LFCS: The value of FOSS fiscal sponsorship

As open source becomes more popular and mature, questions of formalizing the governance and corporate structures of projects are becoming of increasing importance, as can been seen by the rising visibility of various FOSS foundations. At the Linux Foundation Collaboration Summit in San Francisco, Tony Sebro shared his insights about the value that fiscal sponsors bring as umbrella organizations for FOSS projects. Sebro is the General Counsel of Software Freedom Conservancy, which is the home of about 30 free and open source projects, including Samba, Git, and BusyBox.

Sebro kicked off his talk (slides [PDF]) by explaining some of the problems that unincorporated open source projects face. The Internet makes it easy for developers to get together and collaborate on a project. Unfortunately, there are several potential downsides in such a loose organization, especially when a project grows larger. While individuals and corporations can contribute time and code, it's difficult for unincorporated projects to raise and manage funds. Of course, many projects use PayPal, Flattr, and other means to obtain funding, but an unincorporated project has no central place to hold and manage the assets. What happens in practice is that the project founder or a similarly trusted developer will hold these assets.

Fortunately, this arrangement works out in most cases, but it can lead to severe problems in the case of a dispute—the person who registered the domain name owns it, rather than the project, and it's unclear who holds trademark rights. Sebro noted that it's possible to hold common-law trademark rights even if a trademark has not formally been registered. This is something few developers are aware of and it can lead to uncertainties as to the ownership if there is a dispute. More generally, unincorporated projects suffer from a lack of administrative support and expertise. Most developers want to write code and tend not to worry about administrative tasks.

Sebro further explained that developers working on an unincorporated project face potential risk and legal exposure. For example, if a project intends to organize a conference they may have to sign a contract with a venue. Since an unincorporated project cannot sign contracts, one of the developers would have to do so. The person who signed the contract would be on the hook if there were any serious problems, for example if the project had to cancel the conference due to lack of registrations or unforeseen events. Finally, Sebro argued that there's little insulation from corporate influence. An unincorporated project could be taken over by a company quite easily by employing the core developers or by spending significant engineering resources on the project.

Advantages of forming a legal entity

The solution for these problems, according to Sebro, is to provide a corporate home for the project. For most projects, a 501(c)(3) non-profit is the most appropriate structure, he said. 501(c)(3) refers to the US tax code that defines a charity. A 501(c)(3) charity can receive charitable donations on behalf of the project, manage and spend funds according to its mission, and enter into contracts. A non-profit can also provide administrative support, such as bookkeeping, legal services, and technical infrastructure for the project. The non-profit can act as the central place to hold project assets, so there are no uncertainties as to the ownership of trademarks, domain names, and physical assets (such as servers or t-shirts and other merchandise).

Sebro suggested that a non-profit may potentially limit the exposure to risk for individual developers. He cited the US Volunteer Protection Act, which limits the liability of volunteers acting on behalf of a public charity. Sebro noted that developers would have to act under the auspices of the charity in order to benefit from the protection and they cannot be grossly negligent. While Sebro seemed fairly confident that the Volunteer Protection Act would limit the risk for developers, "this has not been tested", he said. However, a non-profit home can certainly protect individual developers from risk associated with contracts, conferences, and similar activities.

Another advantage of a formal structure is that it insulates a project from corporate influence. A 501(c)(3) charity must work toward meeting its charitable mission and must act in the interests of the public. A charity may not tailor their activities toward one or more individuals or corporations. Furthermore, while corporations can make donations, they cannot dictate how their donations are to be used. Answering a question from the audience, Sebro explained that this is a fine line to draw. He said that a company cannot donate to a non-profit in order to get a specific feature implemented that is of primary interest to the company, as that would provide a direct benefit to the company. However, it can certainly make donations so the non-profit can add specific features on its roadmap—even if the company benefits from these features. At this point, Sebro briefly explained the difference between 501(c)(3) organizations, like Software in the Public Interest or Software Freedom Conservancy, and 501(c)(6) organizations, like the Linux Foundation and the Eclipse Foundation. While the former is a charity which has to act in the interest of the public, the latter is a trade association—companies working together to further a common goal. According to Sebro, a 501(c)(6) insulates the group from imbalanced corporate influence, as the organization has to balance the interests of competing members.

(Don't) do it yourself

Having explained the advantages of incorporating as a 501(c)(3) organization, Sebro explained different ways that projects can go about obtaining the benefits of such a structure. The one that may seem most obvious is to create your own. The process in the US would be to create a corporate and governance structure, such as officers and a board of directors, and to incorporate at the state level. The tricky part, however, is to attain 501(c)(3) status, which is required so that donors get tax deductions for their contributions. Unfortunately, new applications for 501(c)(3) undergo close scrutiny where the mission involves free and open source software, he said. Any newly formed FOSS organization will be handicapped, according to Sebro, as it will be difficult to obtain 501(c)(3) status.

A new organization would also have to answer many questions regarding its service plan: would it handle bookkeeping and legal services in-house or via a third party, and most importantly, does it have enough funding to cover that overhead? Summarizing pros and cons, Sebro said that the organization would benefit from the single brand and complete autonomy that comes from having its own non-profit. However, it comes with significant drawbacks—high overhead, a lack of clarity about who is actually going to do the work and provide the required business and legal skills, and the major uncertainty regarding attaining 501(c)(3) status.

