CHAPTER 2

Practical Governance in Nonprofit Organizations

Don Macdonald

Introduction

Governance could be described as the “systems and processes that ensure the overall direction, effectiveness, supervision and accountability of an organization” (Cornforth 2003). It may seem obvious but it is essential to set up a legal structure to run your nonprofit organization; otherwise, as an unincorporated association, some funding will not be available to you, while association members could be personally liable for any debts or claims.

Different factors will affect governance in different ways; long-established organizations should already have proper procedures in place, while large or complex organizations should also have more detailed procedures in place, for instance with specialist teams for issues such as safeguarding or specialist subcommittees of the board.

Most importantly the governance of a nonprofit organization should be fit for purpose in several respects. Thus the right legal structure should be selected to achieve the objectives of the organization; a nonprofit organization involved in generating most of its income through commissioning or trading would be best setting itself up as a social enterprise (see the following for the different types), while other nonprofit organizations, involved in generating income in other ways, would be best becoming a charitable organization. In addition the composition of the board should be fit for purpose and include members with the right specialist skills and knowledge (also dealt with later).

Legal Structures

A range of different legal structures can be used in different countries for setting up nonprofit organizations including:

There are numerous legal differences and different regulators in different countries and also between different states within those countries, which must be borne in mind if you operate there.

The following Table 2.1 outlines different legal structures that can be used to operate nonprofit organizations in the United States and UK, partly derived from the book by Ridley Duff and Bull. There are organizations set up to help and support people setting up and operating not-for-profit organizations. For more information on each structure, you can access the agencies and websites listed in the table. Some agencies recommend that professional advice should be taken before adopting any one of these. It may be possible to access this advice on a pro bono or free basis from law companies.

Some registered charities also register as companies limited by guarantee to ensure that their liability is limited to a greater degree, while others will register their trading arms as limited companies. One advantage of charitable status is that some trusts and companies will only donate to registered charities. Also some national nonprofits will manage their regional branches from the center, while others with a more decentralized structure, like the YMCA, will have local chapters with greater autonomy.

Legal Requirements

It is important to note that all nonprofits are also subject to general company legislation and steps can be taken if these are not met; thus because of financial mismanagement, trustees of the failed UK charity, Kids Company, are being threatened with being banned as company directors.¹

Table 2.1 Popular legal forms for not for profits (adapted from Ridley Duff and Bull 2016)

Category	The United States	The United Kingdom
Charity, trust or foundation	1.  Foundation 2.  Not-for-profit corporation 3.  Public benefits corporation	1.  Charity 2.  Charitable company 3.  Charitable incorporated 4.  foundation or association (CIO)
Regulating and Support Agencies	Internal Revenue Service www.irs.gov/pub/irs-tege/governance_practices.pdf National Council of Non Profits www.councilofnonprofits.org	Charity commission www.gov.UK/government/organizations/charity-commission National Council of Voluntary Organizations https://ncvo.org.UK
Cooperative or mutual	1.  Minimum numbers varies by state 2.  Cooperative society 3.  Credit union 4.  Solidarity co-op	1.  Minimum numbers three 2.  Cooperative society 3.  Credit union 4.  Community benefit society (formerly friendly society)
Support Agencies	Community-wealth.org http://community-wealth.org	Cooperatives UK https://UKcoop
Socially responsible businesses	1.  Benefits corporation (B-Corp) 2.  Private company (C3) with nonprofit trading activities 3.  Low profit corporation (L3C)	1.  Community interest company (CIC) 2.  Private company (CLG or CLS) with social objects 3.  Employee-owned business
Regulating and Support Agencies	Social Enterprise Alliance https://socialenterprise.U.S./ B Corporations https://bcorporation.net/what-are-b-corps	CIC Regulator https://gov.UK/government/organizations/office-of-the-regulator-of-community-interest-companies Social Enterprise UK www.socialenterprise.org.UK/ Social Firms UK www.socialfirmsuk.co.UK

Most Appropriate Structure

There are advantages and disadvantages for each structure. The need for good governance prevails across all different types. The most common structure for new UK social enterprises, spun out as mutuals, is the Community Interest Company (CIC), (Spin Out, Step Up, Social Enterprise UK June 2013), which is flexible, while demonstrating a commitment to nonprofit values. In the United States the B Corporation structure appears to be the norm for social enterprise. However in both countries registered charity status has enormous tax advantages.

