about Operation False Charity at the FTC site here.

The California Attorney General's suit against one charity, Law Enforcement Apprenticeship Program ("LEAP"), its directors, and its fundraisers, contends that they:

Conspired to defraud donors.

Engaged in unfair business practices in violation of Business & Professions (B&P) Code Sec. 17200.

Failed to use contributions for the purpose solicited in violation of B&P Code Sec. 17510.8.

Made illegal distributions in violation of Corporations Code Sec. 5237.

Knowingly filed false public documents in violation of Corporations Code 6215.

Failed to keep corporate books and records in violation of Corporations Code 6320.

While the case against LEAP may be based on egregious violations, there are lessons here for other charitable nonprofits:

Spend a significant amount of funds raised in furtherance of charitable purposes stated in the organization's governing documents and solicitation materials.

Do not loan funds or otherwise improperly distribute funds to directors.

Keep accurate corporate books and records.

File accurate information returns.

Board Actions by Email - California Nonprofits

2009-05-31T16:18:58-07:00

While it may be common practice for nonprofit boards to take action by email voting, this may not be permissible under the California Nonprofit Corporation Law. Boards may take action only at a duly held meeting or by unanimous written consent. The issue then is whether an email vote meets the requirements of a duly held meeting or unanimous written consent.
A board meeting may take place via conference call or electronic video screen communication, provided that all directors participating can hear one another. A meeting may also take place via other electronic transmission if (a) each director participating can communicate with all other directors participating concurrently, and (b) each director is provided the means of participating in all matters before the board. Generally, an email vote would not meet such requirements because of the lack of real-time participation by all participating directors.

A board may also take action by unanimous written consent, that is, "if all members of the board shall individually or collectively consent in writing to that action." An "interested director" (generally, one with a material financial interest in the transaction being voted upon) is excluded from the "all members of the board" requirement. Such action has the effect of a unanimous vote of the directors.

The California Corporation Law does not expressly authorize a unanimous written consent to be executed by email. However, an email vote may constitute a unanimous written consent if all directors, other than any interested directors, approve the same action "in writing." "In writing" is defined in the Nonprofit Corporation Law vaguely to include "facsimile, telegraphic, and other electronic communication as authorized by this code, including an electronic transmission by a corporation that satisfied the requirements of section 20." Section 20 in turn requires that an email by a corporation satisfy the federal E-Sign Act, which defines an "electronic signature" as "an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record."

For a unanimous written consent, an approval in writing requires a valid signature of the director, whether it be manual or electronic. Where the signature is simply the typed name of the sender, a major issue is whether the board relied with due care on the authenticity of the signature. While not directly applicable, the California Government Code, which applies only to communications with public entities, offers some guidance. It states that "the use of a digital signature shall have the same force and effect as the use of a manual signature if and only if it embodies all of the following attributes:

It is unique to the person using it.

It is capable of verification.

It is under the sole control of the person using it.

It is linked to data in such a manner that if the data are changed, the digital signature is invalidated."

For a trivial action, If the purported sender of an email consent denies sending it, there may be little, if any, harm. However, the same may not be true for a major transaction or corporate change. In such case, the requirement of a manual signature seems prudent. Because it may be too much trouble to determine where an email consent would or would not be appropriate, I generally disfavor unanimous written consents by email without use of manual signatures or unique digital signatures.

See also Can Association Boards of Directors Vote by E-Mail or Fax? by Jeffrey S. Tenenbaum; and
Electronic Signature Legislation by Thomas J. Snedinghoff and Ruth Hill Bro.