Parallel Foundations

Almost every Canadian hospital has a “parallel” public foundation. These entities are registered charities that raise money on behalf of the hospital and hold investments, especially perpetual endowments. While parallel foundations may have started at hospitals, they are now a fixture of the charitable landscape. There are foundations for international charities, universities and schools, art galleries and museums, social service agencies, professional associations, and religious organizations.  They have become so common that few people know why they exist.  There is just this vague sense that a “foundation” is the necessary pre-condition for successful fundraising.  

We are continuing to see an increase in the creation of public foundations, primarily as a response to funding pressures within the sector. According to Canada Revenue Agency (CRA) data, the number of public foundations (excluding religious entities) has grown from 2,500 to 4,000, or 60 percent from 1992 to 2004. While some of these new foundations are independent, such as community foundations, I suspect much of the growth comes from parallel foundations.  

Having recently been asked by a number of charities for information on establishing parallel foundations, I thought it would be useful to outline the benefits as well as some pitfalls. Parallel foundations are useful tools, but the board of an operating charity considering the creation of a new foundation should know what they are getting into before the lawyer incorporates and registers.  

A bit of background

   In Canada, parallel foundations started appearing in the 1970s, although the rush didn’t register didn’t begin until the 1980s. Registered as public foundations (with arm’s length boards and multiple unrelated supporters), parallel foundations are separate legal entities from the parent operating charity.  CRA recognizes the two as being associated charities.  

  In its simplest form, a parallel foundation is analogous to an investment holding company in the corporate world.  The foundation has a clear legal relationship with its operating charity through its objects and board structure, but it’s legally separate.  Just like a holding company, a parallel foundation takes assets off the books of parent and protects it from creditor, or as is more likely the case in the charity world, government funders.  (Ironically, in the late 1990s, the Canadian Institute for Chartered Accountants introduced accounting standards for associated charities whereby the controlling charity would report the financial results of the foundation on its books.) 

Arthur Drache describes the history of associated charities in Taxation of Donation and Charities.  Once upon a time, when government funding was generous, hospitals built up capital surpluses.  The provinces threatened to cut the hospitals’ budget because of these accumulations.  The hospitals responded by created parallel foundations enabling them to transfer the capital and income off book. The ABC Hospital Foundation was empowered to support the ABC Hospital and also to make grants for other related activities, to ensure the entity could not be accused on being a sham.  Presto: assets are protected; the operating charity is purged of “excess” capital and income.

   Two other categories of parallel foundation also appeared in the 1970s and 1980s.  The first model occurred within universities.  These are alumni run organizations, often created to raise scholarship funds and to ensure endowment funds are appropriately managed.  In some cases, the university had a history of poor endowment management and a cavalier attitude to donor intentions.  Sometimes these entities became rival development offices within the university.  The foundations also occasionally negotiated a monopoly on endowments and sometimes planned giving. The second model is the foundation associated with a not-for-profit organization.  For example, a professional association might establish a foundation to provide scholarships to advance the profession.  

   Fundraising and endowment management were the side benefits of this separation of tasks, but these activities did not come all at once.  Most early parallel foundations were kept on very short leashes. The parent charity would control the board and manage the foundation’s books.  If the foundation had staff people, the executive director (as they were known in pre-title inflation days) reported to the CEO of the parent charity.   

   In a few cases, hospitals had charitable assets in special purpose trusts, either from bequests received over the years or royalties, in addition to budget “overages”. These were also transferred to the parallel foundation for protection purposes.  As a result, early boards were often very focused on investment management of the budding endowment. The secondary activity was fundraising, usually restricted to a few volunteer-run events.  

Fundraising Focus

However, over time, with increasing fundraising demands, certain foundations began to grow distant from the priorities of the parent entities. Volunteers became entrenched and the culture of many foundations focused on asset protection, not growth. In my experience, when a parent charity conducted a capital campaign, the associated foundation would nervously sit on the sidelines guarding “their” donors.  This internal rivalry was awkward and unproductive.  

   By the mid-1990s fundraising was becoming a professionally-driven activity, and this changed the direction of many parallel foundations.  In many cases the structural tension led to the appointment of new leadership at foundations and clarity of mandate: parallel foundations became the sole fundraising arm of the operating charity. (Or with a few university foundations, the university took over the fundraising and turned the foundation into the endowment.)  

