How can we incubate an innovative, profit-making nonprofit project?

As covered in our last post, Starting a Self-Sustainable Nonprofit, it may be possible and advantageous to operate a sustainable, profit-making, charitable project as a nonprofit organization. If this route is chosen, the leaders should ensure that the organizational, governance, and administrative structures are carefully constructed at the outset to provide a strong foundation for the organization. A weak foundation may jeopardize the nonprofit and its ability to engage in its contemplated activities and expose its leaders to personal liability. For example, an overly restrictive purpose statement may prevent the organization from engaging in certain activities or using its assets to further another purpose; an unlawful bylaws provision may lead to internal governance disputes and litigation; and lack of financial and internal controls can lead to losses, investigations, and penalties against the organization and its leaders.

Where the early stage funding is going to be modest, and there will initially be little effort to build solid organizational, governance, and administrative infrastructures, you should consider fiscal sponsorship as an alternative to starting a nonprofit. A fiscal sponsor can provide you with an existing 501(c)(3) nonprofit vehicle to house the charitable project. Legally, this means that the fiscal sponsor “owns” the project, but programmatic management is delegated to your group. And in a good sponsorship agreement, there will be an exit clause so you can move the project to another 501(c)(3) nonprofit in the future - either another qualified fiscal sponsor (if you become unhappy with the initial fiscal sponsor) or a new entity (your startup nonprofit). In many cases, this makes a good fiscal sponsorship arrangement an ideal incubator for a nonprofit project. If the project works, spin it off; if it doesn’t, no need to go through all of the steps and burdens of a formal dissolution – you can simply shift your energies to a new project.

In considering fiscal sponsorship, it may be very valuable to first discuss this option with a knowledgeable expert and have an attorney review any contract. In this contract, all of the ownership of your project may be transferred to the fiscal sponsor, so you need to understand and protect your rights regarding how to get such rights back to a new nonprofit under your management. Fiscal sponsorship done right may be a great option, but it is often done wrong – and that may lead to trouble. A small investment up front towards establishing and understanding a solid fiscal sponsorship agreement can provide you with the assurance and confidence to concentrate on creating social change rather than dealing with future disputes and investigations.

Gene Takagi is a San Francisco-based exempt organizations attorney and author and publisher of the Nonprofit Law Blog. Prior to opening his independent office in 2005, he practiced in the corporate group of the AmLaw 100 firm Sheppard, Mullin, Richter & Hampton LLP, during which time he was awarded Outstanding Barrister of the Year from the Bar Association of San Francisco and featured in Equal Justice magazine. In October 2007, Gene was featured on the front page of The Recorder, Northern California’s leading legal newspaper, and law.com.

Gene holds a law degree from UCLA and a graduate degree in nonprofit administration from the University of San Francisco. Prior to becoming an attorney, Gene held various management positions both in the for-profit and nonprofit sectors, and was responsible for annual budgets of up to $50 million and for the preparation of RFPs cumulatively worth over $500 million. He is a former director of the medical and behavior divisions of the San Francisco SPCA.