Setting Up Subsidiaries for Nonprofits and Associations

The Association Law Blog recently published an article on unrelated business income, and how under certain circumstances it may be advisable for a nonprofit association or foundation to establish a subsidiary to address unrelated business income and activities. This posting provides a brief overview of how a subsidiary is formed.

First, the existing nonprofit organization should determine that a subsidiary is needed. This analysis should include review of tax issues, the increased costs and burdens of operating an additional entity, future plans of the organization, and similar issues.

If it is determined that a subsidiary should be formed, it is helpful to form a task force to carry out the project. The task force should be fully accountable to the parent organization, and all substantial documents and plans of the task force should be subject to ratification by the board of the parent company.

The task force should focus on developing a purpose statement and business plan for the new entity, and in engaging any assistance it may need, such as an accountant and attorney. The business plan should include draft articles of incorporation, bylaws and policies.

In order to maintain control of the subsidiary, the board of the subsidiary, or at least a majority of the board of the subsidiary, should be appointed by the parent nonprofit. Further, the bylaws of the subsidiary should require explicit written approval of proposed changes to the subsidiary bylaws before they become effective.

Notwithstanding the above paragraph, it is critical for leaders of both the parent and subsidiary organization to understand that the subsidiary is a separate legal entity that must be governed by its own board. The parent board may not make decisions for the subsidiary. Rather, the parent board should appoint persons to the board of the subsidiary who will carry out their duties responsibly. If the appointed persons displease the parent board, they may be removed from the subsidiary, but the parent board has no right to substitute its judgment and decisions for that of the subsidiary board.

Upon approval of these documents, the subsidiary should be incorporated, hold its first meetings, adopt the bylaws, obtain appropriate licenses and permits, obtain an employer identification number, and commence its own operations.

Of course, the above is just a rough outline, and as always, the devil is in the details. This is why it is important to engage the services of competent advisors. Despite the effort and expense involved in establishing a subsidiary, many nonprofits have them, and they can be critical to its success. It is not uncommon for both the nonprofit and for-profit operations to benefit from being distinguished from one another, leading to unanticipated efficiencies.

In every case, however, it is critical that a parent and subsidiary stay in close communication, and work together constructively. This is not always easy, and is likely to be the subject of future posts.