Common Risks for Nonprofit Organizations and How to Prevent Them
Nonprofit organizations are essential to the well-being of our communities, delivering critical services to support those in need. While their charitable missions empower them to engage in unique, mission-driven activities, they are not immune to risk. In fact, as tax-exempt entities, nonprofits must navigate an added layer of regulations that for-profit businesses often don’t face. Proactively identifying and managing these risks is crucial for long-term sustainability and mission impact. In this post, we’ll examine some of the most common risks nonprofit organizations encounter and how to prepare for them effectively.
1. Conflicts of Interest Must be Disclosed and Addressed
Unlike for-profit entities, board members, officers, or other key persons involved at a nonprofit organization must disclose when they have conflict of interest or potential conflict of interests when making decisions that can impact the organization. When a conflict of interest or potential conflict of interest is identified, it is best practice for that person to remove themselves from the decision-making process.
If an organization engages in a related-party transaction where a conflict of interest exists, it can be at-risk of violating IRS rules that impose a significant tax and possibly jeopardize its tax-exempt status. This is particularly the case for private foundation, where self-dealing, when a key person benefits from a transaction to the organization’s detriment, can result in a hefty excise tax.
Although the IRS does not require a Conflict of Interest Policy, many States, such as New York, require that the organization have one in place to guide them through the decision-making process.
2. Governance and Compliance Risks from Internal and External Sources
Governance and Compliance risks cover a host of issues that nonprofit organizations may face. It is critical that board members, officers, and other key persons at an organization be familiar with the organization’s internal policies and aware of external laws. This includes complying with state, local, and federal tax rules to ensure the organization is only engaging in activities that carry out its charitable purpose in order to maintain its tax-exempt status.
A nonprofit organization must ensure that it is complying with its internal policies (Bylaws, Conflict of Interest Policy, Grant Policy, OFAC Policy, etc.) in order to maintain seamless and reliable operations. It is recommended to review internal policies every 3-5 years and ensure new board members get familiar with the organization’s governing documents before joining the organization.
Organizations must ensure compliance with external laws and requirements. This includes changes to nonprofit corporation laws, tax laws that impact the organization and applicable agency laws. By having ongoing communications with its general counsel, an organization can be nimble in responding to sudden changes in the law in order to avoid jeopardizing its legal standing.
3. Communication Risks to External Parties May Harm Organization’s Reputation
A nonprofit organization must be mindful of its communications. This includes social media posts, emails, and when members of the organization speak in public settings.
A nonprofit should have a procedure in place to review its communications prior to publication to confirm they accurately describe its charitable mission in a transparent manner. If a nonprofit organization does not, it may be at risk misrepresenting itself in contract negotiations, grant applications, or donor engagements. The result may be catastrophic if funding is lost or the resulting reputational harm is irreversible.
When advocating for or informing the public about its charitable goals, nonprofits must avoid engaging in partisan political activity and must not have a substantial part of their activities be lobbying. Organizations are allowed to advocate for supporting their charitable causes, but they cannot engage in prohibited political activity as there is a high risk of potentially losing 501(c)(3) tax-exempt status.
Adopting a policy and process for external communications will help create parameters on the type of language that can be used, the authorized platforms, and the individual responsible for reviewing the final products.
4. Financial Responsibility Cannot Be Abdicated
Nonprofit organizations rely on donations, grants, and fundraising events to support its operations and activities. It is the Board’s responsibility, both collectively and individually, to oversee the financial health of the organization.
The organization’s financials must be handled in a transparent manner and ensure the majority of funds are used to carry out the organization’s charitable mission.
The organization should reiterate to its Board that financial compliance and responsibility remains with the Board at all times and is not a responsibility that can be transferred to someone else, whether a committee, CPA, attorney, or outside consultant. There should be checks and balances in place to ensure that filings are submitted to the IRS on a timely basis and that the finances are properly invested to meet the organization’s overall goals. Failure to do so may result in loss of tax-exempt status, which requires significant cost and time to regain from the IRS.
5. Reputational Risks May Result from Internal or External Events
Reputational risks usually refer to the potential loss of public trust and credibility due to actions, behaviors, or external perceptions of an organization. A “bad reputation” can cause a ripple effect through the organization and impact its internal structure and external partners. This is because nonprofits rely on their reputation in order to receive donations, grants, and enter into contracts. Reputational risks can cause internal disruption and cause a stagnant Board not be able to make important decisions for the organization. It can also cause community backlash, loss of funding and opportunities, and may even prompt an investigation from the Attorney General.
Contact Our Experienced Nonprofit Lawyer Today
Risk is an inevitable part of running an organization, but it doesn’t have to hinder a nonprofit organization’s activities. Recognizing risk is the first step to resolving it. By taking proactive approach to risk management, board members, officers, and other key persons can help set up the organization for long-term success to make a lasting difference in their communities.
At Abelaj Law, P.C., we understand the various risks nonprofit organizations face and work with them to mitigate and resolve current or potential issues. Our work is about giving the tools and resources an organization needs in order to succeed. To hear more about our services, call a seasoned lawyer at Abelaj Law, P.C. You can reach them at 212-328-9568.
Also, check out or Board Member Training: How to prevent Disruptions Before They Occur https://www.abelajlaw.com/elevate-your-nonprofit-governance/