Create a foundation, make an impact. Our guide simplifies the process, clarifies the '5% rule,' and shares best practices for your philanthropic journey.
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Are you interested in making a lasting positive impact on something you believe in within society? Establishing and managing a foundation is an effective way to mobilize your resources
This is not an easy endeavor, and it certainly doesn’t happen overnight, but creating a foundation could be incredibly rewarding.
This article will explore the step-by-step process of how to start a foundation. It will also delve deeper into the confusing “5% rule” and explain some best practices.
Let’s get started!
A foundation is a nonprofit organization or trust that provides funding (usually in the form of grants) to a particular cause. These grants almost always go to other nonprofit organizations to support charitable programs and initiatives.
Both public charities and private foundations hold 501(c)3 IRS status. However, public charities receive a greater portion of their financial support from the public.
Private foundations are generally started and financially supported by individuals, couples (think of the Bill and Melinda Gates Foundation), families, or even corporations.
In general,
Before we explain how to start a foundation, let’s spend some time going over some of the benefits and advantages of doing so.
Starting a foundation can be a great way to make a positive impact on your community and society in general.
For example, maybe you have a deep passion for helping stray animals.
The Coca-Cola Foundation is a good example of a foundation that has made a huge impact. Over the years, the foundation has allocated more than $94 million to more than 300 organizations around the world:
However, you don’t have to be a multi-million or billion-dollar organization to start a foundation and help society.
Individuals and families also start foundations to leave a legacy for either themselves or someone they love.
For example, if your grandfather died of cancer, you could start a foundation that supports nonprofit organizations that work with cancer research in his name. That way, you are honoring your loved one while also helping others.
Private foundations qualify as a 501(c)3 organization with the IRS, which means your foundation will be exempt from taxes. So, the contributions you receive can be allocated to causes you care about, removing a lot of the tax burden.
Not only that, but you can entice potential donors with tax advantages—they can claim their donations as tax deductions on their Form 1040. Just be aware that your private foundation must benefit the public in one of the following ways in order to be considered “private”:
You will need to submit IRS Form 1023 to ensure the federal government considers your foundation as tax-exempt.
This form can get complicated, so you may want to find an expert or professional in tax law to help you so that you complete it correctly and receive your 501(c)3 determination letter from the IRS.
Probably the main benefit of starting a foundation is being able to support an endeavor that you are passionate about.
When you have your own foundation, you control exactly where the grants and funding are going. You can directly support initiatives that you care about and that are important to you personally.
An added bonus is that this support can enhance your personal or corporate reputation.
For example, The Ford Motor Company started the “Ford Foundation” in 1936 to support public welfare, education, and scientific advancement.
This long-running foundation has also enhanced the corporate branding of the car manufacturer.
Pro Tip: If you are looking for corporate grants to support your nonprofit, check out this guide on how to tailor your grant proposals to fit their funding needs.
Now that you know what a foundation is and the benefits of starting one, you should understand that launching a foundation can be a laborious process.
Fortunately, there are some ways you can prepare to make the process more streamlined.
Before starting a foundation, you should have a clear understanding of your assets.
You will also need to determine who will actually run the foundation (whether that is you or someone you trust).
There is no set amount needed to establish a private foundation. It really just depends on how much money your endowment fund needs to generate an adequate amount of investment income to fund your chosen grants.
Most foundations will start off with anywhere from several hundred thousand dollars to millions of dollars. However, you need to understand how you can maintain this funding so that you can use it to help your community.
There are also costs associated with filing your 501c(3) status and maintaining the IRS requirements. However, you can actually fundraise from the public to support these costs.
If you are establishing a corporate foundation, some of the funding could even come from the corporation itself.
A Step-by-step Guide: How to Start a Foundation
It’s finally time to explain how to start a foundation. We will give you a step-by-step guide to ensure you understand the best practices, potential challenges, and how to navigate through them.
The first step to starting your foundation is defining your purpose and mission. Your purpose and mission will guide your foundation’s activities to ensure your grant monies are supporting the right causes and organizations.
In order to do this, you should ask yourself these two questions:
Once you answer the questions above, you can develop a clear and concise (and memorable!) mission statement.
