The Holy Grail of Nonprofit Tips ✨
Get all of the information you need to efficiently manage your nonprofit with our monthly newsletter.
7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries

7 Crucial Questions on Nonprofit Law and Nonprofit Subsidiaries

Danica

Not many nonprofit organizations know a lot about subsidiaries or how they work, yet they present a solution to many problems within the nonprofit world.

Perhaps you are temporarily unable to perform fundraising while awaiting IRS approval, or you seek to explore a high risk, high reward endeavor without putting your current organization’s status in a vulnerable situation. 

While subsidiaries may indeed be a solution to these types of problems, there remain many questions regarding their lawful usage, formation, and similar issues. 

Don’t worry, we are here to answer all of your questions. From the articles of incorporation worksheet to more advanced steps, we will guide you through the following topics to ease your journey into the land of subsidiaries:  

No time to read this article now? Download it for later.

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-what-is

#1: What is a Subsidiary

A subsidiary is in essence a child organization of another parent organization. In other words, this type of corporation is under the control of the other

For example, a national nonprofit dedicated to the elimination of animal cruelty may want to begin a separate entity. The child organization will be dedicated to supporting the reentry of formerly incarcerated people into the workforce by providing them job opportunities in animal shelters. Rather than incorporating this program into the existing nonprofit, they may set up a subsidiary organization focused on a separate mission.

Just because your organization is a nonprofit does not mean that the subsidiary must be also, it can be either nonprofit or for-profit. 

Subsidiaries also go by various other nomenclatures, such as affiliate companies, support corporations, or title-holding entities. 

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-can-a-nonprofit-own

#2: Can a Nonprofit Legally Own a Subsidiary

Yes, charities and private foundations may own an additional non-profit or for-profit subsidiary, although there are different laws and regulations supervising the parent-subsidiary structure and legalities of each. 

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-is-it-legalEmily was thinking if it would be legal for her nonprofit to own a subsidiary, good thing she found this article!

Here are some requirements and regulations to keep in mind: 

  • The parent company should oversee the child company, but not manage daily affairs. Providing annual goals and similar objectives is the expected avenue of control. The parent company is expected to supervise senior management employees, administration, and accounting services for the subsidiary company. Revisiting our previous example, the parent organization focused on animals may ultimately be in charge of hiring upper-level management and setting accounting and reporting standards for the parolee reentry organization, but would not manage the everyday details of the second organization.

  • Finances can be transferred from the child to the parent company, but there are specific regulations governing this transaction. Each organization must keep separate accounting records and mandate treasury regulations. 

  • While board members can wear two hats on both boards, the drawback is that it can cause more conflict of interest and loyalty divisions, as well as make it difficult for a board member to fulfill these duties adequately based on the increased time demands. 

Nonprofit Subsidiary Laws

Whether the parent entity is a nonprofit (in the case of our earlier example) or a for-profit entity (e.g., Alphabet, Inc., Google’s parent company, setting up the Google Foundation in 2005 to focus on economic opportunity, education, inclusion, and crisis response), there are a number of regulations that apply to specifically nonprofit subsidiaries: 

  • The parent company is responsible for creating the Articles of Incorporation and Bylaws. 

  • Within the articles, the parent company should create a section stating that they have the ability to approve amendments to this document.

  • They should also create provisions for the parent company’s right to appoint or dismiss board members with or without cause in the bylaws. 

For-Profit Subsidiary Laws

Just as both for-profit and nonprofits can have nonprofit subsidiaries, both can have for-profit subsidiaries as well. If a nonprofit has a profit-generating business, they can house it in a separate entity to keep their nonprofit status, and tax exemption, for the core organization. Many of these formation laws at similar as a nonprofit, but here are a few differences: 

  • The parent company shareholder has the right to vote for board members, although they may still remove board members at will and have the ability to approve amendments to bylaws and the articles of incorporation. 

  • The parent organization is obligated to contribute to the child organization’s capital. 

  • Both formation of the subsidiary, as well as contribution methodology, should be in compliance with all state and federal laws and regulations. 

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-why-would

#3: Why Would a Nonprofit Want to Own a Subsidiary?

You may be surprised at the many reasons why a nonprofit may want to own a subsidiary. Here are some typical reasons why nonprofit organizations and private foundations may want different types of child entities. 

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-why-ownSadie knows her nonprofit owns a subsidiary, but she's not sure why.

For-Profit Subsidiary

  • Protecting Tax-Exemption Status - A nonprofit may have an interest in engaging in unrelated business and want to provide security for their nonprofit’s 501(c)3 status. A separate subsidiary does not allow the organization to avoid paying taxes but it can serve as a distinction between the two to more clearly delineate for-profit and nonprofit activities. 

  • Providing Business Venture Access - If leadership has an interest in performing business activities unrelated to the nonprofit, having a for-profit subsidiary is a great way to distance these operations from those of the parent company. As it is a separate entity, it can follow for-profit rules and keep all accounting completely isolated to reduce conflict of interest or improper procedure risks. A private letter ruling (PLR) can be beneficial in helping designate applicable tax laws with the IRS. 