The alternative solution is to create a relationship with an existing FOSS foundation that can act as a fiscal sponsor. It's important to note that a fiscal sponsor does not sponsor a project through monetary contributions. Its function is to provide a legal structure and environment in which projects can operate and raise funds. Many fiscal sponsors also offer a range of services to projects, typically for a fee or by taking a certain percentage from a project's donations. Sebro's talk explained two types of fiscal sponsors: comprehensive fiscal sponsors and grantor/grantee fiscal sponsors.

Comprehensive fiscal sponsors

When a project joins a comprehensive fiscal sponsor, they sign a fiscal sponsorship agreement (FSA) and become fully integrated into the sponsor—in a sense, it's like a merger and acquisition in which the fiscal sponsor takes over the open source project. The fiscal sponsor supervises the project to ensure that it follows rules of the IRS (Internal Revenue Service, the US tax agency) and is in compliance with the mission of the fiscal sponsor (which is broadly defined to encompass many projects). In the case of Software Freedom Conservancy, technical decisions and questions of infrastructure are decided by the project. The Apache Software Foundation (ASF), on the other hand, dictates parts of the development process (the Apache Way). In return for joining a comprehensive fiscal sponsor, projects will benefit from the service portfolio offered by the organization. This can include legal services, bookkeeping, conference organization, and more. Software Freedom Conservancy, for example, offers a service plan from which members can choose à la carte. Furthermore, developers are shielded from risk because they are acting as volunteers for the non-profit.

There are a number of advantages of this type of structure: overhead is shared, the fiscal sponsor has 501(c)(3) status already, and it is likely to have a lot of experience running a non-profit so it can offer reliable services and solid advice. A drawback is a certain loss of autonomy: since a fiscal sponsor is responsible for several projects, they are likely to be more conservative than a single project may be on its own. Another risk is that pooled resources imply pooled risk: if member A owes funds, would the assets of members B and C be at risk? Sebro cited the Charitable Trust Doctrine which says that donations have to be spent for the declared charitable purposes under which the donations were solicited. Spending member B's resources to pay for debts caused by member A may be in conflict with this doctrine, which could therefore provide some protection. Sebro mentioned a case that held "New York's long-standing policy honoring donors' restrictions on the use of the property they donate has greater weight than the claims of creditors." While there is some uncertainty in this area, Sebro argued that the best way to manage this problem is through good governance.

Grantor/grantee fiscal sponsors

An alternative arrangement is for projects to enter into a grantor/grantee relationship with a fiscal sponsor. This model is more lightweight: projects don't join the fiscal sponsor but remain autonomous. Sponsors can receive and manage funds on behalf of the project and provide these funds to the project in form of a grant. The sponsoring organization has a duty to ensure that the funds are spent in an appropriate way. In a sense, the fiscal sponsor acts as a bank for the project, but it can also offer a range of services to projects. Software in the Public Interest (SPI) follows this model.

This structure also allows the sharing of overhead burden and provides administrative functions to the project. While the project can stay autonomous, it won't benefit from potential risk protection at it would have if the work was done under the umbrella of a non-profit. The project and organization also have to be careful that grants are spent according to the purpose of the grant. If a fiscal sponsor takes money and gives it to a project without supervision on how it is being spent, it may run into problems with the IRS.

Advantages for developers and corporations

Sebro summarized the advantages of joining an existing non-profit foundation: it's a shortcut to benefit from 501(c)(3) status, there are economies of scale and lower administrative costs, and the administration can be outsourced to people who have experience running a non-profit organization.

In addition to these direct benefits, projects may also find it easier to obtain funding and other contributions from companies. Compared to an unincorporated entity, a 501(c)(3) fiscal sponsor provides better governance, better structure, and mentorship. In other words, it provides stability to an open source project, which is something corporations are seeking before they invest in a project. Non-profits also provide a neutral territory: a company is not able to control how the project is operating but neither can its competitors. However, corporations can still "vote" by allocating employee time: if a project has different sub-projects or tasks, it can decide which areas to focus on.

Role and sustainability of fiscal sponsors

Sebro explained that there are different roles that fiscal sponsors can play for projects. He asked whether a fiscal sponsor should be seen as a playpen, an apartment, or a nursing home. In fact, these roles are not mutually exclusive and a fiscal sponsor can play all of them. In the playpen role, the fiscal sponsor essentially provides an environment for incubation until a project reaches a certain maturity and decides to go its own way. Sebro cited former Conservancy member jQuery which decided to form its own trade association. Many projects view a fiscal sponsor as an apartment—a long term living solution. Sebro mentioned that a comprehensive fiscal sponsor could hire staff for a specific project, although Conservancy is far away from being able to do that. Finally, a nursing home, or mausoleum, can provide a home for projects that are essentially dying off. There is some value in that context as the copyright and other assets can be assigned to the fiscal sponsor. This makes it easier to the revive the project or relicense its code in the future.

Finally, Sebro raised the question of sustainability. Fiscal sponsors usually take a cut from donations to member projects in order to fund their operations (Conservancy: 10%; SPI: 5%). In the case of Conservancy, this is not sufficient to cover its operations and it relies on donations to the general fund from corporations and individuals. Sebro mentioned examples from other areas (e.g. the arts) where fiscal sponsors have achieved a sustainable model, but many FOSS fiscal sponsors still have a long way to go in that respect.