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Business Officer Magazine

Family Ties

How do you maintain an arm's-length relationship with affiliates? A well-articulated agreement can simplify life for a parent institution and its foundation offspring.

By Ric Porreca

Our donors thought the foundation was the university, so they wrote their checks to the University of Colorado. After all, that's the institution they wanted to support. Lost on our donors was the fact that the university and its fundraising foundation are two distinct, separate legal entities.

At the heart of this confusion is the identity crisis inherent in any relationship between an institution and its foundations (used here as a general term for all affiliated and university-related independent organizations, whether they relate to fundraising, real estate, athletics, research and grants management, technology transfer, or alumni relations). Generally, the public sees the foundation and the university as one and the same. Legally, the foundation is created to support the university yet, at the same time, remain at arm's length. If that separateness doesn't appear to exist, the external entity may jeopardize its independent status.

To clarify for business officers the complexities of relationships between an institution and its foundations, I recently had a conversation with these two foundation veterans:

Thomas Heck, vice president and treasurer of the Ball State University Foundation, Muncie, Indiana. In addition to providing investment oversight, he is responsible for gift processing, charitable trust and annuity administration, budgets, technology, and strategic financial planning for the foundation.

Cecil Phillips, a management consultant based in Baton Rouge, Louisiana, who specializes in development programs for nonprofit organizations. In 2004, he retired as the president and chief executive officer of the Louisiana State University Foundation.

What purposes do foundations and other "independently incorporated" entities play in supporting an institution of higher education?

Phillips: Public universities, in particular, are usually subject to state laws that can restrict money management and spending policies. Some states, for example, may require all accounts to be spent in each fiscal year, or they may allow the institution to have only fixed-income investments. That's not the best way to manage money for the long term, so foundations are created to take advantage of laws governing private investments.

Heck: We have considered creating a new foundation to take on the risk associated with a specific project.

Phillips: Separate foundations are often created to own real estate and certain kinds of vehicles—especially aircraft, which have a high risk inherent in their operation.

Heck: Foundations provide an opportunity to engage and involve volunteers in ways that may not be available to the institution. In Indiana, for example, the trustees of any state university must live in the state. Significant donors who live outside the state are therefore unable to serve as university trustees—but you can name them to the foundation board.

Also, in Indiana, we have strong legal protection for information that resides within the foundation. As a private corporation, the foundation is not required to disclose its underlying investments, which can therefore broaden its investment opportunities. For example, there have been cases when an investment firm rejected the investment from a state agency because doing so would expose its holdings to public scrutiny under the Freedom of Information Act.

Phillips: A foundation also protects the confidentiality of donors who do not want their names or the size of their gifts publicized.

Heck: Anonymity is a significant issue, especially in the planned giving area. Donors who may be inclined to receive public recognition for their current gifts may be more sensitive about their planned gifts. That's one reason at Ball State our current fundraising is done by university staff—but the planned giving fundraising has always been done within the foundation.

Isn't the separation of assets a technicality? Doesn't the money really belong to the college or university?

Phillips: There's no question about ownership: Gifts made payable to the foundation are the foundation's property. But while the foundation owns the assets, it owns them in trust for the benefit of the university. In other words, the foundation's mission is to serve the university.

Heck: Beyond the articles of incorporation, which state the foundation's purpose and justify its 501(c)(3) status, the two organizations need to have strategic plans that tie them together. Periodically, they should be discussing what directions they're going in and what the foundation's role is in supporting the university.

Phillips: Those types of conversations usually happen in preparation for a big capital fundraising drive. The university expresses a vision for the next 10, 20, or 30 years, and the foundation responds, "Let's support the university's long-range plan by raising x million dollars to help implement it." That's a good example of the university's strategic plan feeding into the fundamental methodology of the foundation.

Heck: The kinds of conversations people have when planning a capital campaign, such as determining institutional priorities, are good to have at other times as well—from a team-building standpoint, if nothing else.

So which entity ultimately decides how to expend the foundation's unrestricted fund balance?

Phillips: My feeling is that unrestricted fund balances should not be spent at the discretion of the foundation but rather at the discretion of the university. The chancellor, president, or university leadership should determine the priorities for the use of those funds.

In fact, a good model is for the foundation to have a president's discretionary fund. A large part of the unrestricted funds—not necessarily 100 percent of them—should be placed at the president's discretion to spend.

Heck: If the foundation board decides to create a president's discretionary fund then, ultimately, it does decide how to spend the fund balance.

Phillips: Yes, in that case the foundation has the decision, in broad terms, to turn over those funds to the university for expenditure. In contrast, another model has the foundation operating like a grant-making organization. The foundation board receives grant requests from the faculty and researchers and then decides which ones to fulfill.

That's not a good plan because the president or chancellor isn't involved in evaluating and deciding how to spend those unrestricted funds.

