Nonprofits, as mission-driven organizations, have to constantly make critical calculations, weighing short-term versus long-term benefits and measuring them against the mission itself. As an organization dedicated to a particular problem or set of problems or providing an indispensable service to those in need, the mission comes first. However, considerations of stability, consistency, and long-term survival are also critical. After all, is it more in line with the mission to achieve your goals only for one year or to last for decades? These are the sorts of questions that can create major difficulties for organizations that want to plan for the long term.
One of the ways that nonprofits work to ensure survival in the face of unexpected challenges is by investing some of their funding. Although this seems somewhat counterintuitive, a strong investment portfolio can actually provide a much more consistent and predictable source of revenue for a nonprofit than donations or grants. Additionally, when it is not needed, it can grow, becoming more useful in case it is needed during an economic downturn or other difficulty. Nonprofits have 501(c)(3) status under the Internal Revenue Service’s (IRS) tax code, which makes their income tax-exempt, including some investment portfolios. However, there are strict rules in place that are meant to prevent nonprofits from entering into the private sector. Here are the primary restrictions as well as different types of investments nonprofits can make:
Restrictions to nonprofits
No benefits to private interests
Nonprofits cannot use any donations, cash or otherwise, to excessively benefit private individuals or organizations. This typically governs cases where a nonprofit is paying for a product or service owned by a private third party or organization. During such a transaction, it is possible or even expected that the organization provides the product or service at a rate which is profitable to them. However, should this rate greatly exceed the market value of the product or service, this is considered an excessive benefit and could result in an excise tax. These rules apply to loans, grants, and other forms of payment as well.
No excessive lobbying
501(c)(3) organizations are forbidden from engaging in excessive lobbying on behalf of or against a political candidate or piece of legislation. This includes encouraging voting for or against candidates, contacting elected representatives, or other efforts undertaken to influence the conduct or outcome of a political process. However, this does not mean they cannot engage in nonpartisan educational sessions, get-out-the-vote drives, or other efforts to encourage civic or democratic engagement.
If you have enough funding to open an investment account, the first step is to work out an investment policy statement, or IPS. This statement is the roadmap for your portfolio, outlining the time horizon, investment priorities, asset liquidity requirements, and tying all this information back to the mission and purpose of your organization. Although an IPS is subject to change as circumstances around the organization change, it should be considered the definitive guide for whoever is in charge of the portfolio.
The IPS is the start of a longer process, and it is essential that your asset managers routinely review and update it. The process of maintaining a healthy investment portfolio is a balancing act, applying three different measurements to determine the overall “success” of the investments. These measurements are:
- Maintaining the stability of the initial financial investment.
- Growing the value of the portfolio over time.
- Maintaining a level of access and asset liquidity necessary for the nonprofit to continue achieving its mission and goals.
Why should a nonprofit invest?
There are some key advantages to nonprofit investing which makes it attractive even to smaller organizations. Although it involves quite a bit of upfront work and due diligence, it can help the nonprofit weather the instability of donation- and grant-based funding, which can be inconsistent, unreliable, and expensive to obtain. It can also become part of the mission of the organization itself — some nonprofits apply rules and themes to their investment, focusing it on a particular industry relevant to their mission as a secondary way of advancing their cause. For example, a nonprofit focused on cleaning up the oceans might make some investments in private organizations designing products to clean up ocean waste. It can also allow you to accept different types of donations, including equity or private property, which is difficult to manage without a portfolio.
Additionally, because the tax-exempt status applies to the portfolio, nonprofits can make more aggressive short-term investments, as they don’t have to worry about being taxed too heavily. Because some investments can be considered tax-inefficient, this gives them a unique entry point in the market that can grow their investment quickly.
Another key option for investment is to invest in a trust. Trusts, like the one we operate at 501(c) Services, are similar to investment portfolios in that they offer your organization a chance to invest and grow funding independent of traditional nonprofit fundraising. Some trusts can be dedicated to a specific purpose. In our case, the 501(c) Agencies Trust allows organizations to forgo paying state unemployment taxes and instead invest that money in a trust that they can withdraw from to pay unemployment benefits back to the state on an as-needed basis. This allows organizations to save the money they would otherwise pay to the state and instead grow that money in a trust. This is distinct from an investment portfolio, which doesn’t necessarily draw from funds allocated for taxes, but it offers many of the same advantages.
In conclusion, nonprofit organizations, guided by their altruistic missions, face unique challenges in financial management and long-term sustainability. Balancing immediate needs with long-term goals is a complex task, and this is where strategic investing becomes crucial. By carefully navigating the constraints of 501(c)(3) status and leveraging investment opportunities, nonprofits can build a more stable financial foundation. This not only helps in ensuring operational consistency but also in expanding the impact of their mission over a longer period. Whether it’s through an investment portfolio aligned with the organization’s values or innovative approaches like trusts, these financial strategies enable nonprofits to become more resilient in the face of fluctuating funding sources. Ultimately, embracing these financial practices is not just about fiscal responsibility; it’s a strategic move towards fulfilling their noble missions more effectively and ensuring their valuable contributions endure for years to come.
For more than 40 years, 501(c) Services has been a leader in offering solutions for unemployment costs, claims management, and HR support to nonprofit organizations. Two of our most popular programs are the 501(c) Agencies Trust and 501(c) HR Services. We understand the importance of compliance and accuracy, and we are committed to providing our clients with customized plans that fit their needs.
Contact us today to see if your organization could benefit from our services.
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The information contained in this article is not a substitute for legal advice or counsel and has been pulled from multiple sources.