Helpful Hints for Making the 501(c)(3) Transition
It certainly isn’t easy to be charitable. You’d think getting your 501(c)(3) tax-exempt status so you can begin the important work of saving the world would be a simple formality. You would breeze right through the paperwork and begin collecting much-needed government grants (to supplement the spending you’ve already been doing against your mortgage or on your own personal credit cards). Alas, that is not the case.
Instead, expect a grueling process that can take as long as a year. And what are you supposed to do while you’re waiting? The credit cards may be maxed but your clients need services!
Welcome to the catch-22 of becoming a nonprofit. You need to be able to start receiving governmental grants and contracts to support your mission, but you can’t until you’re legally a 501(c)(3). With the right expectations and proper planning, however, you can get through this financially strained period and your organization will be even stronger for it.
In my work with the Research Foundation of CUNY, we encounter many charitable groups that are in the process of getting their tax-exempt status. Inevitably, it takes longer than anyone imagined. This doesn’t mean the organization’s services grind to a halt. Instead, with strategic thinking and proper foresight, these up-and-coming nonprofits successfully make the transition to full-fledged 501(c)(3)s. Are there bumps and delays along the way? Of course – this is the nonprofit world, after all. But they’ve employed a range of strategies to make their transitions easier. Here are a few of their secrets:
1) Become a program of a larger nonprofit.
One successful strategy for fledgling groups is to tap into larger, established organizations whose work complements their missions. For example, if your work helps advocate in court for survivors of domestic violence, why not look into entities that provide support services for these individuals already, like shelters? Perhaps the shelter could temporarily house you as a program of their organization.
Or if your mission is to provide mentoring for at-risk youth, you could consider organizations that already provide services to your target population, and then offer to provide an additional program. Obviously you wouldn’t want to duplicate a parent company’s existing services, so you should focus on finding something where your services would be supplemental. Perhaps an entrenched after school program has plenty of kids, but doesn’t have a one-to-one mentoring component yet. That’s where a new group could step in and provide a valued service.
The advantage for the existing nonprofit is receiving additional services from a team of passionate experts that could strengthen its ability to fulfill its mission. These services would benefit the organization’s clients and may even help the nonprofit look even more robust to potential funders. This is a win-win for them: it satisfies both clients and funding sources.
There are many advantages for the up-and-coming nonprofit as well. By being a part of an established and successful nonprofit, the new organization gains credibility. It also has the opportunity to sharpen its services and gain valuable experience. This is a chance for the new nonprofit to get its feet wet in the nonprofit world without the full-on responsibility of actually running (and securing funding for) an entire organization. In many cases, the parent organization will also provide space and administrative services, like payroll, in exchange for the opportunity to have this new program involved.
Of course, your work isn’t over once you’ve been “adopted” by a larger nonprofit. As you’re awaiting your 501(c)(3) designation, you should also be applying for a wide range of funding opportunities that will be in your organization’s name. You should also be negotiating your exit from the larger nonprofit, if applicable. Perhaps you will decide to stay on as a partner with a separate 501(c)(3), or perhaps you’ll be ready to spread your wings in a separate office space and with your own administrative staff. In that case, you’ll need to make sure your back-office is ready.
2) Attain a fiscal agent or fiscal sponsor.
Another option for organizations transitioning to the nonprofit sector is to work with a fiscal agent or sponsor. (I use these terms interchangeably, although legally a fiscal “agent” does not exist.) A fiscal sponsor is a nonprofit that will accept money on behalf of somebody else. This can be invaluable for organizations who are awaiting their 501(c)(3) status, as fiscal sponsorship can be a fast and efficient way to receive and administer grants that are earmarked for nonprofits.
The challenge, however, is finding one. Your mission and the fiscal agent’s must be aligned, meaning that an organization who provides care to rescued animals couldn’t serve as the fiscal agent for a program for incarcerated youth. And the fiscal agent must assume the risk, which means they may be reluctant to extend the benefit to everyone who asks. They also may have strict rules of their own about how to manage the funding to mitigate their risk, which can be challenging for newer organizations who are not accustomed to this type of funding or the fiscal sponsor’s way of doing things.
And some fiscal sponsors are even more restrictive. One nonprofit, for instance, prevents anyone for whom they serve as a fiscal sponsor from becoming a nonprofit themselves. While this may be acceptable to smaller groups with no plans to grow or achieve autonomy, it does limit groups who do plan on getting their own tax-exempt status. This is worth keeping in mind when thinking about a fiscal sponsorship agreement.
3) Diversify your revenue
Although this advice certainly applies to all nonprofits, it is especially important for anyone awaiting tax exempt status. You don’t want to achieve 501(c)(3) status – finally! – only to find that poor financial management already has your organization in the red from the beginning. You also don’t want to take on a great deal of personal credit card debt in support of your new organization, assuming that once you become a nonprofit, all the grants you’ll get will allow you to pay yourself back. Unfortunately, it’s not that easy. In fact, often governmental grants will only reimburse nonprofits for pre-approved expenditures, so you may find it impossible to ever get reimbursed for that trip you took to Egypt two years ago in support of your international charity’s mission, and for which you’re now paying back at 19.9% APR.
Instead, be realistic about your projected revenue and spend accordingly. As you’re awaiting your 501(c)(3) letter from the IRS, do some research and solicit private donations from individuals or foundations that don’t require grantees to be nonprofits to cover expenses. You can certainly be ambitious with your organization’s mission; just make sure you have the funding in place before you go on a spending spree (even if it is for a good cause). And if donations aren’t enough to pay the bills before you qualify for that federal grant, consider getting a line of credit for your nonprofit to help with expenses. This may be important to have in place anyway, particularly during funding gaps when you’re waiting for reimbursements.
Nonprofits have always faced an uphill battle, and the process of attaining 501(c)(3) status is no exception. But if you plan accordingly and consider some of these options, your organization will be ready for the ongoing challenges it will inevitably face. Think of it this way: it’s not easy to become a nonprofit, meaning that only committed, capable folks will succeed. Be one of them.
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