The First and Most Critical Step: Nonprofit Articles of Incorporation
Continuing our series on nonprofit formation… we know why we are starting a nonprofit; we thought through whether we needed a new nonprofit; we decided how to structure the relationship to our for-profit entity; now... we form it.
This post will tackle the Articles of Incorporation, specifically for a California nonprofit public benefit corporation, using our new entity for organizations targeted for their DEI work as an example. A document that is usually no longer than a page or so, many people do not realize that they are making a number of important choices when they file their Articles of Incorporation. Choices that are not always easily unwound.
Let's walk through those together.
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What state are we incorporating in?
Our firm typically incorporates entities for clients based in California in one of two states: California (obvious) and Delaware (less obvious unless you know that 80% of US corporations are incorporated in Delaware).
If it were just a matter of what state law I liked better, it'd be California every time.
I won't derail this post with the full discussion of the benefits, but typically if we incorporate in Delaware, it is for one of two reasons:
1. The prospective client may be in California now but may not always be. Delaware asks very little of the nonprofits that incorporate there. California requires that nonprofits incorporated there follow all of its requirements, including Attorney General reporting, even if the organization no longer operates or solicits in the state. So, incorporating in Delaware may save that nonprofit a bit of time. (I'm not planning on taking any other bar exams in my lifetime so I’m expecting we'll always have a California presence.)
2. The client will have overlap between the Board and the staff that flunks California's 49% rule.
In a well-intentioned but, in my opinion, slightly overbroad rule, Cal Corp Code 5227 says that no more than 49% of the Board can be either paid by the organization in a staff or contractor capacity (a director capacity would be OK) or related to someone who is paid by the organization in such capacity.
In my experience that pushes two different types of nonprofits to incorporate in Delaware.
The less sympathetic but most common situation: Married couple starts a family foundation (which typically has an all family board) wants to be able to pay their child a (let's assume reasonable) salary to be executive director or program officer of the foundation. With the 49% rule, that family would be forced to choose between (A) adding a majority of nonfamily directors or (B) not paying their family members for service to the foundation. Not exactly a Sophie's Choice in my personal opinion, but trust me when I say that some families view this as completely unacceptable. In those situations, we often end up incorporating in Delaware to preserve flexibility.
The more sympathetic (in my opinion) example is the worker governed nonprofit. Many organizations want to simulate the governance structure of a worker owned cooperative by having their Board consist mostly or entirely of employees. Incorporating in California would effectively require them to always elect a majority of non-employee directors. I do think there are ways to make that work in a manner consistent with worker democracy principles (e.g., staff elects entire Board, with bare majority of non-staff directors, and a voting threshold that requires at least 75% for example). But most worker-directed nonprofits prefer the flexibility to have their Board consisting of staff without constraints that feel arbitrary or like it encourages them to be subordinate to outsiders/donors.
Neither of those apply to us. Our Board will be mostly or entirely attorneys and non-attorneys who are not being paid by this organization and are volunteering their time to it.
So... Long way of saying, let's do California.
What kind of California nonprofit?
Once you select California, you technically have three choices: public benefit corporation, religious corporation, or mutual benefit corporation.
Let's cross out mutual benefit corporation, those are only appropriate for certain kinds of member driven nonprofits (trade associations, social clubs) and are not consistent with 501c3 requirements.
And let's cross out religious corporations (which can be 501c3s and benefit from more flexible corporate arrangements and reduced regulatory obligations) because this is obviously not being formed primarily for religious purposes.
So, California nonprofit public benefit corporation it is.
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The Actual Form: Here is what we landed on as the Articles of Incorporation for Defending Equity Initiative. (If you're asking why we are not just using the state form here, which certainly works too, you will see that there are a couple provisions that benefit from a little customization in our opinion.)
Let's walk through it step by step. (Feels like a good time for a disclaimer — remember that none of this is legal advice, and every situation is different — we hope this is a useful resource for being doing self-help on forming their own charity, but please keep this in mind, read this and any other sample carefully, and ask for help if you need it).
1. Article I: The Name of the Corporation.
Truly the hardest part of the process. California is flexible on naming as long as you're not taking something that someone is already using in the state. So, check the state website. Then do a quick web search to see if anyone is using the same name that might cause confusion. If the name and logo are something you expect to want to trademark and protect, maybe do a trademark search too to see if you'll be able to register after forming or if you'd be infringing on anyone else's.