Payment of Trustees

As the U.S. Internal Revenue Service states “Charities should generally not compensate persons for service on the board of directors except to reimburse direct expenses of such service.” Board members, like any other volunteers, may deduct expenses they incur in connection with their volunteer service, including mileage to travel to meetings using their own car.²

A small number of (UK) charities are allowed to pay their trustees—they can only do so because it’s allowed by their governing document, by the UK Charity Commission or by the courts with specific rules to be followed. The larger UK housing associations now pay a stipend to their nonexecutive directors and this was also introduced in 2013 by Turning Point, a UK nonprofit organization providing health and social care for almost 50 years.

Organization and Management

Legal Requirements

It is a legal requirement to appoint directors when you set up a company, such as a nonprofit organization and they must be registered with the appropriate regulator. These directors then have a range of legal obligations and “must take into account a range of wider ‘environmental’ factors that are considered to characterize responsible corporate behavior in the 21st century” (Davies 2006).

These requirements, both legal and good practice, may not be familiar to those who have not established new companies or organizations previously. While some are spelt out explicitly (for example, accounts’ requirements), others are common sense requirements (for example, insurance), which will cover the organization in case of problems. The full list includes:

Board and Management Responsibilities

The board of directors (or trustees) has extensive financial, legal, regulatory and good practice obligations. As detailed working-up of policies and careful implementation are required, any management team will do most of this work, with numerous templates and examples of good practice available. However if the nonprofit is of any size or bidding for contracts, policies will be vetted by funders and commissioners so the board should agree the most crucial policies, ensuring they are all of an acceptable standard; the board may even have more specialist knowledge and experience than management in some specific areas.

In general boards should be responsible for strategy and policy while senior management should be left to concentrate on day-to-day management. Although major decisions and expenditure need to be properly scrutinized by boards, they should not interfere too much and become involved in micro management. Whatever the size and scope, it is essential to differentiate between roles and to separate governance issues and management or operational issues. Table 2.2 is derived mainly from the “Governance of Social Enterprises” (Schwab Foundation 2016), which outlines key differences between the roles of board and senior management.

Table 2.2 Roles and responsibilities

Board	Senior management
Agrees financial plans and budgets	Draws up draft financial plans and budgets
Oversees management	Manages operations and organization
Agrees strategy, mission, and vision	Works toward strategy, mission, and vision
Approves contracts above agreed level	Seeks out and negotiates contracts

The Board

The board is required to determine the future of the organization, to ensure that the nonprofit organization achieves its social aims and financial solvency. It needs to set the overall strategy, goals and targets of the organization, while making sure that the social aims are being measured and demonstrated by measurable social impacts. The memorandum and articles of association used to set up the nonprofit organization should define how the board is run; in some cases, legal advice will be required to check any structures are both legal and compliant with the regulations specific to the structure.

The board will also be held accountable if there is evidence of: inspection failures, financial mismanagement, disregard for legislation, including current health and safety, employment or equal opportunities or abuse of stakeholders’ trust. So this requires a board to be active and properly informed, with relevant expertise, having been carefully selected and inducted into the organization’s services and operations.

Cooperative Boards

Cooperatives are owned by their staff. Some concern has been expressed about the availability of suitable board members for cooperatives and mutuals. However as one consultant pointed out member-led organizations like cooperatives and mutuals have an advantage, in that they have a pool of members from which to recruit new board members, although “proper structures need to be in place.......by having structures which involve members in the life of the business at a range of levels so that there is a ladder up and a ladder down” (Hollings 2013).

Legal Implications for Board Members

Everyone on the board, both directors and management, should be aware of their legal position from the beginning. Directors have more legal responsibilities than management: they are required by law to apply skill and care in exercising their duty to the company and are subject to fiduciary duties. If they are in breach of their duties or act improperly, they can be barred from holding directorships and if a company becomes insolvent, or bankrupt, legislation imposes various duties and responsibilities on directors that could involve personal liability and criminal prosecution. Managers on the other hand should be aware that, legally, they can be dismissed by the directors.

Board Support and Oversight

As the Schwab Foundation (Schwab Foundation 2016) points out, boards serve two primary responsibilities: support and oversight. While these could be seen these as exclusive or even in conflict, in fact they can complement each other, particularly in a small, new organization or a well-established but high-performing organization. A task which requires both support and oversight is the approval of key management decisions; this process ensures that the overall mission of the organization is being followed and, at the same time, provides legitimization for these decisions.

Topics that require board approval include the following:

Boards should define and list which matters require their approval to ensure proper oversight is understood and followed. But the board should not micromanage the management team. For example, board approval should only be required for spending and investments above an agreed threshold, while management should be permitted to spend up to that limit.

