Non-Profit Social Enterprise: What You Need to Know

Today we have a guest post from Laurel Rogal of Klamp & Associates, a law firm dedicated to representing charitable organizations.  She walks us through some of the do’s and don’ts of non-profit social enterprise.

Nonprofits are increasingly seeking alternatives to their traditional dependence on donations and grants. While such contributions are often essential sources of revenue, exclusive reliance on them may make organizations susceptible to unpredictable economic fluctuations.

Revenue-generating activities are an effective way to diversify and sustain income for charitable programs. For example, a homeless shelter may earn revenue by selling products made by its residents. An art museum may rent its building for private events such as weddings. A humanitarian organization may license its logo to a national retailer in exchange for a portion of sale proceeds.

If not done carefully, however, revenue-generating activities can have adverse tax consequences. First, the IRS may impose an “unrelated business income tax” (UBIT) on otherwise exempt organizations that regularly conduct a trade or business that is not substantially related to their charitable mission. Second, and more seriously, nonprofits that engage in a substantial amount of “commercial” activity can lose their tax-exempt status. This is because the IRS takes the binary view that activities are either charitable or commercial and considers commercial activity incompatible with 501(c)(3) status. While the IRS has broad discretion to determine which category an activity falls into, it often emphasizes (1) whether it competes with for-profit businesses and (2) whether it is priced at or above cost.

Nonprofits have three options to generate earned income without jeopardizing their exemption:

  • First, nonprofits can conduct revenue-generating activities that are charitable rather than commercial in nature. This means conducting the activity in a manner distinct from for-profit businesses. For example, a microfinance activity may be considered charitable rather than commercial if it takes more risk, offers more generous terms, and/or provides more support to borrowers than commercial lenders. Likewise, a publishing activity may be considered educational rather than commercial if the charity avoids paying royalties, sells the publication through its website rather than sales agents and paid distributors, and/or subsidizes the publication with donations.
  • Second, nonprofits can earn revenue that will generally be treated as an exception to the commerciality rules, such as (1) sponsorship income and (2) passive income. Sponsorship income is paid by businesses in exchange for acknowledgment as the charity’s official sponsor. Passive income includes rents, royalties, interest, and other income that accrues without ongoing activity by the charity. Please note that if either of these undertakings becomes vastly excessive in relation to the nonprofit’s actual charitable activities, the nonprofit may face IRS scrutiny and/or penalties.
  • Third, nonprofits can engage in revenue-generating activities that are an insubstantial portion of the organizations’ overall operations. The IRS has considerable discretion to determine whether an activity is substantial, since this term is not defined. In some cases, an activity that amounts to 10% of the charity’s revenue may be considered substantial. Please note that, unlike the previous two options, income from an insubstantial activity may be subject to UBIT.

Nonprofits should consider these tax issues when designing and implementing revenue-generating activities. Careful planning can protect the nonprofit while increasing its capacity to serve the public good.

Build the Better Budget: Non-Profit Budget Tools from Consultant-Land…and Reality.

An old friend and I were catching up the other day and she observed, “Your approach to philanthropy has really changed since you joined a board, hasn’t it?”  While I’m not sure that it’s been a change in only one direction, I do know that leading a board has made me a better consultant, more cognizant of the tough realities of non-profit management and tied into the calendar.  And that means it’s budget planning time…  I’ve been diving through the waves and waves of non-profit budget planning tools available, both to make sure we’re doing the best possible job as a board, and to take a look at what’s out there, as I wear my “consultant” hat.  But first, a few thoughts on the budget process before the tools are needed…

It may be cold comfort for those who recognize themselves in these situations, but here are the budget and goal-setting processes we hear too often:

  • The budget is set as a mandate from on high and the goal is delivered, Moses-like on tablets carried from the top the mountain.Buried-in-Paperwork-300x200..
  • The year’s impact goals are never really set and the budget is forced to fit the fund development projections…
  • …and that projected goal is developed with a shrug of the shoulders – “Who knows what we can raise next year?  We’ll know when we do it…”
  • …or the budget and goals for the coming year are dictated by donor interest, “We’ll do what our donors support.  How should I know what our budget should be until our donors tell us what they want?”

Being a responsive organization that can build visionary plans and achievable goals does not involve carrying stone tablets, delivering divine proclamations.  And being a donor-centric organization stops considerably short of doing whatever “The Donor” – whoever that mythical being is – wants accomplished.

On to the ideal!, says the consultant side of me.

Ideally, the organization’s leadership will begin with an annual review of the strategic plan:  where has progress been made?  What progress is next?  Which strategic goals need adjustment?  Which have been accomplished?  And from this review of the agreed upon, multi-year strategic plan, the year’s tactical goals for creating impact and outcomes should emerge.  Then the team asks themselves:  what is needed?  What investment of time, equipment, or resources is needed to achieve this goal?  Is it new staff?  New phone system?  And a first pass at the budget is developed from the strategic goals to the impact goals sought in the next fiscal year.

