Nonprofit Bylaws: Best Practices and Mistakes to Avoid

‍Podcast episode transcript ↓

Josh:

Nonprofit bylaws are the foundation of healthy nonprofit governance.

The stakes are high, and pitfalls are many.

However, nonprofits who are diligent in understanding and maintaining their bylaws can weather many storms and ensure their organization has a strong foundation for success.

I'm Josh with Anedot and welcome to Nonprofit Pulse, where we explore trends, insights, and resources that help nonprofits accomplish their mission.

On this episode, we're joined by Greg McCray on the topic of best practices and mistakes to avoid with your nonprofit bylaws.

Greg is the founder and CEO of Foundation Group, where he and his team have empowered nonprofits with expert guidance and solutions for more than 25 years.

Hey Greg, thanks for coming on Nonprofit Pulse.

Greg:

I am glad to be here. Thanks for inviting.

Josh:

Yeah. So today we're going to be talking about nonprofit governance, specifically bylaws.

What are bylaws for a nonprofit?

Josh:

So maybe just starting from the beginning, what are nonprofit bylaws and what's really their function?

Greg:

Well, nonprofit bylaws or bylaws for any organization, it is a legal document.

And basically it is the policies and the regulations and the procedures for governance that any organization and in our context, we're talking about nonprofits.

These are going to be the guidelines and the regulations that the board of directors uses to work with anything from a governance standpoint with the organization.

So typically a set of bylaws are going to cover things like, you know, how do you define an officer or director?

How is an officer or director appointed? Potentially, how are they gotten rid of? All of the things that involve governance.

Not so much what happens in the day to day operationally, but more high level as far as the mechanics of the actual governance system.

Josh:

So what's at stake in not getting your bylaws correct or not keeping them updated and correct? What's really at stake there?

Greg:

A lot and from a number of different points.

For one, without a good set of bylaws or without any bylaws at all, the board really doesn't know where the guardrails are as far as how they govern the organization.

The other part of it is making sure you have bylaws that are consistent with nonprofit law at the state and federal level, that's really a big part of that.

You can have a set of bylaws and they be completely inconsistent with the nonprofit corporate law in the state that you're incorporated in.

Or you could have provisions in the bylaws that violate IRS.

We're assuming, let's say, that it's a 501(c)(3). You may have provisions in those bylaws that don't comport with what tax exempt law requires at the IRS.

So not only having them, that's critical, but also making sure that they are drafted from a standpoint of being compliant and making sure that there's something that's going to match how the organization intends to operate, because it's not one size fits all.

I mean, you could have an organization, that is, let's say, it's governed entirely by a board of directors, or you need bylaws that are going to speak to that reality.

On the other side of it, you may have an organization that is partially member run. So you've got members who can vote in a situation like that.

Normally the members might elect the board and the board is the primary set of governance or the primary seat of governance.

So the bylaws need to be specific and address the issues that are going to relate to that co-leadership structure of member versus board, but making sure they're compliant, state and federal, and making sure there's something that's going to match how the founders of the organization intend to operate it. Those are huge.

Josh:

Yeah, just that cultural buy in of is this how we want to run the organization?

Is this something that we can actually achieve and do in a reasonable resourcing?

You know, I know in Texas here, I believe you said board meetings have to be in person, which means you have to travel to Texas for nonprofit board meetings.

And every state is different, but is that something you as an organization can achieve? Do you want to resource that? You know those questions.

Nonprofit bylaws best practices for new nonprofits

Josh:

So just thinking about new nonprofits, what are some best practices for new nonprofits who are just getting started and they're just starting the process of figuring out, all right, what do our bylaws need to be legally?

But also how can they serve us? And we be able to achieve those and not have a huge burden?

Greg:

Yeah, that's a great question.

I think one of the biggest mistakes that we see with founders and we deal with, at Foundation Group, our company, we help anywhere from 750 to as many as a thousand nonprofits get started every year and go to the IRS to get 501(c)(3) status.

And a very common thing we see is a very serious under appreciation for what the bylaws are.

And maybe just a complete disregard for what they're even supposed to be about.