Table 2.3 (Kreutzer and Jacobs 2011) defines the spectrum between support and control.

Table 2.3 Spectrum between support and control on boards

High Oversight	Board as inspector-oversees management	Holistic and responsible board
Low Oversight	Apathetic board--ineffective	Board as consultant--collaboration with management
	Low Support	High Support

Stakeholders

A stakeholder is a person or organization with a legitimate interest in what the nonprofit organization does, including service users, staff, volunteers, and any organization or person with a financial interest in the organization. This could include funders or local authorities who have provided support or startup funding.

According to Peter Drucker (Drucker 1990), stakeholders play a much more important role within voluntary and community organizations. So the views of stakeholders must be collected and considered more extensively in nonprofit organizations than in normal profit-making companies. Nonprofit organizations may operate in a slightly less formal manner than private companies, but some nonprofit organizations will formalize their relationship with stakeholders by setting up extensive and formalized consultation structures, including having clients or former clients on their boards.

Responsibilities and Membership of the Board

It is essential to have a board of directors that is “fit for purpose,” with the ability to lead and oversee management in a complex environment, matching financial realities with the organization’s social and environmental values and mission.

Choosing the right mix of experience and skills for your board increases the organizations’ chances of success and survival. Venture Navigator, a business support organization, produced a guide setting up nonprofit organization boards, which makes a key point:

Clearly the requirements for the board composition depend on the size of the venture, the services being offered and any backing agencies, who may require board representation in return for funding at a significant level. If the turnover of organization is small, then substantial financial knowledge is not essential at the start.

As a nonprofit organization grows and changes, the board’s composition should also change to meet changing circumstances and demands.

In fact there is an argument for boards to have time-limited membership, though some expertise is in very short supply for unpaid directorships particularly financial, which is why some board members stay on for long periods. Most boards now have staff or service user representation, an example being St Mungos, the substantial UK homeless nonprofit. Successful local business people can make an invaluable contribution to the board of a nonprofit organization; if they have no experience of the nonprofit sector, they must have empathy for and an interest in the specific organization’s objectives. An accountant or lawyer can also play a key role on the board.

Diversity

Lack of diversity of nonprofit board members continues to be a serious problem in both the U.S.^3,4 and the UK. A UK Government review criticized nonprofit boards for being predominately old, white, and middleclass (Marsh, Cabinet Office 2013), just like this author.

The U.S. Council of Non Profits has highlighted the issue and puts forward several arguments for diversity:

Size of Board

The right size for a board varies a great deal between organizations and can be determined by a number of factors:

Boards should not be too large otherwise decision making becomes difficult, nor too small otherwise the directors may have an unfair burden of work; between three and nine directors is normally adequate.

Types of Director

Different service areas require different specialist knowledge on their board to provide the right direction: for example, sports clubs are very different from drugs prevention projects, so it would be sensible to recruit at least some directors with the necessary specialist experience and knowledge. There are organizations that will help recruit volunteer directors, such as Volunteer Match in the U.S.⁶ and Reach in the UK; but if particular expertise is required it may be necessary to advertise.

The application process for board positions should be fair and transparent, with a formal person specification and a common application form, along with advertising in nonprofit organization or trustee networks. According to Trustees Unlimited, background checking is one important part of the process and it does not have to be burdensome. Small organizations can do it themselves by talking to someone, who has worked with the potential trustee in a similar position. “You can ask things like, ‘Have you seen them chair a board before? What were they like? Can they manage meetings effectively? Do you have any concerns or issues?’ You really need to explore these things before you offer someone a place on your board.” (Joseph 2013).

A successful board is likely to include people with:

Personal qualities are also important, as the Venture Navigator (2013) paper stresses, with a need for directors to be “willing to work as part of a team,” be “prepared to accept responsibility for decisions made by the board,” and be “patient, good humored and clear communicators.”

It could be useful to have a manager from a well-run nonprofit organization who has relevant experience of viable community ventures, as well as board members with whom the managers have worked previously, who understand and trust each other’s work methods.

Board Officers

It is important that the role of the board officers is clarified and delineated early on; it seems misguided that in some guides to setting-up nonprofit organizations no mention is made of this feature. Yet the roles of chief executive and chairman are fundamentally different reflecting the difference between the board and management, listed earlier. In small noncharitable nonprofit organizations the role of chair and that of managing director are often combined. In consultancy type or creative nonprofit organizations, it is more likely that management and directors will overlap, which is permitted in the structure of a limited company or community interest company.

