Nonprofit organizations get funding from a variety of sources. One of the most common of these is called a “feeder organization.” A feeder organization is a business that is run for the benefit of the members or the constituency of a particular NPO. In this way, it “feeds” into the activity of the main NPO.
Feeder organizations are also limited in the way that they can give money back to their parent NPO. They cannot, for example, give out grants. Instead, they must turn intact funds over to the NPO.[i] Furthermore, feeder organizations must operate in a manner that is secondary to the mission and work of their parent NPO. The IRS uses something called a “primary purpose test”[ii] to assess whether an organization is primary or secondary. Generally, this test means that if a feeder organization makes significant money with a product or service, the parent NPO must either expand to make use of those funds, or the money must be given away to another nonprofit.
Feeder organizations and parent NPOs must have separate financial records, and the transfer of funds from one business to the other must be understandable and transparent. Those who run a feeder business can be volunteers or employees, but members of the parent NPO may not expect reimbursement for work done at a feeder organization.
While running such an organization means a sizeably increased load of paperwork, the potential for creating a source of self-sustained funding can be very appealing. While running a feeder organization cannot eclipse the primary purpose of the mission of an NPO, if legally established, it can be a useful and long-lasting source of revenue.
[i] ” Feeder organizations pay all of their profits to one or more IRC 501 organizations. An organization that directs all of its profits to research and dispenses fellowships to individuals rather than institutions is not a feeder. Edward Orton, Jr. Ceramic Foundation, 56 T.C. 147 (1971).” -- ibid.
[ii] "An organization may engage in extensive business activity and yet its charitable activity may be regarded as meeting the primary purpose test if its program of charitable contributions and grants is reasonably commensurate with its financial resources." -- Ibid.
