How To Conduct Due Diligence Research on Nonprofits

Do I Let Due Diligence Sway My Decisions?

Nope. I do my due diligence but the last few nonprofits I volunteered for (or donated to) would not get a passing grade. In fact, I ended up writing their GuideStar copy and bringing them to the Gold Level of Transparency.

What’s most important is what service are they providing and is it relevant to the needs of the community? Usually nonprofits are great at providing services and not so much at filling out paperwork.

I look to see who is supporting them and if their financials make sense. I don’t dwell on the percentages of administration costs to program costs for several reasons:

  • Nonprofits are notoriously bad at figuring out the percentages of program, administrative, and fundraising expenses.
  • Their accountants aren’t that much better at it.
  • Those percentages come from divvying up line-item costs and are best-guess scenarios anyway.
  • Nonprofits need to support their infrastructure and staff.

Most of my due diligence is conducted on GuideStar, which asks you to register on their site and limits the amount of free searches you can make. I also consult ProPublica’s Nonprofit Explorer and Grantmakers.

What Is Due Diligence?

“Due diligence” is the term used for conducting research on nonprofit agencies. There are many reasons to conduct due diligence, for example, a foundation will research nonprofits to see whether or not they qualify for funding.

Nonprofits can update their GuideStar profiles to include everything a funder might want to see, including

  • IRS Determination Letter
  • Local and state registrations
  • Tax returns
  • Annual reports
  • Program descriptions
  • Target Population
  • Locations served
  • Accomplishments
  • GuideStar’s “Charting Impact” questions

How I Conduct Due Diligence As A Volunteer and A Donor​

Here’s what I check on a nonprofit’s GuideStar page before I choose to volunteer or donate. These are just the things I look for; others may look at different things.

  • Have they claimed their GuideStar profile?
  • Have they filled anything out so I can get a good idea of who they are?
  • What level of transparency have they achieved? There are four: Bronze, Silver, Gold, and Platinum.
  • Does the information on their GuideStar profile match the information on their website?
  • Have they uploaded any of their own documents (tax return, auditeds, photos, videos, etc.?
  • What I look for on their tax returns:
    • Did they lose money, and if so, is it a scary amount?
    • Did they also lose money the year prior?
    • Do they appear to be getting grants and donations, or is most of their income from program services? Only getting funded for program services indicates that they are reliant on government funding. More stable organizations will have a fund development program in place to supplement government funding.
    • Did they receive interest on their investments? A small amount of interest shows that they probably do not have a large endowment fund or Board emergency fund (reserve account).
    • Are their relatives on the Board or in positions of responsibility? It’s not a deal-breaker if the agency is new or small and there’s not a lot of money involved. A lot of new nonprofits have no other choice but to recruit friends and relatives so this is just one thing I consider.
    • Who is on their Board? What types of professionals are they attracting to help advance their mission?
    • How much is the E.D./CEO getting paid in relation to their other expenses?
    • Do any of their expenses appear to be out of whack? I researched an agency that had less than $150,000 in income and expenses but paid an accountant $25,000. Sounds like the nonprofit either hired a relative or got scammed.
    • Have they done a decent job filling out the text portions of the tax return?
    • Are they fulfilling the minimum requirements of a 501 (c) 3? (Conflicts of Interest, Whistleblower policies, etc.)
  • Do their programs make sense, given their needs statement and budget?
  • Are they serving low-income, historically disadvantaged and under-served areas or are they only providing services in the more affluent areas? People in affluent areas need help too, but in Los Angeles, where I live, nonprofits are concentrated in the affluent areas. Personally, I’d like to impact and help historically under-served areas.
  • Are they affiliated with other agencies?
  • Have they listed (or received) any awards?

How I use GuideStar as a Job Seeker or Consultant

Here’s what I check a nonprofit’s GuideStar page before I choose to apply for a position or paid consultant. This list will be similar to the volunteer/donor list, with a few differences.

There are some things I can accept as a consultant but not as a potential employee, particularly if they are showing economic fragility. If their Board and senior staff are friends and relatives, it may be difficult for them to accept and implement any new ideas.

Usually new agencies have to recruit friends and relatives for the Board. This doesn’t necessarily mean that it’s a bad agency or that they’re not doing great work. It’s just that working under these conditions would not interest me. It would be a waste of what I can offer and it would be too stifling. Besides, they can hire an administrative assistant for a lot less money!

  • First I look at their tax returns (IRS F990). None of these items are deal breakers but I want to know what the red flags are and then decide.

Please note that a lot of nonprofits operate on a fiscal year, typically running from 7/1 – 6/30, rather than a calendar year. This will affect how they look during the COVID-19 pandemic: nonprofits on a 2019 fiscal year will have experienced the pandemic shutdown during March 2020 – June 30, 2020. On their 2020 tax return they’ll have experienced the pandemic shutdown July 1, 2020 through at least May 2021 if not all the way through June 30, 2021.  Nonprofits on a calendar year will have experienced nine or ten months of the shutdown in 2020 (March through December) and at least six months of the shutdown in 2021 (January through June).

    • Did they lose money, and if so, is it a scary amount?
    • Did they also lose money the year prior?
    • If the answer is yes, I look at the three years prior. You can only get three years’ tax returns on GuideStar. For anything earlier you have to go to Pro Publica’s Nonprofit Explorer.  https://projects.propublica.org/nonprofits/
    • Do they appear to be getting grants and donations, or is most of their income from program services? Not a deal-breaker as a consultant but it could be as an employee, as government funding is not guaranteed over the long run.
    • Did they receive interest on their investments? A small amount of interest shows that they probably do not have a large endowment fund or Board reserve.
    • Are their relatives on the Board or in positions of responsibility? It’s not necessarily a deal-breaker as a consultant but it definitely is as an employee. It’s possible that you may be comfortable with their answers during the interview process, but if they’re losing money, be sure to ask questions that can reveal a dedication to a dysfunctional status quo.
    • Who is on their Board? What types of professionals are they attracting?
    • How much is the E.D./CEO getting paid in relation to the other employees? Their other expenses?
    • Have they done a decent job filling out the text portions of the tax return?
    • Are they fulfilling the minimum requirements of a 501 (c) 3? (Conflicts of Interest, Whistleblower policies, etc.)
    • Their Statement of Functional Expenses: I don’t look at the Program vs Administration vs Fundraising expenses too closely because a lot of smaller nonprofits don’t know how to fill that out correctly. I look at the salaries, volunteer services, how much they’re spending on transportation (is the agency buying cars for the staff?) and those types of things. I also check to see if there’s a lot of money listed under “Miscellaneous,” because if it’s too high, I wonder why they’re not describing their expenses under their line item expenses.
  • Then I look at their audited financial statements (FS).
    • Does their FS agree with their tax return?
    • Does the independent auditor clearly state they are following “Generally Accepted Accounting Principles” (GAAP)?
    • Does the auditor make any negative statements? If so, do the issues appear to be minor?
    • Do they show a healthy amount of volunteer hours, including professional volunteers?
    • Is their Board providing professional services on a pro bono basis?
    • Are they getting a healthy amount of in-kind gifts?
  • If their programs make sense, given the need, do they appear to be qualified to operate these programs?
  • Are they affiliated with other agencies?
  • Have they listed (or received) any awards or community recognition?