However as the Schwab Foundation (Schwab Foundation 2016) states “In one-tier or voluntary boards, a single person often exercises the roles of chairman and chief executive. Such a structure erodes the system of checks and balances and constrains the independence between board and management. A joint leadership structure provides a unified focus and communicates strong leadership to the external community, while splitting these two functions bears costs and administrative efforts. Thus, organizations face a trade-off between effective case monitoring (the separation of the two functions) and strong leadership. If a single person holds both positions, the board should appoint another board member to lead on any issue that requires separation of duties, such as reviewing the compensation of the chief executive.”

Board Chair

The role of chairperson is crucial. They are the most senior person in the organization, they are often its public face and they are both responsible to and responsible for the board, which in turn is responsible for strategy. They may also have to take swift decisions between board meetings, usually designated chair actions, which are then reported to the board. The chair should have a good relationship with the CEO and provide ongoing support and advice on a regular one-to-one basis, acting as a critical friend, in a constructive but challenging way.

The post of chair is seen as so important that some large voluntary organizations, such as Royal British Legion Scotland, have rules about how long someone can hold this role, while at the same time having in place a structured promotion and training process; in this set-up, potential chairpersons first act as board members, then vice chairpersons before taking the chair, thus enabling candidates to be trained up for the role. At the same time, it gives both candidates and other board members time to assess their suitability for the role.

Other Officers

Most boards will have someone designated as responsible for financial oversight, the treasurer, who may convene a finance subcommittee. Finance for small nonprofit organizations has become quite complex; even small ones must now provide pensions (in the UK), along with tax and insurance, while also producing accurate accounts and returns for regulators, so the voluntary treasurer’s post has become more important.

In most nonprofit organizations the role of company secretary is carried out by a senior member of staff, such as the CEO or senior finance officer, ensuring that the proper records and minutes are kept up to date and regular returns made to the statutory regulators. Organizations should also have rules about removing those directors who do not attend an agreed number of meetings, unless their expertise is seen as so valuable that they are designated as an essential advisor.

Safeguarding Responsibilities

Child abuse has become a major issue and as a result directors and trustees have very significant additional safeguarding responsibilities, in organizations delivering children’s services or providing residential or day care or work with vulnerable adults. The UK Charity Commission has emphasized that the overriding duty of charity trustees in safeguarding matters is as follows:

These duties include overseeing practice, arranging training, producing policies and obtaining criminal background checks for staff and volunteers in regular contact with clients. The checks themselves can take a long time to obtain. However in the U.S. the Children Bureau⁸ and in the UK the NSPCC provide help with developing and implementing appropriate policies for safeguarding children.⁹

Conflicts of Interest

It is inevitable that both disagreements and conflicts of interest will arise on the board. Healthy disagreement is good, but the chair should act swiftly to deal with any damaging disagreements on the board, which can fester and seriously disrupt business. Dealing with these disagreements can be quite a demanding process, requiring a high level of skills; away days or consultancy can be ways of dealing with them.

On conflicts of interest, boards should develop policies and procedures on how to deal with potential and real conflicts of interest, which should be brought into the open and shared for discussion. Potential sources of conflicts of interest include the following:

Ways to handle conflicts of interest include:

Pay Ratios

Over the last few years, there has been concern in both the U.S. and the UK over what is seen as “excessive” pay for CEOs and senior staff¹⁰ and the ratios between highest and lowest paid staff in the nonprofit sector, particularly in large charities. In 2010 the UK Prime Minister commissioned a review to consider ways of “tackling disparities between the lowest and the highest paid in public sector organizations.” Various newspapers carried articles on the theme in both countries.^11,12

While clearly the ratio of top to bottom pay in the largest charities is in fact much lower than for large companies, there have been recommendations that “Adopting a clear policy on pay and pay ratios can be a valuable tool in encouraging positive perceptions. It is also a crucial tool for enabling a swift and convincing response to any hostile scrutiny of pay issues” (Equality Trust 2011).

There is growing evidence that staff are less productive in organizations with large pay differentials between top and bottom and where the perception was that pay was decided unfairly (Hutton 2011); this report recommended that public and nonprofit sector organizations should report pay ratios annually.

Conclusion

Governance in the nonprofit sector is a hot topic, due to concerns about the misuse of funds, child abuse, mismanagement, and high pay for staff. It is clearly a crucial issue which organizations ignore at their peril; an example of its importance is how hundreds of customers at the Cooperative Bank, a UK mutual, withdrew their accounts in 2013 due to the revelations about the notorious lifestyle of the former Chair, Rev. Flowers; whereas previous more serious issues, of enormous debts and the disastrous mishandling of the takeover of another bank, were ignored by customers (Independent Nov 2013).