  • Additional Revenue - Once protected as separate entities, having a for-profit can increase revenue resources, which can be shared with the parent nonprofit by following specific guidelines and procedures. 

Nonprofit Subsidiary

  • Liability - Even though there are different insurance policies to provide protection for a nonprofit organization, having a subsidiary can offer an added measure of protection if the nonprofit wants to pursue avenues that may include significantly risky ventures. The affiliate company deviates from the risk from the parent by assuming the responsibilities for the new activities. 

  • Independence - From time to time, nonprofit leadership may have an interest in performing different events or activities that may benefit the nonprofit, but are not aligned with that organization’s mission statement. Having a secondary nonprofit subsidiary offers the freedom to pursue other charitable ventures while maintaining the parent’s focus on fulfilling its vision. 

Pro Tip: People get emotionally invested in projects and these are often the people that know the ins and outs of the achievement goals. So, if you are planning to transfer a project over to your subsidiary organization, be sure to do so in stages over a significant period of time. This will prevent a complete breakdown of the project as a whole. 

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-how-is-it-governed

#4: How Is a Subsidiary Governed?

Similar to the parent organization, the subsidiary is run by a board of directors. The parent nonprofit, as established in the subsidiary’s articles of incorporation and bylaws, has the power to appoint or remove officers on the child organization’s board. 

When making decisions about who is suitable to sit this board, think about questions such as:

  • Does the potential candidate completely understand why the subsidiary exists? 

  • If they serve on the parent board, will they have enough time to fulfill duties for both organizations? 

  • Is the officer qualified to perform the required duties given the difference between entities? 

  • Who ultimately has the power and liability when considering subsidiary governance?  

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-can-you-have-an-overlap

#5: Can You Have an Overlap of Directors?

Yes. This relationship is called brother-sister overlap and means that a single member serves on both boards in some capacity. More often than not, subsidiary boards consist of a "majority" of overlapping board members as a measure to ensure that the parent has control over how the child organization fulfills its goals and mission.

Other non-overlap board members are often chosen for having significant interests in the mission statement of the parent organization to provide additional insight but maintain the measure of control. 

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-how-do-you-form

#6: How Do You Form a Subsidiary?

When planning for the creation of a subsidiary, take into account the following: 

  • What is the primary reason for forming a subsidiary? 

  • What operational considerations do you need to take into account before initiating start-up procedures? 

  • What type of management structure will you implement and who will make up the governance board? 

Once you have answered those questions, here are the steps for making your subsidiary official: 

  1. Your board must vote to form the child company, then sign a resolution, signed by the board chair. 

  2. Determine the type of company, generally LLC or corporate structure, then prepare the paperwork and pay the fee.

  3. Prepare the articles of incorporation and bylaws for the subsidiary, clearly stating the right of the parent board of directors to appoint and dismiss child board of directors as well as term restrictions. 

  4. Fund the subsidiary, often through the parent organization.

  5. Oversee operations to ensure that everything is set for your subsidiary to achieve success through efficient business operations.

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-umbrella-agreements

#7: What are Umbrella Agreements?

An umbrella agreement is when another nonprofit agrees to process your fundraising under its tax-exemption organization’s status while you wait for your documents to be approved by the IRS. If a nonprofit determines that they want to set up a subsidiary that will also function as a nonprofit, the parent organization can utilize an umbrella agreement while awaiting an official nonprofit, tax-exempt designation.

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-subsidiary-governingMatt is doing some additional research on umbrella agreements.

This may also prove useful if you are figuring out how to reinstate your revoked status to rejoin the ranks of other tax-exempt organizations.  

As it takes time to fulfill either of these circumstances, having another nonprofit sponsor yours can help during the interim period. The process is similar in some ways to becoming a subsidiary of that organization.

Here’s what you need to do to establish an umbrella agreement: 

  1. Find a nonprofit organization with a similar purpose as yours.

  2. Seek sponsorship with one of these organizations.

  3. Consult with a legal advisor to ensure the umbrella agreement meets compliance.

Some benefits your nonprofit can enjoy through an umbrella agreement include:

  • Faster application for grants, as most grants, expect tax-exempt status.

  • You can start accepting tax-exempt donations immediately.

  • Some sponsors offer assistance with administration. In addition, they can serve as valuable mentors, providing instruction, auxiliary help, and general counsel to get your organization on its feet.

  • If your nonprofit is intended for a limited amount of time, this avenue can prove easier than making an official application.

  • It provides you a chance to test the waters and make sure that you are able to achieve success with your new organization.

Enjoyed the article? Download it to keep or share with others!

7-crucial-questions-on-nonprofit-law-and-nonprofit-subsidiaries-end

 

Organization & HR
Danica
Member Management

Everything You Need to Know Before Buying a Membership Database Software

15 min read
Trish
Finance

A Detailed Breakdown Of Nonprofit Accounting Basics

10 min read
Trish

How to Build the Perfect Nonprofit Board of Directors

5 min read
Danica