And really failure to take the bylaws seriously or failure to operate in a way that your bylaws spell out. I mean, that can have some serious legal consequences.

We shot a video today for our YouTube channel that was a question from a follower of ours, and it was about some rogue activity going on on their board.

The board president was just going off the rails and some of the things that she's doing.

And so it was a two part question, can the board be sued and, or can the organization be sued and can we remove this board member?

Well, the answer is yes. On the sue part, anybody can sue anybody for anything. And can the board member be removed?

Well, hopefully, because actually the way this question was worded, she was conducting criminal activity in the way that she was operating this.

I mean, it was not felonious activity, but it was in absolute defiance of state law.

But if your bylaws don't include a provision for removing a director, then you've got a difficult situation there.

So for startups, number one, understand that the bylaws are a governing document.

So you need to understand what it is and what your accountability to that is, because what a lot of board members of a new nonprofit don't understand and even new board members coming onto an existing nonprofit is that board members have a fiduciary duty.

And that means they have a personal liability to make sure that they are conducting business in a way that is in the best interests of the organization and making sure that it's legal and transparent.

And the bylaws are a huge part of that because it dictates how you're going to govern that organization.

So understanding what bylaws are, understanding what's going to be appropriate for your organization, working with someone that can make sure the bylaws that you're going to use when you're a startup are compliant both at the state and federal level.

Those are huge, huge issues and just not making this mistake of under appreciating just how critical that document is.

Nonprofit bylaws best practices for established nonprofits

Josh:

Yeah.

So thinking towards older organizations or organizations that have been around for a few years and may need to be updating or at least looking in reviewing their current bylaws, what are some best practices that you could recommend for those organizations?

Greg:

Yeah, I think one of the first and foremost things is make sure your board every single year gets a copy of the bylaws.

I don't care if they've been on their board ten years.

Every year, get your board members a copy of the bylaws and make them sign off on a statement that they've reviewed them. That's actually something the IRS asks about on the Form 990.

You know, what is your procedure?

I mean, they ask specifically, number one, do you require board members to review your bylaws annually and what is your procedure for doing that?

So it's not necessarily a situation that if you answer no, you're going to get audited. It's nothing like that. But the IRS is concerned enough about it that they actually ask on the Form 990.

So make sure your directors are looking at your bylaws every year, signing off on them.

Do a self evaluation as a board.

Are we conducting business if we're having monthly board meetings or quarterly board meetings? Are we conducting these meetings according to the way the bylaws dictate?

Are we giving the proper notice? Are we doing it in person like what you were talking about with Texas, other places you could do it through a Zoom call.

Well, you're going to find a lot of things regarding, you know, being together in a physical presence and things.

A lot of the state law has not caught up with the reality of, you know, computer and video technology and things like that.

But making sure you're continuing to do things in a compliant manner, editing and amending those bylaws if necessary, but following the procedures, you know, if there's anything that we see and this goes back to the question that we had from a follower that we shot on today.

Make sure you're following those, because that's actionable.

We worked with a client many years ago. It was an existing organization.

It was a church that had removed ten members from membership, but the board did not follow to the letter the way the bylaws dictated that a member had to be removed.

So those former members sued that church and they didn't sue for money, they sued for control, and they got it.

Not only did they have their membership reinstated, but the court on Long Island actually granted them. The judge actually removed the board that was seated and replaced them with the plaintiffs.

And they gained and the whole thing hinged on were they following the bylaws requirement for how are members removed? And it required, it was a multistep process that included verbal notice, included written notice, and the board sidestepped the written notice part and the court found in favor of the plaintiffs.

So does that happen every day? No.

But when you deal with as many nonprofits as we have, you do see these things happen.

And, you know, so many small organizations in particular treat bylaws as an afterthought until it bites them. And then it's not an afterthought anymore.

What are some common mistakes nonprofits make?

Josh:

Yeah, so let's talk more about that.

Let's explore that, you know, common mistakes that you've seen in your 20 plus years of serving nonprofits?

What are some common mistakes, both, you know, new orgs as well as established orgs that y’all see really over and over?

Greg:

Probably the biggest mistake is disregarding the bylaws entirely.

