Starting any type of business is a risky endeavor. Whether you’re starting a consulting firm, a food truck, or a nonprofit food pantry, entrepreneurs face unique risks. And given that nonprofits can’t have owners, many social entrepreneurs face an even higher level of risk. But there is a nonprofit governance model that can address some of these concerns: the sole member nonprofit.
For 25 years Foundation Group has helped people all across the country start new nonprofits…over 20,000 of them! In that time, we’ve worked with virtually every startup scenario you can imagine. Many nonprofits get started with an already-recruited board of directors made up of high caliber individuals, a solid business plan, and significant funding in place or pledged. These nonprofits launch large and have immediate impact. The risk to any one individual is relatively small, and the volunteer board hires staff to run operations. In reality, though, these startups are the exceptions.
There’s an even larger group of startups that don’t look like that. It might surprise you to know that over 75% of new nonprofits have initial budgets under $50,000 per year! They are started and run by passionate individuals or families who see a need, and decide to tackle it. The founder recruits some board members who can help, is usually the President of said board, and is often the primary person who puts in the long hours to make it all happen as the ultimate super-volunteer. It’s their passion, their dream, and without them, nothing would ever get off the ground. Some even go so far as to leave their career and risk everything in the hope that someday, this little startup catches traction and is able to be a new, paid career.
Now, this individual could start a private foundation, and there’s nothing wrong with that. A private foundation is a 501(c)(3), after all, and it is allowed to have a closely held board of directors (such as all members of the same family). The problem with this choice, however, is that private foundations aren’t really designed for conducting programs. They’re better suited for grant making to the other, better choice of 501(c)(3): the public charity.
Further, rules governing private foundations make it very difficult for board members to be paid as employees, no matter how much work they’re doing for the organization. It’s not impossible, but it’s a narrow, heavily-scrutinized path. And finally, private foundations are usually internally funded, and external fundraising can be extra-challenging.
A public charity is the best choice of 501(c)(3) in such a situation, but it comes with its own problems, the most significant of which is the requirement for a majority-independent, unrelated board of directors. In such a scenario, the founder/president is but one vote among all the others on the board.
Sadly, there are situations where such a founder, the one who has shouldered all or most of the risk, eventually gets sideways with his/her board, and gets voted out of the very organization they started, they initially funded, and maybe they counted on to finish out their career.
Is that fair? Sometimes, yes. Sometimes the founder has worn out their welcome and has actually become a liability to the organization’s future. Far too often, however, it’s just simply tragic.
So is there a way for a social entrepreneur with outsized risk to prevent such an outcome? There is, and it’s called the sole member nonprofit.
All nonprofits, including public charity 501(c)(3)s, are required to have a board of directors. Some organizations also have a membership that participates in governance.
You’ve likely seen nonprofits like this. You may have even been a member of such a nonprofit. Examples include churches with voting members, or maybe a private school where the tuition-paying parents make up the membership.
In membership organizations, the board of directors is still the primary governing group. It is the members who nominate and elect the board members who will represent them. Typically, the board will hold periodic meetings of the membership, at least annually, to update the members about the status of the organization, and to elect new directors for those whose term is expiring.
A sole member nonprofit is a unique version of this public charity, where the membership is made up of one, permanent member, usually the founder. You will occasionally see a variant of this that includes another person…maybe a spouse. The member(s) still has the requirement to seat a board of directors, which usually includes him-or herself.
The most obvious benefit is the degree of protection provided to a founder who has risked much to start the nonprofit in the first place.
As stated above, in a sole member nonprofit, the board of directors is still the primary governing body. But, if the organization and its Articles of Incorporation and Bylaws are properly established, the board members are recruited and elected by the member(s), and effectively serve at the pleasure of the member. And in the unlikely event that the member was also part of the board, got sideways with the majority of the board, and was removed from the board, he or she is still the sole member of the organization. The board has no authority to remove the member. In fact, the member can (usually) unilaterally remove a director and replace them with someone else.
The net result of such a setup is relatively permanent protection for the founder/sole member, and the assurance that the sole member remains the driver of the vision long term.
While a sole member nonprofit structure can be invaluable to some founders, they are not without their problems.
The biggest downside is the risk of tunnel vision, or founder’s syndrome. You simply don’t find many successful organizations or companies that are controlled by one person who rules with an iron fist. You don’t have to have a sole member organization to see this. Unfortunately, way too many small nonprofits resemble little fiefdoms, run by dictator-founders who may have a board, but they’re a board of do-nothings who have no skin in the game and simply allow the organization to be an ego-exercise of one person.
Another problem that can arise is the difficulty in keeping board members. If a sole member simply treats directors as legally-required placeholders who are subject to removal if there is a disagreement, good luck finding anyone else willing to serve. Why would they?
Finally, this structure is not allowed in all states. New York, for example, requires at least 3 members in a member-run public charity. That may still work, but it’s not as solidly protective as sole member.
To run an effective sole member nonprofit, you have to know yourself and your real motivation for engineering a governing structure where you have that much control. Ideally, your motivation is to protect yourself from real risk, and to protect the vision of the charity. You’re smart enough to get real contributors of time, talent, and treasure on your board, people that you trust, to help you advance your mission. You let these directors fulfill their intended role to provide advice and consent, and you allow your ideas and methods to be challenged and improved on to make your nonprofit the best and most effective organization it can be.
Sole member nonprofits can be an incredibly effective way to both accomplish something wonderful in your community and to also protect founders who are putting it all on the line to make it happen. They’re complicated to set up, and they are definitely not a do-it-yourself project. Get help…call us if you want to form one of these. We know how to do it right.
A sole member structure is not the ideal setup for every 501(c)(3) public charity. It’s probably not the ideal structure for most of them. But, for a select few, it is truly the right way to establish a new nonprofit.
Originally Published by www.501c3.org