Using an exit agreement to manage your nonprofit’s leadership transition

All good things must come to an end - including the tenure of a respected founder or executive. Just make sure that the departure of your nonprofit's leader remains smooth throughout the exit and transition process. An exit agreement may help.

Compensation and a continuing relationship

Exit agreements are legal documents, usually developed by a nonprofit's board of directors, which detail the terms of a leader's departure. Unlike separation agreements - which generally protect employers from lawsuits or competition - exit agreements deal with compensation and the employee's continuing relationship with the nonprofit.

Here's an example: The founder of an arts organization initially accepted only a modest salary and has for years been drastically underpaid relative to other nonprofit executives. What's more, she's received little in the way of retirement benefits. When she announces her departure, her nonprofit's board decides to use an exit agreement to compensate for her hard work in making the organization a success. Generally, this is known as a "catch-up" agreement. The financial award acknowledges that the executive's salary has been lower than it should have been for a long period or that the organization's retirement contributions have been minimal or nonexistent. 

"Stay" agreements are also common. A nonprofit's executive director might be eager to retire, yet his board wants him to stay on in some capacity because his knowledge and connections will be critical for an upcoming campaign. The board includes "stay" incentives for a specific time period in the exit agreement.

Exit agreements can also be sued to award a one-time honorarium. Even if a leader has been adequately compensated, a board may want to honor the executive's extraordinary service on the way out.

Avoid possible pitfalls

Usually, nonprofit boards approve exit compensation because they believe it's "the right thing to do". But even if you nonprofit can afford to compensate a former employee right now, it might not always be in a position to do so. You can help ensure your organization has the financial resources to make a generous offer to your department executive by awarding a lump-sum amount. However, if you decide to extend compensation payments over a period of time, make sure the agreement specifies the source. It also should provide for discontinuation of payments if they jeopardize your charitable mission.

Look into the possibility that compensation leader could put your organization in danger of violating private inurement rules. These rules prohibit certain transfers of assets (particularly "excessive" compensation) from nonprofits to insiders. If the IRS deems such compensation unreasonable, it could impose fines and penalties on your nonprofit and on individual board members who approve the compensation package. In a worst-case scenario, your tax-exempt status could be revoked. 

In addition, consider how your nonprofit's stakeholders might react when they hear about the package you're offering a departing executive. They may feel it's excessive or unnecessary and that your board's actions are suspect. You'll need to report any financial compensation on your nonprofit's annual Form 990. To protect against accusations of improper actions, make sure your board meeting minutes record discussions about the exit agreement and justifications for any compensation offered.

In the event of a breach

Even with the best intentions, it's possible for an exit agreement to be breached. Check your organization's liability insurance policy and talk to an attorney to learn about any protection. Contact us to discuss whether your nonprofit has the financial resources to offer a departing leader compensation.

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