And you see this a lot in nonprofits, primarily because you're dealing with a lot of volunteers, and volunteer recruitment.

You know, if you're dealing with an organization that has very frequent turnover.

Like, let's say, a homeowner's association. A lot of people don't know that homeowner's associations are usually 501(c)(4)s.

So they're a type of tax exempt nonprofit. But trust me, as somebody that has served on an HOA board, nobody wants to do that for long. So you get a ton of turnover.

But those groups are notoriously terrible at educating their new members about the bylaws, if they can even find a copy of them.

And so you end up in a situation where you get into generational bad habits of, you know, each successive board gets further and further away from what the bylaws require.

Until you have a homeowner that realizes they're being required to do things that the bylaws say nothing about, and then you end up with a food fight in your neighborhood or you end up with a lawsuit filed.

And that's just with an HOA. It can happen with any organization.

Member organizations, I think, are more susceptible to this than even nonmember organizations, because members they're stakeholders. And they're the ones that typically elect the board.

And if the board is operating rogue of what the bylaws require, it's usually the members that are going to stir up a hornet's nest and things like that.

So that generational drift is a huge, huge factor that we see so much in nonprofits.

And you would think you wouldn't see it all that often where a board doesn't even know where their bylaws are or what's in them.

That's very, very common. Unfortunately.

Josh:

What are some other maybe more tactical or functional mistakes you see other than just ignoring them completely?

What are some other common mistakes?

Greg:

Disregarding things that may not seem important anymore.

And that's the thing. If you've got things in your bylaws that are outdated, don't just go around them because they're outdated.

Amend the bylaws. And most states don't require you to file bylaws with the corporation’s division. It's not like your annual report that you have to file every year.

Most states do not require a copy of the bylaws, but usually they can be submitted if you want to.

But at a minimum, if you're going to create new bylaws, if you want to make that publicly available and show the updates, that's a great thing to do to keep people aware of it, but take the time to amend it.

Usually there's a clause in the bylaws that allows for amendment, and that's usually pretty tough. We see - and it should be.

I mean, bylaws are kind of like the constitution, you know it's only this thick. US law is this thick and that's your policy and procedure manual.

That's another big mistake that we see people make is they try to take every policy and procedure that's going to be used operationally in the organization and enshrine that in the bylaws.

And you end up with a 50 page set of bylaws that no one can keep up with. That has a legal connotation that a policy and procedure manual doesn't.

So don't elevate non-governance issues to your bylaws. That's a huge mistake.

But if you do have elements in your bylaws that are governance issues that have become outdated, don't just go around them because they're outdated.

Actually take the time to amend the bylaws, record that, produce the new copy, and make that available where people can see it.

How to change bylaws for a nonprofit

Josh:

Yeah, so talking about amending bylaws, what do you counsel your customers, your clients, about how to go about that? You know, Is it a slow roll?

Begin the conversations a year out and kind of work your way through it? Is it something that, you know, hey, this should be accomplished within a 90 days or a quarter?

What's your counsel for organizations who are realizing, you know what, we do need to amend our bylaws either by adding sections or by removing a lot of that operational policies and procedures that have snuck in.

Greg:

Yeah, I think it depends on how much it's affecting the operations of the organization.

If this is something that is causing real pain points and you're being limited in what you can do because you've got restrictions in your bylaws, maybe that probably should have been in a policy and procedure manual, but they've been enshrined in the bylaws.

And so the organization is being prevented from doing some things that are making some changes that would facilitate their growth or evolution as an organization.

Those probably have more of a priority to be fixed quickly, you know, things that aren't going to affect anything but the board operation, you know, maybe that's dealt with a little bit more over time.

The big issue is, what do the bylaws say, as far as what's required?

A lot of times you're going to see original bylaws drafted in a way that bylaws amendments, take them, take a unanimous vote of the board. That's usually overkill.

But we see that. That makes it really tough. We had that situation on the HOA board I served on.

We see this kind of stuff with clients, but I experienced it personally. There was a bylaws provision that required a maximum of 5% dues increases per year.

