Why structured due diligence matters
Major gifts — whether $10,000, $100,000, or a multi-year pledge — move an organization’s strategy and often its finances. A structured due-diligence process protects both donor intent and public benefit. Done well, it increases the odds your gift achieves measurable outcomes, reduces reputational and legal risk, and creates a clear paper trail for tax and governance purposes.
This article gives a repeatable process, practical checklists, red flags, and sample language you can use when evaluating a nonprofit. In my practice advising philanthropists and family foundations, I focus on three priorities: mission alignment, financial sustainability, and verifiable impact.
Quick due-diligence checklist (one-page)
- Confirm tax status and basic registrations (IRS tax-exempt status, state charity registration).
- Review the most recent 2–3 years of Form 990s and audited financial statements. (See Form 990 glossary for details.)
- Ask for recent program evaluations, outcome metrics, and logic models.
- Examine board composition, bylaws, and conflict-of-interest policies.
- Visit operations or meet program staff and beneficiaries where feasible.
- Request a draft gift agreement that defines use, reporting cadence, and termination conditions.
- Identify potential restricted-gift issues (naming rights, endowment vs expendable, program reporting).
Step-by-step due-diligence process
- Confirm legal and tax standing
- Verify 501(c)(3) or other tax-exempt designation on the IRS Exempt Organizations Select Check or IRS website (IRS: Charities & Nonprofits). Confirm the organization is in good standing with your state attorney general’s charitable division. If the nonprofit is a private foundation or uses a donor-advised fund, the implications for tax treatment and administration differ (see our donor-advised funds article).
- Financial review
- Primary documents: Form 990, audited financial statements (if available), management letter, and current-year budget.
- What to watch for on Form 990: trends in contributed revenue, program-service revenue, fundraising expenses, and cash reserves. Look for irregular or unexplained related-party transactions and significant changes in executive compensation. (See finhelp.io glossary on Form 990.)
- Ratios and benchmarks: program expense ratio, fundraising efficiency (fundraising cost per dollar raised), and months of operating reserves. There’s no universal cutoff; context matters. A high fundraising ratio during a capital campaign or start-up phase may be appropriate.
- Program effectiveness and measurement
- Request clear, recent program outputs (what they do) and outcomes (what changes because of their work). Good evidence includes randomized trials, third-party evaluations, pre/post measures, or longitudinal tracking.
- Ask for their theory of change or logic model and the specific indicators they track. Where possible, confirm results with third-party data, partner organizations, or publicly available metrics.
- Governance, leadership, and policies
- Board: size, diversity of backgrounds, meeting frequency, and evidence of active oversight. Well-governed organizations have documented policies: conflict-of-interest, whistleblower, document-retention, and CEO performance review processes.
- Leadership stability: frequent executive turnover can be a red flag. On the other hand, well-managed transitions with clear succession planning are a sign of maturity.
- Transparency and public accountability
- Check whether annual reports, audited statements, Form 990s, and program evaluations are easy to find on the nonprofit’s website. Transparency is a proxy for accountability.
- Cross-check independent ratings and summaries from Charity Navigator, Candid/GuideStar, or the Better Business Bureau Wise Giving Alliance.
- Site visits and stakeholder interviews
- Visit program sites when feasible. Observe how services are delivered and ask to meet frontline staff and program participants. Direct observation often reveals implementation details that papers hide.
- Interview peers, referral partners, and a small sample of beneficiaries to triangulate claims about impact.
- Gift structuring and legal safeguards
- Draft a gift agreement that covers: purpose of funds (restricted or unrestricted), reporting schedule, performance metrics tied to milestone payments (if any), reversion clauses if the program ends, timeline for use, and naming-rights conditions.
- Consider phased funding tied to agreed milestones and independent verification. For very large gifts, include dispute-resolution language and a clear termination or reallocation plan.
- Understand tax implications: unrestricted gifts are simplest for the nonprofit; restricted gifts create donor conditions that the nonprofit must legally honor. Consult your tax advisor for personal tax treatment of large charitable contributions.
- Post-gift reporting and governance
- Require periodic financial and program reports appropriate to gift size (e.g., quarterly narrative and annual audited statement for large multi-year gifts).
- Encourage or require a stewardship plan that details public acknowledgement, communications, and measurable outcomes.
Red flags that deserve follow-up
- Repeated inability or refusal to share audited financials or Form 990s.
- Large, unexplained related-party transactions or unusually high executive compensation without documented justification.
- Program claims with no measurable indicators or evidence of impact.
- Rapid revenue spikes without corresponding program capacity increases.
- Lack of basic policies (conflict of interest, whistleblower, document retention).
If you encounter these, ask direct questions and request supporting documentation. If responses are unsatisfactory, consider redirecting funds to organizations with clearer governance and demonstrated outcomes.
Sample questions to ask staff or board members
- How do you measure program success, and can you share the most recent data?
- What percent of your budget is covered by recurring vs one-time funds?
- How do you prioritize restricted gifts when multiple donors request use for different programs?
- Can you describe a recent program change driven by outcome data?
- May I review your latest audit and management letter?
Special considerations: donor-advised funds and private foundations
- Donor-advised funds (DAFs) offer convenience and tax advantages, but the sponsoring organization legally controls grants. If you plan to recommend grants through a DAF, confirm the sponsoring organization’s grantmaking policies and reporting expectations (see our donor-advised funds resource).
- Private foundations require different compliance and reporting (e.g., Form 990-PF). They also require a minimum distribution and have different excise taxes and self-dealing rules. Get counsel when using or recommending private foundations for major gifts.
Examples and practical outcomes
- In one client engagement, reviewing three years of Form 990s and the audited statements revealed repeated one-time grants counted as recurring revenue. We structured a multi-year pledge paid in tranches pending achievement of enrollment and retention targets; this reduced risk and aligned incentives.
- Another case showed strong program outcomes but weak internal controls. The donor recommended a modest capacity-building grant tied to strengthening financial operations before committing to program expansion funding.
Time and resource expectations
- A baseline review (Form 990, website materials, brief interview) can take 3–6 hours. A full review with site visits, third-party validation, and legal review typically takes 20–40+ hours depending on complexity.
- Use expert advisors for large gifts — philanthropic consultants, nonprofit CPAs, or attorneys familiar with charitable law provide efficient, targeted review.
Documentation and recordkeeping
Maintain a folder with: the gift agreement, Form 990 copies, audited statements, board minutes relating to acceptance (if applicable), and periodic reports. Good recordkeeping supports stewardship and makes future grant decisions easier.
Final considerations and professional disclaimer
Due diligence is both practical and relational. The goal is not to impose burdensome bureaucracy on nonprofits but to ensure transparency, alignment of incentives, and measurable impact. In my experience, donors who combine financial review with program visits and contractual clarity get the best results.
This article is educational and not legal or tax advice. For transaction-specific guidance, consult a qualified tax advisor, attorney, or philanthropic advisor. Authoritative resources: IRS Charities & Nonprofits (https://www.irs.gov/charities-non-profits), National Philanthropic Trust insights, and Candid/GuideStar and Charity Navigator evaluation tools.
Further reading: review Form 990 details on our site and learn more about donor-advised funds and grant effectiveness:
- Form 990 glossary: https://finhelp.io/glossary/form-990-return-of-organization-exempt-from-income-tax/
- Donor-advised funds overview: https://finhelp.io/glossary/donor-advised-funds-flexible-philanthropy-explained/
- Making impactful grants: https://finhelp.io/glossary/making-impactful-grants-how-to-evaluate-nonprofit-effectiveness/
