Into the Sunset: Why Your Nonprofit Should Consider Exit Agreements
Part of good succession planning for your nonprofit should include the following question: What should we do if a longtime CEO is planning to leave? An exit agreement may be a good answer for your organization.
Types of Exit Agreements
There generally are four reasons nonprofit boards explore an exit agreement. These reasons correspond to the type or focus of the agreement. They are:
- Catch-up. A monetary package acknowledging that the executive’s salary has been significantly below market for a long period and/or the organization’s retirement contributions have been low or nonexistent.
- Post-retirement services. A contract for services to be provided after the leader moves out of the executive role.
- Incentive to stay longer. As an incentive to encourage the departing executive to remain as executive for a defined time for purposes important to the organization’s welfare.
- Honor. A memorial, in writing, recognizing or honoring a departing founder of your nonprofit.
Things to Consider
As suggested in the description of the four common reasons for negotiating an exit agreement, there is no doubt that many boards and executives consider these agreements as elements important to successful CEO transitions.
Financial capacity. The decision to provide exit compensation for a long-term executive typically arises from a board’s desire to do something good. Exit agreements assume that the organization will continue along its current financial pathway or even improve. In reality, the capacity of both parties to live up to the commitments in an exit agreement may change over time. The organization must have the reserves or ability to raise designated funds for this purpose, so as not to impede future capacity to carry out its mission. For example, the commitment to make periodic lump-sum payments to a departing executive may be in jeopardy if the non-profit suffers a decline in unrestricted funds.
Practice tip: Consider these questions. What is the likelihood that a change in capacity could impact the nonprofit’s ability to provide the compensation, benefits or other resources/support promised in the agreement? What steps can we take now in drafting the agreement to account for any changes in financial capacity?
Private inurement risk. Tax-exempt organizations must operate in a manner consistent with their charitable purpose. “Private inurement” refers to the impermissible transfer of assets from a charitable organization to insiders or disqualified persons who have significant influence over the organization. One example of impermissible private inurement is the payment of more than reasonable compensation to a CEO of a nonprofit. If payments to a CEO are beyond what the market calls for, CEO compensation may be deemed to be excessive compensation, thereby putting the nonprofit at risk of IRS-imposed fines and penalties on the organization and the individual board members who approved the payment of excessive compensation.
Practice tip: Ensure that the board is independent. To prevent bias and preserve independence, individuals on the board should not be related to the outgoing CEO or have significant personal relationships with the CEO. Be sure that the full board is aware of the details of the exit agreement, including financial terms, research and basis for determining that the payout will not be considered excessive compensation by the IRS. Document the action the board takes to approve the final exit agreement. Be sure this is kept on file.
Contractual considerations. The risk of a breach-of-contract claim arises any time an organization enters into a contract with another party. These claims brought against a nonprofit are typically excluded under nonprofit liability insurance policies, which means that the nonprofit will not have insurance to cover the cost of defending such a claim.
Practice tip: To minimize the risk that a former CEO will bring a claim for breach of an exit agreement, draft an escape clause that specifies when the agreement, or any portion of it (such as the obligation to pay a consulting fee), will be void. For example, the nonprofit may have grounds to stop paying a consulting fee to a former CEO if the departing CEO fails to take direction from the successor or is unwilling or unavailable to live up to the terms in the contract.
No matter the type of exit agreement you choose, always obtain legal review of a draft agreement before executing it or asking the departing CEO to sign. Both parties, not just the nonprofit, should have an opportunity for legal counsel to review the agreement.