Heck: We have a variation of that model. Our foundation board has the ultimate say over the expenditure of unrestricted funds. But any requests for use of unrestricted funds are first channeled through the president's office. That way, the foundation doesn't have to evaluate the merits of a particular dean's idea. We run all proposals through the president's office first for approval, before the foundation even considers them.

How do foundations typically generate their operating funds?

Phillips: Many universities have contracts for services with their foundations, just as they would with any vendor. More mature foundations with a long track record of building assets may charge a management fee—typically, in the neighborhood of 1 percent—on the market value of the assets. That's much like the fee an investment bank would charge to manage those same assets.

Some foundations charge a percentage, such as 5 percent, of each gift that comes in to fund their operating budget. But donors may not like this so-called "gift tax."

Heck: If you look at Form 990s for various universities, even those of similar size, you'll see a tremendous difference in reporting. That probably reflects the diverse ways foundations are funded.

The Ball State Foundation has never received service fees from the university. In effect, the service fee approach uses tax dollars and tuition dollars to fund the foundation and its fundraising efforts. About four years ago, we adopted a business model in which foundation operations are paid from investment earnings plus administrative fees on certain funds and fundraising fees, depending on how gifts were raised.

If, for example, the gift was received through telemarketing, something for which we can identify specific costs, a percentage of those costs is charged to the fund. Say we have estimated that the cost of our telemarketing operation is 15 percent of dollars raised. At the end of each month, we assess a fee to each fund equal to 15 percent of the telemarketing dollars credited to the fund.

What areas of foundation operations warrant special attention from university business officers today?

Phillips: The spending rate on endowed funds is now tending toward 5 or 5.5 percent, while it has traditionally been about 4 percent. Some universities have paid as low as 3 percent—and been criticized for it. Business officers don't necessarily control what spending rate the foundation chooses, but they could influence the decision if they feel the foundation is going too far one way or the other.

Heck: When we discuss spending rates with our foundation board—which is a good governance role for them—we review historic investment performance, inflation, and spending rates, but future spending rates are based on estimated future numbers. In other words, what kind of investment return does the model of our portfolio produce long term? Maybe the return is 9 percent, administrative fees are 1.5 percent, and inflation is expected to run 3 to 4 percent. Remember that the Uniform Prudent Management of Institutional Funds Act (UPMIFA) requires the preservation of the real value of an endowment, not the face value. That discussion helps board members determine what will be left as a spending rate.

Phillips: Another area to watch involves auditing. With Sarbanes-Oxley, much more attention is being paid to the role of audit committees, the auditing process, and the governance structure of foundations. There's also the possibility of more federal laws being enacted that will apply to nonprofits.

Heck: Foundations may face more pressure to divulge what they're invested in—whether, for example, they have heavy exposure to alternative investments or investments in specific countries. Universities may be more open about discussing such issues; foundations can be more protective about their investment program, but the resulting public scrutiny may become more intense.

We're also seeing an increasingly entrepreneurial spirit among donors. They have a growing desire to specify the use of their gifts—and they often want to see those gifts used now. I've heard donors say, "You're talking about perpetuity, but I don't care what happens after I die. I'm just interested in the next 10 or 20 years."

It's not unusual for foundations to do both development and funds management. Given that model, you want donors to perceive fundraisers as being closely aligned with deans and senior leadership. But to whom are foundation staff accountable?

Heck: There are different models, but at Ball State we are all university staff contracted out to the foundation. At times, our roles can become blended and perhaps confused. The Memorandum of Understanding—the agreement addressing the fundamental issues in the relationship between the two organizations—helps provide clarity. (See sidebar on "Defining a Contractual Relationship.")

Phillips: It's quite common for the development director to have two bosses. The foundation may pay the development director's salary, but he or she will work full time for a particular dean or department head and, ideally, have an office in that college. The dean would supervise day-to-day activities and priorities. All of that achieves the goal of having the fundraiser be seen as a representative of the academic unit.

This approach sounds difficult in theory but it works well, depending on the personalities involved. The colleges and departments that do a good job of fundraising succeed primarily because of the efforts put in by the deans or department heads. They're more important than who the development director is.

Heck: Of great importance is the culture that develops between the leadership of the university and the foundation. How they work together filters down to the rest of the staff.

We've seen several situations in which the governing boards of universities and their foundations publicly disagree. Where do such problems start—and how can we avoid them?

Phillips: Troubles develop when one party gets out of bounds with its policies and procedures. For example, the university may try to dictate investment and spending policies for the foundation. It's not unusual for deans or presidents to lobby for high rates of payout—say, 7 percent—from the university's endowment.

On the other hand, having hundreds of millions of dollars of assets may translate into political power for a foundation. The foundation may step out of bounds by trying to influence academic decisions, such as the selection of deans, the tenure of the president, or the winners of scholarships.