Sounds reasonable until you run into situations where you've got extraordinary expenses and maybe that maybe prior boards had not raised dues for ten years. And then you're in a situation where the maximum you can do is 5%.

Well, that should have been a policy and procedure probably. Maybe it's a bylaws issue, but with it being a bylaws issue in this particular case, it required the members, which are all the homeowners, to approve that by a two thirds yes vote.

Well, who's going to vote for that? And so you end up in a situation where you've got something enshrined in the bylaws that there's no practical way to changing easily.

So those are big factors with amending is how, what is the vote threshold that you have in place? Because you got to abide by it.

I mean, if it's in there, if you've adopted a set of bylaws and this is where people make mistakes, especially startups, is they'll download a template they found on the internet, glance through it, don't really know what any of it means.

They’ve not consulted with a specialist firm like ours. They've not consulted with an attorney. And they just, in the first board meeting, hey, I found these online. These look great. Everybody says, yay, let's adopt these. They're yours.

If the board has taken a legal vote to accept those as the bylaws and there's provisions in there regarding amendment, that future amendments taken would take a unanimous vote or even a two thirds supermajority.

That's why you need to know what's in there and how that's going to affect your organization, because that can have some serious downstream consequences.

When should nonprofit bylaws be updated?

Josh:

So what do you see as a maybe a time frame of when organizations should really take a hard look?

I know you've mentioned, when one area might be or one time might be, you know, look, is your bylaws restricting you from doing things you need to do? Like your HOA example. Look, we've got to have an infrastructure investment here.

We need to raise 7%, not 5%.

But what's the time frame that you see as kind of a good guide of probably you need to update. You need to update your bylaws.

Greg:

You could go many years without needing an update.

But I think as far as a cadence of when to review them, is this kind of goes along with that IRS expectation that you're letting your board members see those bylaws and become familiar with them again on an annual basis.

I would bake into the annual meeting, even if you've got a board cadence of meeting quarterly or meeting monthly, I would say that at least on an annual basis, part of that annual meeting is set aside for just going through it as a group.

And is there anything in here that's obviously outdated? Is there something in here that is that we have now found that is contrary to state law?

Usually you're not going to find things. You're not as likely to find things that are gross violations of federal law. It’s usually state corporate law that gets tied up into this, are the things that are constricting our activities.

But I think, a steady schedule of setting time aside annually to go through that as a group is a critical governance step.

Josh:

Yeah, it just seems healthy too, right? Just creating that rhythm of this is part of how we function.

This is part of what keeps us safe, keeps us legal, helps us, you know, survive in many ways from storms that may come, whether that's employee issues or board issues.

You know, as you mentioned at the beginning of the episode, this is part of doing nonprofit life is reviewing your bylaws, being aware, embracing them, and practicing them.

Greg:

And look, we deal with, we've coined the term around here that our clients are right brain entrepreneurs.

So they are business founders. I mean, you can't take away the fact that if you start a nonprofit organization, you have started a business of sorts.

It still has to operate according to business principles. You still have to bring in more money than you spend if you're going to survive.

But so many people that get involved in this line of work, they're not the technician who's gone and started their own business.

They're not the accountant that was working for a CPA firm that decided to go set up their own business.

These are typically passion driven people, cause driven people and, you know, they want to solve the problems that they've identified, things like boards and budgets and bylaws.

This just makes their head hurt and trying to get them to slow their roll enough to realize that this is not semantics. It matters.

And it has huge consequences if you don't get it right. It's one of our biggest challenges is trying to get feelers and passion driven people to really not just take this seriously, but understand the consequences of getting it wrong.

Josh:

Yeah. Which again, are huge. I mean, you could lose your entire organization, you know, as you mentioned earlier.

Closing thoughts

Josh:

So imagine we are in a room full of hundreds of nonprofit leaders.

What is one thing that you would want to convey to these nonprofit leaders about governance and bylaws for nonprofits?

Greg:

Understand that the health of your organization long term is going to hinge on good governance.

You can write, you can - the gas tank will go quite a bit, quite a ways based on founder passion. And you see this a lot in founder driven organizations. You've got a key person who was the idea person.

