A new nonprofit is commonly created when a program or project spins off from a separate nonprofit. Sometimes a project spins off from a fiscal sponsor, perhaps after a planned incubation period. And sometimes a program spins off from a nonprofit because of a mutual desire to provide greater or different opportunities for the program, diverging risk profiles, conflicts in leadership, or a poor fit.
The spinoff might result in an independent nonprofit, a subsidiary or affiliate of the nonprofit that originally housed the program/project, or a joint venture with another organization.
In this post, the focus will be on a spinoff of a Model A fiscally sponsored project (FSP) from a 501(c)(3) fiscal sponsor to an independent, newly created nonprofit. The descriptions here may not apply in every circumstance due to a number of variables, including aspects of the fiscal sponsorship relationships and agreements.
The Parties
- The Fiscal Sponsor currently housing the FSP.
- The New Nonprofit that will house the programs, activities, and assets of the FSP
- The Other Party to the fiscal sponsorship agreement with the Fiscal Sponsor
Assuming the Model A fiscal sponsorship was properly and appropriately constructed, these parties will need to be in agreement for the spinoff to occur.
The Fiscal Sponsor owns all of the assets and liabilities associated with the FSP and has a responsibility to reasonably ensure that any of its charitable assets will not be misused if transferred to another organization.
The New Nonprofit has no inherent rights to the FSP assets and should have appropriate structures and capacity to reasonably ensure that it will lawfully and appropriately use these charitable assets consistent with the charitable purposes of the FSP. Generally, the New Nonprofit will expected to have IRS recognition of exemption under Section 501(c)(3) of the Internal Revenue Code before it is eligible to receive the FSP assets.
The Other Party commonly is responsible for creation of the New Nonprofit with overlapping individuals in leadership or control interests. However, the separateness of the Other Party and New Nonprofit must be respected. The Other Party commonly has rights under the fiscal sponsorship agreement to terminate the agreement and require the Fiscal Sponsor to transfer the FSP assets to a mutually agreed upon, qualified successor. While it may be relatively rare for there to be disagreement on a particular successor, it’s important to realize such possibility exists. In such circumstances, the Fiscal Sponsor must understand that, as between the Fiscal Sponsor and the Other Party, only the Fiscal Sponsor may be held legally responsible and accountable for an appropriate transfer of the FSP assets with reasonable care and in the best interests of the Fiscal Sponsor in light of its charitable mission. Accordingly, in rare but appropriate circumstances, the Fiscal Sponsor may deny recognizing New Nonprofit as a qualified successor.
The Transition Period
- The Other Party provides notice to the Fiscal Sponsor about its desire to terminate the fiscal sponsorship agreement and have the Fiscal Sponsor transfer the FSP assets to another qualifying nonprofit (New Nonprofit once established).
- New Nonprofit is incorporated and goes through the process of developing appropriate governance structures, programmatic plans, fundraising strategies, and financial models. Typically, New Nonprofit will not operate its programs, fundraise, or have other financial activities until after it applies for and obtains IRS recognition of 501(c)(3) status. However, in certain circumstances, New Nonprofit might have some limited activities while the fiscal sponsorship agreement and relationship is still in place.
- Shortly after New Nonprofit obtains IRS recognition of 501(c)(3) status, the Other Party and the Fiscal Sponsor will agree to terminate the fiscal sponsorship agreement and have the Fiscal Sponsor transfer the FSP assets to New Nonprofit. As of the transfer date, the programs previously operated by the Fiscal Sponsor will be operated by New Nonprofit, the contracts related to the FSP will be effectively assigned to the New Nonprofit or terminated (assuming all authorized consents are received), and the employees associated with the FSP will become employees of the New Nonprofit (to the extent that the leaders of New Nonprofit want to retain such employees).
The period described in paragraph 2 above represents the transition period. During such period, the FSP operates within the Fiscal Sponsor while New Nonprofit goes through a typical 501(c)(3) nonprofit startup process.
