Private Foundation Governance
Private foundation governance is an important topic for families with multi-generational wealth. This post describes what a private foundation is and how responsibility can be transitioned to next generation family members.
Legal Definitions
Private foundations can issue tax receipts for donations, make gifts to other registered charities, and manage an investment portfolio. Private foundations are also tax exempt, which means they do not pay taxes on the investment income they earn.
Practically speaking, a family foundation doesn’t have to exist as a registered charity. A family can simply co-ordinate their charitable endeavors privately and use a donor advised fund to provide tax receipts and investment services if necessary.
Formally registering and maintaining a private foundation usually happens when a family wants to customize the nature of a charitable endowment’s investment portfolio, maintain control over the cost structure of the foundation, and customize the way the private foundation operates. For example, a family may want to align the investment portfolio of their charitable endowment with their philanthropic mission by making specific impact investments which most donor advised funds will not allow.
Legally, a private foundation is type of registered charity with the following characteristics:
- is established as a corporation or a trust
- has exclusively charitable purposes
- carries on its own charitable activities and/or funds other qualified donees, (e.g., registered charities)
- may have 50% or more of its governing officials not at arm’s length with each other
- generally, receives most of its funding from a donor or a group of donors that are not at arm’s length
- and, the income earned is not used for the personal benefit of any of its members, shareholders, or governing officials
Family Foundation Governance
A private foundation is established as a corporation or trust by articles of incorporation or a trust deed. The foundation can also write additional by-laws that clarify or amend the foundation’s legal rules.
Board Members
All private foundations in Canada must appoint board members (directors or trustees) who in turn manage the foundation’s affairs or appoint officers to do so on the foundation’s behalf. The board members of a private foundation do not need to be independent of each other and can be members of the same family. This is one-way private foundations differ from public foundations who must have independent board members.
Succession Planning
Private foundations should make plans for succession. A family can lose control of a family foundation when board members die without documented succession plans. To avoid this, a private foundation should formally document the foundation’s succession plan.
Horror Story
Consider a private foundation with three board members who are two brothers and their accountant. Each brother donates $10 million dollars of cash to the foundation and invested in a portfolio of stocks. Each year the brothers decide where to donate the investment income the stock portfolio provides. Their accountant as a board member does the bookkeeping to ensure tax returns for the foundation are filed each year.
All goes well for several decades, and nobody considers what will happen when one of the brothers dies. Everyone is surprised to learn that no succession plans have been made, and the by-laws of the foundation have not been changed since it was created.
The brothers each have two kids, who are now adults with their own children. It was always assumed that the private foundation will be the responsibility of the kids.
What Next?
When one of the brothers unexpectedly dies, the family must scramble to appoint new family board members to their foundation’s board and write by-laws to protect the family foundation going forward.
Easy Solutions
There are easy ways for a family to remain in control of their charitable foundation. They can appoint more family members to the board so that when one dies or resigns family board members always outnumber outsiders. The foundation can also adopt by-laws that detail the rules that apply when board members die or resign to ensure the family always remains in control.
The best solution is for the foundation to plan for succession by creating a strategy to transition the next generation into their roles within the private foundation BEFORE someone dies or resigns. This includes documenting a succession plan in the by-laws of the foundation so that the legal authority of the family is protected.
Awkward Discussions
Many families find it awkward to discuss wealth with their family members. This is especially true as family wealth grows to include cousins and their own kids. But when great wealth is at stake including a large philanthropic endowment, the risks become too high to ignore succession issues. The best strategy is to make plans and formally document them.
Family Office Solution
Our family office will solve your private foundation governance challenges. We can also create and implement a succession plan for your family foundation by identifying your family’s overall estate and charitable goals, then by crafting a plan that considers your family’s unique situation. We will draw on other professionals to complete the legal work and provide tax advice. Overall, we will decrease the time you spend on administering the process of your private foundation’s succession plan so you can focus on big picture decisions.
Click this link to learn more about Family Foundation Succession Planning
