Advice for Forming Private Foundations

Advisers who are working with hedge fund principals to form a private foundation have several issues to consider. Private foundations are superior to other donor-advised funds and other charitable structures because they offer a broader range of investments.

One of the major issues is whether fund principals invest in their own funds. A principal is considered a disqualified person with respect to his foundation and this may indicate that the fund itself is a disqualified person. Self-dealing is an issue that comes up often and it is broadly defined in the code, so an investment by the foundation into the principal’s fund would be considered self-dealing. You can avoid self-dealing by waiving fees for charitable organizations and being aware of the rules that govern ownership and suitable investments.

Before forming a fund, fund principals should be advised of the restrictions that the IRS imposes on the operation of the foundation. The foundation has to make “qualifying distributions” of at least 5% of its worth every year. Notably, a donation from one private foundation to another is not a qualifying distribution.

Principals also have to decide whether to provide publicity or privacy. If the foundation favors privacy, then principals can form around that desire and remain more anonymous.

Private foundations can be a great way to integrate family members into charity, but be sure that if you’re compensating them, the compensation is reasonable to avoid any self-dealing claims.

See Stephen Liss and Evan Jehle, Foundations for Fund Principals, Financial Advisor, Mar. 2012. 

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.