One critical issue to manage during this transition period is the name issue. Generally, New Nonprofit should NOT have the same exact name as the FSP, which may be considered a fictitious business name (also known as a DBA) of the Fiscal Sponsor. When two separate organizations in the same line of business or charitable activities use the same name, particularly in the same geographic areas, there is likely to be confusion over which entity is fundraising and operating. A state charities regulator may find this to be a misrepresentation to the public and even a sign of fraud. The Fiscal Sponsor may find this to be a violation of the fiscal sponsorship agreement or incorporated policies. And donors and funders may find this to be a breach of their trust and confidence in the leadership.
This restriction against using the same exact name for the New Nonprofit as the FSP does not mean that they cannot share substantial similarities so long as they would not reasonably mislead the public. For example, Improvisation for Good Foundation and Improvisation for Good Foundation – California may be considered sufficiently distinct, but Improvisation for Good Foundation and The Improvisation for Good Foundation may be considered too similar and misleading. Once the FSP is terminated and the spinoff completed, the New Nonprofit could change its legal name to that of the FSP, but, depending on the circumstances, that might take a fair amount of work. In some cases, it may be advantageous for the New Nonprofit to simply take on the legal name of the FSP as a fictitious business name or DBA.
Transfers from the FSP to the New Nonprofit
Both the Fiscal Sponsor and the Other Party have likely long contemplated all of the remaining assets of the FSP (including cash, physical assets, and intellectual property) transferring to the New Nonprofit in connection with the termination of the fiscal sponsorship agreement and the spinoff. Similarly, the parties are typically on the same page about the known liabilities associated with the FSP transferring from the Fiscal Sponsor to the New Nonprofit. However, there may not be mutual agreement about liabilities associated with the FSP that were unknown to the parties at the time of the transfer from the Fiscal Sponsor to the New Nonprofit (the “Transfer Date”).
The Fiscal Sponsor may hold back a certain amount of cash associated with the FSP beyond the Transfer Date to pay for previously unknown liabilities associated with the FSP. Typically, the holdback period may be in the range of a few months to several months. However, some liabilities, particularly those associated with a lawsuit, may become known after the holdback period, and the parties should have some understanding on how such liabilities should be managed. This may not be so simple as (1) liabilities may arise from different activities (e.g., Fiscal Sponsor’s back office administrative activities, program activities carried on by persons who moved from being employed by the Fiscal Sponsor to being employed by the New Nonprofit); (2) they may be covered in part or in whole by the Fiscal Sponsor’s insurance (which might not provide coverage if another party has indemnified Fiscal Sponsor for such liabilities); and (3) they may have been factored into the administrative allocation paid by the FSP restricted fund to the Fiscal Sponsor’s general fund.
Contracts entered into by the Fiscal Sponsor specifically related to the FSP must be reviewed for assignability (transferability). In some cases, the other party to such contracts may either need advance notice or have approval rights to allow for assignments from the Fiscal Sponsor to the New Nonprofit.
Similarly, certain data may also require approval from a third party before the Fiscal Sponsor can transfer it to another party. Such data may include protected personally identifiable information. Because different states and countries have sometimes vastly differing data privacy laws, this can be a significant and costly burden to address, and some fiscal sponsors may want to start getting consent in advance before acquiring potentially protected information.
Contractually protected information, which may include both confidential information and intellectual property, may also need approval from other parties ahead of any transfer from the Fiscal Sponsor to the New Nonprofit.
With consideration of the variety of issues involved, the Fiscal Sponsor and the New Nonprofit will want to enter into a contractual agreement governing the transfer of assets, liabilities, rights, and obligations. The transfer agreement may also include the Other Party to provide for the termination of the fiscal sponsorship agreement. If the Other Party was set up as an unincorporated (nonprofit) association only for the purposes of entering into, enforcing, and terminating the fiscal sponsorship agreement, that entity may want to dissolve at the end of the fiscal sponsorship agreement.
Other Resources
Fiscal Sponsorship: Key Resources For Sponsors And Projects