Simultaneously, the fund development team is building their goal from their gifts received and name-by-name projections (you are doing name-by-name projections on your table of gifts, right?!).  The projected goal is hand-built and movement toward key thresholds like reaching 20% of the philanthropy goal from board giving is established. This name-by-name projection is added to the projections for the broader channels of funding, based on program tweaks or overhauls (and the budget costs for those factored on too!) to arrive at an achievable goal.

THEN, these two are compared and any gap is discussed calmly, with a spirit of “Can Do!” give and take.  Cuts are made or more cost-efficient ways to do things are uncovered and the goal grows with innovative ways to increase giving and other revenue sources.

Isn’t that exactly the way it happens every year?  Riiiight.  Perhaps in consultant-land…  Back here in reality, it is seldom that tidy.  But that doesn’t mean we can’t strive for it.

Here are the TWO things (just 2!) we can’t cut corners on:

  1. You must create impact goals tied to the revenue needed to achieve them.  We are doomed to bad business planning and low sights when we don’t know what it costs to deliver the change we seek to make.
  2. You must hand-build that philanthropy goal from the ground up, person by person at the top of your table of gifts and campaign by campaign

If you find yourself applying a flat percentage increase to your fundraising goals or to build your new budget number:

STOP RIGHT NOW. 

TURN AROUND AND GO IN ANOTHER DIRECTION. 

Success in impact and in fund development requires that your goals must be tied to reality.  If you’re having trouble writing a persuasive case for support or convincing donors to give, it’s probably because you don’t have a great answer to this question.

So, to those tools to get this done:

I mentioned in an earlier blog piece, the embarrassment of riches that the wonderful folks at the Wallace Foundation have provided through their new Financial Planning Toolkit.

  • For those going through the budget planning process – especially board leaders – here’s a practical, step-by-step guide for leading this in your organization:  Five Step Guide to Budget Development from the FMA.  This readable .pdf is suitable for sharing with the whole board.

I was also happy to find a thoughtful piece on when to run a surplus budget, break-even budget, or deficit budget from Blue Avocado written by Jeanne Bell called “Nonprofit Budgets Have to Balance: False!”. Did you know you had a choice?  You do.

Need even more?  The National Council of Non-Profits has an extensive toolkit specifically on the budget building process.

A final thought:  my board experience has also taught me that it is just as important that your fund development committee (and fund development staff!) be conversant about your 990 – the ultimate reflection of this entire process – as your finance committee.  Donors deserve to know how your budgeting and spending choices will carry out their giving wishes – that’s the best stewardship and the right way to be donor-centric.

Capitalize Your Development Operation!

by Robert Osborne

Every organization wants more money for its programs but I am constantly surprised at how few organizations are actually willing to spend money to make money. I know of organizations that have cut back their development staff even as they have raised their fundraising goals. I know of organizations that refuse to do stewardship because they think it is too expensive. And I know of “national” organizations that wish to fundraise across the United States but have no travel budget.

The problem becomes even larger when we talk about capital campaigns. Organizations that wish to raise 10x or more of their annual operating budget and tens of millions of dollars often balk at spending even a $100K to do so!

Your development office is a “profit center”, another way of saying that your development office makes you money. But only if it is properly capitalized. While different types of fundraising have different costs associated with them, a good rule of thumb is anticipating spending somewhere between $.15-$.20 for every dollar you want to raise. Events have the highest costs associated with them with a cost of roughly $.30 on the dollar and major gifts have the least with a cost of roughly $.12 on the dollar. But there is no such thing as free fundraising.

Every organization should ask itself what it needs to be successful to meet its fundraising goals. Do you have enough personnel, not just “front line” fundraisers but also administrative support? Do you have the proper technology to operate efficiently and effectively? Do you have the marketing pieces you need including video? Do you have a budget for any necessary travel? Have you built in contingency?

My suspicion is that organization try to do fundraising on the cheap because they do not have the cash on hand when they begin their fundraising. They realize that they are undercapitalizing the effort but are unsure what to do. Ideally, our supporters would help us in this area as Dan Pallotta discuss in this post in the Harvard Business Review and truly leverage their investment, but lamentably capacity building tends to be way down on investors lists of things to fund.

Sadly, there are no short cuts. An undercapitalized effort may even cost you more than not doing it at all. If you don’t have the cash on hand to properly capitalizing a fundraising effort you need to make raising the necessary capital part of your plan. This may take longer but it will be worth it. To not do so is to spend money on what is likely to be an unsuccessful effort. But the right investment can go a long way.

You can follow me on twitter:  @bobosborne17