From the (email) bag – Nonprofit Financial Conduits

Folks are welcome to send email questions about nonprofits. I am happy to answer (with appropriate disclaimers – like check with your local legal professional to be sure that you get advice that is tailored to your nonprofit). This was a good question, so I thought I would share:

Question:
I have a nonprofit 501(c)(3) exempt status, and a friend has asked me if she could use my 501(c)(3) to apply for grants for a business venture. What are the pros and cons for letting someone use my nonprofit’s exempt status? I don’t feel comfortable about sponsoring another organization.

Answer:
It’s acceptable for a §501(c)(3) to act as a “financial conduit” for another §501(c)(3) or similar charitable nonprofit. However, it is considered to be an abuse of your nonprofit status to funnel nonprofit grant funds to a for-profit venture, and your nonprofit risks the loss of its §501(c)(3) status.   I was unclear whether your friend was involved with a for-profit or non-profit organization, but the term “business venture” seems to indicate a “for-profit” nature. This would be the first thing to confirm, before proceeding with your consideration of whether your nonprofit should act as a financial conduit.

Some things to analyze as you consider a request to be a financial conduit for another organization:

Risk — Even if the friend’s project is another §501(c)(3) organization, or an unincorporated nonprofit that clearly has a charitable purpose (and not a “for-profit” business), you are right to be cautious. The “financial conduit” is responsible for the grant dollars that flow through to the target entity. If those funds are misused or lost or stolen, your nonprofit might have to repay the lost amount to the granting organization, plus endure the public shame that would come with the public knowledge of the lost funds.

Relationship — Usually, nonprofits that are not §501(c)(3) organizations, or for some reason do not qualify for a grant (for example, they don’t have a large enough budget, haven’t been in existence for long enough, or are too small to be a §501(c)(3)), have some sort of pre-existing close relationship with the financial conduit. For example, in my home town, the local Food Pantry acted as a financial conduit for the local Thrift Shop on a site improvement grant — this was appropriate because the Food Pantry was the landlord, and both had similar stakeholders and constituents, so it was a natural fit.

Mission — If your nonprofit is very different from your friend’s nonprofit, it might be financially awkward for your nonprofit to act as a financial conduit – it might be tough to show the funds on the books (to find an appropriate accounting way to represent the information), and your stakeholders might question why you are funding a project outside of your primary mission.

Bottom line – while it is considered an acceptable practice for one nonprofit to serve as the grant conduit for another (several granting entities provide for a separate set of forms for the financial conduit, so granting organizations support and allow this practice), it requires your board’s on-the-record approval with “open eyes” to the risk and responsibility of the status as financial conduit.