   Recently, parallel foundations have become more distinct from their parents, which is at least partly the by-product of professional foundation management and upheaval in the charitable sector. There have been a number of hospital foundations that have asserted their independence in the face of a merger -- or a domineering CEO at the parent entity.  After more than one hospital merger, the foundation severed its relationship from the new operating entity, changed its name, and redirected the endowment.  The independence of parallel foundations has also been upheld in the face of government threats and entreaties to use endowment funds for current operating purposes.  The resultant legal precedents (and public relations fiascos) have broken some of the bonds that enabled operating charities to control their foundations.  

   So, this is how we got to a period when boards look at foundations as being an essential pre-condition of fundraising success. The fundraising focus of the parallel foundation is relatively recent and grew out of a history of asset protection.   The logic now seems to be: if an operating charity is serious about fundraising, a foundation is the answer.  But as this brief historical overview shows, the relationship between associated charities can be fraught with challenges.  

Do you need a parallel foundation?

The inquiries I now receive about parallel foundation typically come from mid-sized charities -- often in the social services or the arts – which receive the majority of their funding from various levels of government.  The inquiries fall into two categories:

1. The CEO or board want to ramp up fundraising and/or create an endowment.  A parallel foundation would enable the organization to recruit a fundraising-focused board of senior community leaders and an accomplished fundraiser to provide staff leadership. The foundation will help create a fundraising brand for the charity, as there is often little history of public donations. The hope is to make the foundation self-funding within two or three years.  

2. The charitable organization has been told by its government funder that it has “excess” assets or income on its balance sheet.  Future funding will be dependent on using current resources. Often these assets are trust funds, but sometimes budgetary surpluses that are used as a reserve fund.

In the first scenario all of these goals can be achieved if the conditions are right, but it is important to assess the capacity of the charity.  I ask these simple questions:

a) How much does the charity receive annually in donations, including bequest by will?

b) Does the charity engage in active fundraising, beyond the occasional volunteer special events?

c) Does the charity have one-, three- and five-year fundraising goals?

   I’m not looking for specific answers, merely evidence of past activity that may indicate future behaviour. Generally charities that do not have a history of fundraising, or a clear sense of the role of donations in the overall funding mix, will not achieve greater success through the creation of a foundation.  Better to fundraise within the existing structure and make philanthropy a focus of the charity rather than create a new foundation. Too often the new foundation just involves extra costs, time and complexity: costs to establish and run (paid for by the parent charity); time to recruit and organize volunteers; complexity in coordinating activities of two legally separate organizations.

   A foundation can be a conceptual crutch – a way for the board to duck its fundraising responsibility or for a CEO to be seen to doing something. Better to address the core challenges (such as board makeup and mandate) and achieve some internal success before fundraising is institutionalized through a foundation. Needless to say, foundations are much easier to establish than they are to unwind, so erring on the side of caution is wise.  Put a plan in place to increase fundraising, recruit the right volunteers and hire the best possible staff.  If the funds start to flow (or they are already flowing) and the culture changes, then a parallel foundation will probably be warranted and successful.  

   In the second scenario, the answer is finding the right scale.   If a registered foundation is required, look at the amounts involved and try to keep the structure and administration simple.  I usually recommend keeping the foundation small and passive in these situations.  Treat it like a pure investment entity albeit with a three-person independent board, and ensure the operating charity continues to manage and direct the funds.  If fundraising is another priority, focus on that within the charity, not the foundation. Often I’ve seen fundraisers who get so overwhelmed with foundation management, that they don’t have the time for fundraising.

   Another option is to establish a donor advised fund at the local community foundation or some other public foundation as an interim or even permanent structure.  This is a low-cost way to take the funds off book and ensure the annual income continues to support the mission of the charity.  Depending on the terms of the donor advised fund, if the capital grows sufficiently, it may also be possible to grant out the capital and income to a registered parallel foundation created at a later date. Once the foundation is registered, it probably makes sense to integrate fundraising with the endowment.

   A parallel foundation should be a powerful long-term structure to manage endowments and encourage philanthropy.  Just make sure the foundation is set up to serve the parent charity, not make its job more challenging.

 Uncharitable Treatment? Why Donations to Private and Public Foundations Deserve Equal Tax Status; A. Abigail Payne and Huizi Zhao, C.D. Howe Institute e-brief, January 9, 2007