In my view, the university should allow the foundation to do its money management, and the foundation should not get involved in academic affairs.

Heck: There may also be the potential for problems to arise from a significant donor who attempts to exert influence on the university. The donor may try to leverage an individual gift within the foundation and beyond, perhaps even by selecting a faculty member for a chair that doesn't exist!

Are there situations when a foundation would enter into a gift agreement independent of the university?

Phillips: A foundation should never make a significant agreement—certainly not an endowment agreement or other major restricted agreement—without the appropriate academic approval. My rule of thumb is that gift agreements should involve three parties: the donor, the foundation, and the responsible academic officer of the university.

Heck: Whenever you're talking to a donor about a gift you may not receive for 20 years, you want the donor, the foundation, and the university to have a conversation about the future and what is possible. That's when you're likely to hear how deans and presidents have different priorities and desires.

Our current gift agreements have just two signatures: the foundation and the donor. But we always consult the appropriate university administrator. The culture requires constant vigilance, not only with respect to specific transactions but also the very nature of the relationship between the university and the foundation.

Given the importance of communication, how can a university and its foundation maintain an ongoing dialogue? 

Phillips: It helps to have officials of the university as ex officio members of the foundation board. Conversely, when I was president of a foundation, I was a member of the university cabinet. Attending those weekly and monthly meetings enables you to know what's going on, all the time.

Heck: In addition to sitting in on university cabinet meetings, our foundation president is actively involved in advancement leadership and planning discussions. The foundation sends someone to monthly meetings the dean has with department chairs to provide updated information, address any issues, and answer questions.

Physically, the foundation is now housed in the same building as alumni programs, the development staff, and advancement services. We used to be elsewhere, and the change has been significant. We now run into each other on an ongoing basis, which helps the water-cooler type of conversations and communication in general.

RIC PORRECA is senior vice chancellor at the University of Colorado at Boulder.

Defining a Contractual Relationship

Truth is, once a university has established a separate, corporate, "arm's length" entity to accomplish something on its behalf, it has given up certain controls that are impossible to get back. For both organizations, effectiveness depends upon the quality of the personal relationships involved, the frequency of communication, and the clarity of the contractual relationship.

"Although a Memorandum of Understanding is very difficult to negotiate, its importance can't be understated," says Thomas Heck of Ball State University. "The agreement will last beyond the people and personalities involved, beyond the existing tenures of the administration, staff, and board."

Accordingly, ensure that the university's agreement with a foundation addresses such topics as:   

  • Term and termination. Does the foundation have an automatic termination date? If not, how often will the university revisit and reaffirm the foundation's purpose? What is the term of the agreement itself—and how often will the parties review the agreement? By what process can the agreement be amended or severed?
  • Scope of services. What are the foundation's function and purpose? Does the foundation plan to manage invested assets, including endowed funds, or conduct fundraising programs or provide both types of services? Does it have the right to use the name of the institution?
  • Governance. What is the composition of the foundation's governing board? Is the university president a board member? If so, is the position ex officio and/or nonvoting?
  • Fee structure. Where will the foundation's operating funds come from—a contract for services with the university, investment income, a "tax" on gifts received, a management fee, or some combination of these?
  • Management and disbursement of assets. Who determines how the funds will be invested and spent? What happens to the funds in the event the foundation is dissolved? What guidelines apply to restricted funds held in the foundation that can no longer practically be used for the restricted purpose?   
  • Accounting practices. How will financial and investment information be shared with the university? What reporting format is specified (such as electronic access)?
  • Reporting requirements. In addition to the federal requirements for tax reports, what information is to be shared between the entities and on what schedules? When and how does the university update its fundraising priorities? When and how does the foundation report its investment performance, fund balances, and fundraising results? Will the foundation have an audit committee, and what will be its operating guidelines?
  • Facilities and services. To what extent can the foundation use the institution's facilities, services, and IT infrastructure? How will the foundation reimburse the institution for services?
  • Data sharing and security. What information will the university supply to the foundation (such as alumni contact information) and vice versa? 
  • Personnel hiring and compensation. What relationship do foundation employees have to the university, its benefits, and its employment policies? Does the university have a formal role in the selection of key fundraisers and foundation leadership?
  • Fundraising goals and priorities. Which entity—the university or the foundation—will set the fundraising goals and priorities? If both entities are involved in these decisions, what will be the process?
  • University cooperation and commitment. Does the agreement reiterate the purpose of the foundation and its commitment to working cooperatively with the university in achieving its goals? Are there clear links between the efforts of the foundation and the university's strategic plan? Is the foundation accountable to the university for the performance of the foundation and its personnel?
  • Performance expectations and metrics. How will accountability and performance be judged? Does the agreement outline specific metrics that will be used, such as the cost to raise a dollar?