A good example of a clear and straightforward mission statement is from the Bill and Melinda Gates Foundation:
Your purpose and mission of your foundation are clear, so now you need to choose your foundation structure. You can set up your foundation as a trust or a nonprofit 501(c)3.
In the end, they both have their pros and cons:
To attain your 501(c)3 status at the federal level, you will need to apply for an employer identification number (EIN) through the IRS. This number is basically the social security number for your foundation and identifies it on all tax forms.
You will also need to fill out Form 1023: Application for Recognition of Exemption Under Section 501(c)3 for your tax-exempt status.
In addition to the federal IRS requirements, you will want to check your state to see what requirements they have for filing your foundation at that level as well.
The foundation charter is a critical part of establishing your foundation.
In general, your foundation’s charter should include:
You will also need to finalize the proper name of your foundation, the location of your headquarters, and the overall management structure.
Remember that you should take your time developing your charter so that it can help guide your foundation moving forward.
You will also want to establish your Board of Directors with individuals you trust to ensure your foundation’s mission will be met.
Board members will represent your foundation in important social circles, so you want to make sure they are credible and can connect with other leaders in the community. In addition, they need to have the same passion for your mission as you do.
The IRS requires that a nonprofit has at least three board members and expects that the board meets at least once a year (although we suggest meeting at least every quarter). A board member's term may run anywhere from one to five years typically.
As the head of your foundation, you should also have a presence on the Board of Directors. Then, you should surround yourself with colleagues and influential people who are also passionate about your mission and cause.
You have probably already started with seed money or an endowment, but those funds only go so far. You will need to have a fundraising and operations strategy to ensure that your foundation can continue running.
Many foundations operate off of investment income, though you can also engage in fundraising strategies to raise money for your cause.
Your operations strategy will structure how your funds are distributed and what goals should be prioritized over others.
Diving Deeper: Understanding the 5% Rule
Have you ever heard of the 5% rule for foundations? We will explain what it is and how it works below!
Once you receive tax-exempt status from the IRS, they will require your foundation to essentially “payout” monies in charitable grants that are at least 5% of the foundation’s annual assets. If you don’t, you could lose your tax-exempt status.
It might be difficult to ascertain how much this number is each year; therefore, we recommend working with a tax or accounting professional to determine what amount of funds meets this 5% rule.
Why 5%? This was an agreed-upon number way back in 1969 when lawmakers passed the Tax Reform Act. Essentially, they figured private foundations could sustain permanence (i.e., last forever), while also ensuring they meet their mission’s needs and benefit society.
The 5% rule is important to your foundation’s sustainability because it will guide how much you donate during your fiscal year through what the IRS calls a “payout.” This payout includes two things:
Remember that the 5% is a minimum; that is, most foundations choose to distribute more than the 5% each year to better help their communities.
Best Practices for Running a Successful Foundation
Finally, let’s go over some recommendations and tried-and-tested strategies that should help you run a successful foundation.
You must be very clear about what you want your foundation to do and who exactly you want to help.
Remember, the mission and vision statements will guide everything you do. Knowing exactly what you want to accomplish will make it easier to make a positive impact.
Your foundation should have a strong leadership base.
Make sure that you Board of Directors and your foundation’s leadership team are committed to your mission and passionate about your cause.
You can check out this list of 11 board member responsibilities for more insight into nonprofit leadership and governance.
You also want to make sure your foundation is financially transparent and accountable.
That is, people who donate to your foundation want to make sure their monies are being used responsibly and going to the cause you promised.
Now, foundations do need to file Form 990 (if you are unsure which 990, the IRS discusses the different types here), which are public documents detailing how you spend your money for your tax-exempt status. These forms are another great way to ensure you are staying accountable to the public.
As a foundation, it’s important to engage with your community effectively.
Participate in other philanthropic activities, start your own events, or even promote your foundation through social media.
It’s important for your community and your foundation’s stakeholders to be engaged with your mission and want to support your cause.
Wrapping Up: The Next Steps
Creating a foundation can be one of the most rewarding things you can do with your money and time. You can create a legacy for yourself or someone you love, while also helping society.
However, establishing a foundation can be a lengthy and detailed process—but it’s worth the time and effort. Up next, pair this article with a rundown on the different types of grants that you can offer. Then, watch how a grantor reviews grants from nonprofits seeking funding.
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