When the founder or longtime executive of a nonprofit leaves an organization, the board often grapples with how to say goodbye and thank you. This question is loaded with complexities— feelings and relationships come into play, as do financial, legal, and reputational risks and rewards. There is a range of motivations for considering an exit agreement, some quite compelling. The executive, for instance, may seek a financial acknowledgment that he or she has skillfully led the organization over a long tenure—and maybe for a salary well below market rate. Still, actions that might have strong support within the board and meet the needs and expectations of the executive might not play well with the IRS, a state attorney general, or in the court of public opinion.
This article is intended to offer readers a context and a set of choices in considering whether an exit agreement is needed and, if so, what might be included. Because this is a relatively new area of exploration for the sector, each situation brings unique features, and broad generalizations aren’t possible. What we offer here is a framework for:
Whatever elements you end up putting in your exit agreement, we must stress the importance of seeking legal review of any draft exit agreement by an attorney who is licensed in the state where your nonprofit is located and also well versed in nonprofit law and IRS regulations. As you will see below, it is no simple task to construct an agreement that meets the noble goals of the agreement, protects both parties, and conforms to the myriad laws and regulations governing its terms. Professional advice is recommended.
Perspectives on Exit Agreements
Our writing team comes at this article from two perspectives. Two of us are leaders in developing an approach to successful executive transitions for the sector, and one of us is a thought leader in the field of nonprofit risk management, helping boards and executives better understand the consequences of risk taking and the legal and other risks that arise from governance, strategy setting, and operations. An unshakeable tenet of successful executive transitions is the following simple fact: to have a good beginning with a new executive, it is important to have a good ending with the departing executive. Too many transitions become strained because of lack of attention to what comprises a good ending for an executive— particularly a founder or long-tenured leader.
Clients regularly ask us for help in drafting exit agreements with departing executives. (For purposes of this article, we will use “founder,” “CEO,” and “long-tenured executive” interchangeably, to mean an executive who has had a major role in shaping an organization, either in its founding and long tenure or through leadership during a long tenure.) An exit agreement, as discussed in this article, differs in several respects from a separation agreement and release. (For information on the latter type of contract, please see the sidebar on p. 103.) How many departing executives receive an exit agreement and what are the terms are generally unknown. The terms of these agreements are considered confidential, and unless a party to the agreement intentionally or inadvertently violates the confidentiality provisions in a typical agreement, they are not available for inspection. In our experience, only a small percentage of CEO departures are governed by the terms of an exit agreement. The use of exit agreements occurs most often under circumstances that we will describe below. Most are drafted by an attorney working with an executive, a few board leaders, and perhaps an accountant who specializes in nonprofit compensation and law. In some cases, the CEO and the nonprofit retain separate legal counsel during the negotiation of an exit agreement.
The following are the presenting situations where, in our experience, exit agreements are most common:
There are many other ways to say thank you to an executive who has served an organization well. You may conclude that an exit agreement is not appropriate.
Exit Agreements: The Four Types
There are typically four reasons boards and executives explore the possibility of an exit agreement. These reasons correspond to the “type” or focus of an agreement. This section takes the four general types of presenting scenarios for exit agreements and explores each in more depth through case examples. The cases are fictional and represent a random compilation of multiple situations.
Key Considerations in Drafting Exit Agreements
As intimated in the prior description of the four common reasons for negotiating an exit agreement, there is no doubt that many boards and executives find value in these agreements as elements important to successful CEO transitions. There are, however, some considerations worth addressing to increase the benefit and positive aspects of an exit agreement while diminishing the potential negatives. In this section, we will explore some of the important issues that should be considered prior to finalizing an exit agreement. After presenting each issue, we offer a series of key questions and tips for reflection.
Examples of Approaches to Exit Agreements
Because exit agreements are confidential, it is difficult to provide many details and examples. The following are examples of exit agreements as reported secondhand from knowledgeable consultants and attorneys. Not every example follows all the guidance above. There is no one, rigid guideline, so there exists a wide range of examples in most communities. The best way to learn more is to request an informational meeting with an attorney or tax accountant who specializes in deferred compensation and/or exit agreements for executives in the nonprofit sector.
Example 1: Catch-up
A long-serving executive worked without pay for a number of years. Her financial situation changed as she approached retirement age. The board increased her salary within the limits of reasonable compensation, provided the maximum retirement benefit allowable under pension law, and agreed to retain her for five years after retirement as a consultant to advise on specific areas where she had expertise.
Example 2: Incentive to Stay Longer
At the request of the board, a long-serving executive agreed to continue to serve until age seventy-three, four years longer than his original retirement plan. The organization’s primary funder had been awarding major contracts through a request-for-proposal (RFP) process every four years. The current RFP process had been delayed twice, thus delaying the executive’s departure. In exchange for these additional years of service, the board agreed to continue to pay health insurance costs and make an annual payment for five years past retirement.
Example 3: Post-Retirement Services
The twenty-year founder of a regional clean water agency dedicated to removing all pollutants from the area’s streams and lakes had grown weary of the fundraising and administrative duties that consumed most of her time. However, her passion for pursuing the agency’s mission was undiminished. She asked to become a half-time lobbyist for her agency in the state legislature. The board agreed to move her into that position, with the stipulation that she would be supervised by her successor. They set her salary at $40,000 per year.
Example 4: Honorific
Aware that their retiring executive and his wife were avid travelers, the board of directors gave him a $5,000 “voucher” for use with the travel agency of his choice, as a departing gift. The board paid for the voucher with funds donated by board members and a few longtime individual donors.
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An exit agreement with a departing nonprofit executive is a tool that can bring clarity to uncertainty about the departing leader’s post-CEO role with the nonprofit. In other cases, an exit agreement can be a tool for providing a catch-up financial contribution that recognizes, in part, the achievements and service of an undercompensated leader. Or, it can be a tool for saying thank you. But whatever the purpose or motivation behind the agreement, there are important considerations that must be examined in order to make certain that the final agreement is fair, appropriate, and legally defensible.
Tom Adams is president and co-founder of Transition- Guides, Inc., a national consulting company specializing in sustainability and succession planning, and executive transition and search services, for leading nonprofit organizations. Tom is the author of The Nonprofit Leadership Transition and Development Guide (Jossey-Bass, 2010); Melanie Lockwood Herman, JD, is executive director of the Nonprofit Risk Management Center. She is the author of more than fifteen books on risk management topics; Tim Wolfred, PsyD, developed the executive transition program of CompassPoint Nonprofit Services, in San Francisco, in 1998, and led it for thirteen years. Tim currently provides search and succession planning services for nonprofits as an independent consultant. His most recent publication is Managing Executive Transitions: A Guide for Nonprofits (Fieldstone Alliance, 2009).
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Squire, Lemkin + Company, LLP is a Rockville, MD accounting firm providing audit, tax, accounting and not-for-profit consulting services to companies across the East Coast. Our firm has expertise in not-for-profit Organizations, Entrepreneurial Businesses, Professional Service Firms, High Net Worth Individuals, Estates and Trusts, Employee Benefit Plans and Individual Tax Returns.
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