Research on startups identified that the key elements in success were judging “the right time and place, education and experience, working with partners…and applying better management practices….and technical know-how.” All of this depends on whether the team setting up the project has the experience to make the right judgments and deliver on them, hence the need for a strong team at all levels.

Managers need to examine their ideas and plans very thoroughly and objectively before putting them into action presenting them externally. Sometimes the founder of a company is not the best person to move it onto the next phase of development, hence the need for skilled directors; clearly this was something that did not happen with the collapse of Novas Scarman (see case study) and the results were disastrous. Having a board of directors who rubber stamp everything presented to them is not good practice, even if it requires more preparation, lengthier discussion, and greater scrutiny of plans and progress. Boards which are just made up of the great and the good can often be less effective than ones drawn from committed people with skills especially when the situation becomes difficult.

Governance must be taken very seriously otherwise organizations will suffer. Sufficient time and effort must be put into recruiting, selecting, and training the right directors or trustees, with the right mix of skills and background, and into ongoing training and discussion with senior management. Proper protocols and guidance need to be worked out and published to analyze and define both board and management roles and responsibilities. Finally the whole process and membership needs to be reviewed regularly.

References and Further Reading

Charity Commission 2010 “A Breath of Fresh Air”. https://gov.UK/government/uploads/system/uploads/attachment_data/file/284702/rs23text.pdf

Davies, J. 2006. A Guide to Directors’ Responsibilities Under the Companies Act 2006 (UK). ACCA www.accaglobal.com/content/dam/acca/global/PDF-technical/business-law/tech-tp-cdd.pdf

Drucker, P. 1990. Managing the Non-Profit Organization; Practices and Principles. New York: Harper Collins.

Equality Trust 2011. www.equalitytrust.org.UK/sites/default/files/Pay%20Ratios%20and%20Income%20Inequality.pdf

Hollings, D. 2013. Director of Co-operative and Mutual Solutions Ltd (Linked In).

Independent. Nov. 2013. http://independent.co.UK/news/business/news/cooperative-bank-loses-customers-after-paul-flowers-scandal-8969515.html

Joseph, I. 2013. http://bwbllp.com/file/sunday-times-pdf-1

Kreutzer, K. and C. Jacobs. 2011. “Balancing Control and Coaching in CSO Governance. A Paradox Perspective on Board Behavior.” Voluntas: International Journal of Voluntary and Nonprofit Organizations 22, no. 4, p. 613.

Marsh, M. 2013. Voluntary sector Skills and Leadership Review. Cabinet Office.

Reach; https://reachskills.org.uk/volunteers/become-trustee

Ridley Duff, R. and M. Bull. 2016. Understanding Social Enterprise, Practice and Theory. Thousand Oaks, CA: Sage.

Schwab Foundation 2016, “The Governance of Social Enterprises.” http://www3.weforum.org/docs/WEF_Governance_Social_Enterprises_2106_light.pdf

Sunday Times 2013. https://www.thetimes.co.uk/article/a-wake-up-call-to-charities-dn2g0cjs0cn

Venture Navigator 2013. This was accessed in 2013 but Venture Navigator has now been wound up.

¹ http://thirdsector.co.uk/former-trustees-chief-executive-kids-company-facedisqualification-proceedings/management/article/1431316

² https://councilofnonprofits.org/tools-resources/can-board-members-bepaid#sthash.75x0ei9u.dpuf

³ http://nonprofitwithballs.com/2015/03/the-supply-and-demand-of-diversityand-inclusion

⁴ https://nonprofitquarterly.org/2015/03/04/the-face-of-nonprofit-boards-anetwork-problem

⁵ https://councilofnonprofits.org/tools-resources/diversity-nonprofit-boards

⁶ https://volunteermatch.org

⁷ http://forms.charitycommission.gov.uk/media/90446/safeguarding_strategy.pdf

⁸ https://acf.hhs.gov/cb

⁹ https://nspcc.org.uk/preventing-abuse/safeguarding/writing-a-safeguardingpolicy/

¹⁰ https://nonprofitquarterly.org/2017/03/08/million-dollar-compensationnonprofit-ceos

¹¹ http://huffingtonpost.com/2013/04/08/10-insanely-overpaid-nonp_n_3038162.html

¹² http://telegraph.co.uk/news/politics/12055422/The-charity-chiefs-paidmore-than-100000-a-year.html