They're the energy behind it, they're the vision behind it. And they've got this whole group of people following them.

And you can run a long way on that. You can go a long way on founder passion.

But ultimately, if you don't have a good governance structure in place, at some point the gas tank is going to run empty.

The wheels are going to fall off and things are going to go sideways and sometimes catastrophically.

We've seen founders end up on the outside of their organization looking in because they ended up being removed by a board, maybe because they made it too easy to remove somebody.

They downloaded a set of bylaws and adopted them. You know, that said, a simple majority vote of the board can remove a director or an officer.

You know, maybe they made it too easy. So these are not minor things. You could easily find yourself in a situation where you're not even inside your own organization anymore.

So if I was looking at a room of potential founders, I understand that you want to solve the world's problems, but if you don't get your foundation built, if you don't get the groundwork laid, that's going to provide the stability, because this is a legal entity you're setting up.

This is a corporate entity in most cases, you got to get the groundwork laid or it's going to cave in at some point.

Josh:

Yeah. And have those hard conversations upfront at the beginning of your organization starting, rather than six months or six years later.

Coming to the board and saying, hey, it no longer serves us to have just a majority vote to remove a board member.

Those are hard conversations once that culture is baked in.

Greg:

I mean, we had an organization here in the Nashville area and these guys unfortunately made the news several years ago.

They didn't realize that it was against state law for the organization to loan money to an officer or director.

So they loaned a large sum of money to the board president who was the founder. And they set it up according to the legal loan guidelines, and there was a payback.

It wasn't wasn't free money. It was going to have to be paid back. But the state of Tennessee absolutely forbids nonprofits to lend money to an officer or director. They didn't have provisions in the bylaws to prevent that.

You know, they had not again, I think they used a template set of bylaws. They got off of somebody and that was a huge deal.

It was like $450,000, that was involved and somebody reported it to the state, and the attorney general's office got involved, and huge embarrassment publicly for this organization.

You know, the board president had to immediately pay back all those funds. And fortunately, he had the means to do that. But this is what I'm saying. These are not minor issues.

You have to know what you can and can't do. And it starts with making sure those bylaws are thorough and they are consistent with what the law requires.

Josh:

Yeah, you know, just thinking about how trust based nonprofit work is, you know, it could take years to build that trust in the community or nationally, depending on what your scope is. And your nonprofit.

And then it just takes moments to undo all of that hard work of trust building and it may not even be you know, it could be an ignorance.

But again, that doesn't matter at a you know, in the public eye, especially when there's legal ramifications for your actions too.

Greg:

Oh, yeah, absolutely.

Josh:

Yeah. So thinking through resources, Greg, what are some resources you would recommend to our audience, whether they're Foundation Group resources or others?

Greg:

I think from a standpoint of understanding board compliance and one of the best groups out there is a group called BoardSource, and that is a nonprofit organization.

It's boardsource.org. We're members of that, as our company, Foundation Group, and we take advantage of some of their materials.

They've published more material than anybody can ever read when it comes to governance and board structure issues with regard to nonprofits, it's a fantastic resource.

I highly endorse those guys. We don't get any kind of recognition or kickback from it, but we use them. It's just a great, great resource. I think every nonprofit should probably be a member of BoardSource to have access to that kind of content.

And then on a practical level, make sure you're working with a firm for when it comes to things like your tax filings and your bookkeeping and all that kind of stuff.

Those are the type services our company offers.

Make sure you're working with a third party that can be that other set of eyes on your particular situation and making sure that there is there's accountability for the way things are being done and conducted there every year as you go about operating your programs.

Josh:

Awesome. Yeah. Check out BoardSource. And also check out Foundation Group.

Big fan of Greg and what he's built over the past two decades.

Just incredible wealth of information on your YouTube channel and you give all that information away for free and it's just so helpful and encouraging to see how you all serve the nonprofit community, both on the business side but also on the free resources side.

So thanks for doing that.

Greg:

We love doing it, and we're glad to be able to be a resource.

Josh:

Awesome. Greg, thanks so much for joining us today.

Greg:

Thanks so much.

‍Josh:

Hey, thanks for checking out this episode!

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