For us, through a rigorous Slack poll methodology, we landed on Defending Equity Initiative (DEI for short).
Both the name and its acronym are intended to signal that the nonprofit will be dedicated to maintaining that diversity equity and inclusion are legally necessary concepts for nonprofits to pursue, and they must be protected from frivolous arguments that those efforts are unlawful. And that we shouldn't feel the need to hide our intentions when it comes to this clearly charitable and just mission.
2. Article II: The Purposes Statement.
Some clients like to use this paragraph as their mission statement. I tell them not to. That is because whatever you put here creates a legally binding restriction on the funds you receive while it's in place, enforceable by the attorney general and each director and officer, to only operate within those bounds. It's just very rare that any mission statement survives forever without needing to be evolved.
So, our purpose statement is drafted to conform to legal requirements and to be broad enough to allow us to do anything within 501c3. Sometimes, we'll give clients the "including but not limited to... [specific plans]" for those who insist. But since people might use this as a sample, I'm going to go with the most generic option.
Note also that we are referring to charitable purposes. The state form will let you choose public purposes instead but that's rarely the correct answer on its own for a 501c3.
3. Article III: The Name and Physical (and Mailing If Different) Address of the Corporation.
Yes, you do need a street address somewhere. And if you don't have an office or a work address you can use and don't want to make your home address public, you do need to secure some kind of office address.
We started with our firm’s main office address since we are launching this thing. This can always be updated later.
4. Article IV: Agent for Service Address.
This is where legal service (e.g., lawsuits) gets sent. We could just have it be me at the above address but let's use the registered agent service that we use just to make that consistent across all entities for us.
5. Article V: Organizational Test — Required Purpose Language.
This language is required to satisfy the “organizational test” under Internal Revenue Code Section 501(c)(3) — this says that a tax-exempt organization must be the right kind of organizational structure, meaning that under its organizational document, it is only legally permitted to carry out activities consistent with Section 501(c)(3). If you review IRS denials, you’ll see many organizations get denied for not having this clause in the document or forming as the wrong kind of entity (e.g. an LLC or for-profit corporation).
6. Article VI: Dissolution Clause.
Once money and assets go into the 501c3 stream, they don't come back out. If this nonprofit dissolves, it needs to send whatever is in it to another 501c3. That's the gist of this paragraph, which is also required to satisfy the organizational test.
Outside of the option to designate a particular nonprofit to receive the assets, there's not a lot of flexibility here either so it is best to just leave this alone.
7. Article VII: Amendment of Articles.
The default under law for a corporation without members is that the Board can amend these by majority vote. That is fine, but when we do this with a Designator structure, we generally have that power be subject to the Designator’s consent (the idea being you don't want to allow circumvention of that power through amendment of the Articles). I'm not all that worried about that here, but we added this provision to model the best practices approach to a Designator structure. (You would not want to include this article obviously if your bylaws are not going to provide for a Designator.)
8. Signed by: The Incorporator.
Who is the Incorporator? Well, it's anyone who signs this document. It can be anyone. We often have it be whoever will be CEO but it does not need to be.
The incorporator is the person that bridges the gap between when the articles are filed and when the Board is appointed, and they are the ones who name that initial Board.
Until that Board is appointed, the incorporator has all of the Board’s power. Once they are appointed, all of their power as the incorporator disappears.
Wanting to be all-powerful for a brief moment in time, I've listed myself as incorporator in this document and signed it.
9. Last step: File..
We use a filing service to do all of our filings. It's nice to have someone else take responsibility to make sure it is done right and in a timely fashion. But it is something that you can do yourselves. California permits online filing here.
The entity does not exist until the Articles are filed, and you won't have proof of existence until the Secretary of State sends them back stamped as accepted and filed. Here's what that version looks like.
And with that your nonprofit is born!
Only catch: it was born without any of the following:
1. A federal EIN (necessary to open a bank account)
2. Registration with all applicable entities in California regulators (Attorney General, Secretary of State, Franchise Tax Board)
3. A Board of Directors
4. Officers
5. Bylaws
6. Key policies and corporate actions
7. Tax exemption
So, it's alive, but it still needs a bit of work before I recommend releasing it in public.
In our next post, we'll tackle the first round of administrative steps to get everything in place and in order.
