Understanding the Financial Risks in Sponsorships and How to Avoid Them

Common financial risks for sponsors

Sponsors can face numerous risks when engaging in a sponsorship deal. Since they are the ones investing money, they are in an unfavorable position if something goes sour. We’ve broken down some of the most important risks for them below. 

1. Brand reputation damage 

Sponsors are at risk of losing their reputation if they partner with problematic nonprofits. For example, if they support events organized by individuals who are politically exposed persons or associated with them.

While PEPs aren’t criminals by default, they are at higher risk of being ones than regular individuals. This is because they can misuse their funds and reputation to launder money, finance terrorism, and conduct other illicit activities. 

You should certainly implement a politically exposed person screening process, as it can help you prevent sponsoring potentially problematic individuals. 

If you happen to sponsor a nonprofit that’s led by individuals who were involved in scandals, mismanagement, or accused of unethical behavior, it will poorly reflect on your reputation, leading to lowered profits and even financial fines due to breaking AML regulations. 

2. Misuse of funds by the nonprofit

Sponsors that entrust their funds to the nonprofits expect that the money will be used transparently and effectively. This isn’t always the case, and sometimes, the nonprofits can exploit the financial support for the financial gain of the leadership. 

When sponsoring an NPO, make sure that they have financial management practices in place. Furthermore, setting milestones and ensuring that they’re using the money as intended is crucial for minimizing the risk of misuse of funds. 

3. Lack of measurable ROI

While there are some sponsors that support NPOs due to pure altruism or sending a message, the majority of them are looking for something in return. The benefits sponsors can have include increased brand visibility, consumer engagement, and positive comments.

However, clear KPIs and performance metrics must be chosen. This way, your business will ensure that the sponsorships benefit both parties. Without understanding the metrics, you’ll be unable to calculate your return on investment. 

4. Ethical misalignment between the sponsor and the nonprofit

A misalignment between the sponsor and the NPO can be a serious problem that could lead to the termination of the sponsorship. While some disagreements are normal, if the NPO breaks certain principles of the sponsor, it could lead to a negative outcome for both.

This can lead to a public backlash, lowering the sponsor’s brand reputation and, potentially, profits. For example, a healthcare company sponsors an event that promotes well-being, yet the majority of vendors there offer fast food and alcoholic beverages. 

The contradiction can be enough for people to turn away and to have lowered trust in your company. To remove this financial risk, it’s best to set clear goals and messages before the sponsorship is made. 

5. Negative public perception

The public can perceive the sponsor’s company as exploitative or misaligned with the brand’s message. This can lead to negativity, and it’s important to communicate the message and the idea behind the sponsorship to the public. 

One way to achieve this is to communicate with the public by holding public lectures and webinars that help bring the vision of the sponsorship closer. 

6. Legal or regulatory issues

Sponsorships can lead to legal or regulatory issues due to unclear agreements or terms. If the terms are unclear, violate local laws, or fail to comply with the advertising standards, it could lead to legal penalties. 

Before the two parties sign any agreements, it’s essential to ensure that the nature of the partnership and the activities they aim to conduct are aligned with local and regional regulations. Legal penalties can negatively impact the brand’s reputation and stock value. 

7. Unexpected financial burdens due to long-term commitments

All long-term commitments are at risk of experiencing financial problems. This can happen due to sponsors changing their direction or due to a market shift. Regardless of the reason, the extra funds that went to NPOs can become a burden on the sponsor’s budget.

One of the most important ways to solve this is to set flexible terms for your partnerships. Sponsors should research how their sponsorships impact their finances in their reports, which allows them to recognize the moment at which it becomes unsustainable. 

Risks for nonprofits (NPOs)

While the NPOs can’t experience lowered profits or other risks associated with the sponsors, they can indeed be harmed. Many of their problems stem from the lack of financial independence and failure to adhere to the regulations.

1. Over-reliance on a single sponsor 

Relying on a single sponsor can be a significant financial problem for NPOs. The market is susceptible to change, which can lead to one sponsor suddenly cutting off all funds. To solve this, it’s best to diversify the sponsorships.

By securing sponsorships in different industries or securing different ones for each event, the NPO will be able to be more independent. Steady sponsorships with multiple partners can significantly minimize various risks and ensure long-term operations. 

2. Restricted funding 

Corporate sponsors often place restrictions on how their funds are used. In some ways, this is completely understandable, yet it can limit the nonprofit's ability to allocate resources freely across different programs and events.

The disruptions of the processes can be avoided by negotiating flexible terms with the sponsors and setting clear terms. Of course, there should be some guarantee that the funds will be used properly, ensuring trust between the parties. 

3. Cash flow instability 

Regardless of the reason, corporate sponsors can be subject to financial problems or delayed payments. This can also lead to NPOs having an insatiable cash flow, which can lead to canceled events, or events that poorly perform.

The solutions for the problems associated with the cash flow include setting clear payment terms and requesting funds in advance. NPOs can also aim to build cash reserves during periods when they don’t organize events. 

4. Ethical and reputation risks from partnering with controversial sponsors

Just like how NPOs can harm the sponsor's reputation, the opposite is true as well. For example, an ecological NPO can partner with a clothing brand that is known for using non-ethical practices. 

NPOs should carefully choose who they receive funds from, as controversial sponsors can cause more harm than good. Even if the money is much needed, it’s best to ensure the longevity of the NPO rather than losing the public’s trust. 

5. Mission drift caused by sponsors influencing nonprofit priorities

Some sponsors can be intrusive to the NPO's message and operations. Although they should always know where their funds are directed, they shouldn’t interfere with the NPO's goals. The impact of the sponsor on the NPO can lead to drifting away from the main message and the initial supporters. 

Mission drift can be prevented by setting the boundaries in the contract about which operations the sponsors are allowed to be involved with. 

6. Hidden costs and administrative burdens

The process of obtaining, managing, and fulfilling the sponsorship can sometimes carry more costs and burdens than initially thought. This can be caused by extra staff time, tracking funds, and reporting to sponsors.

Again, one of the ways to solve this is to have a clear financial plan and calculate additional costs and administrative tasks that should be executed. 

Financial risks in sponsorships need to be carefully observed

Corporate sponsorships are often vital for NPOs. However, the risks that sponsorships carry can sometimes outweigh the advantages. This is why both parties need to understand the potential negative outcomes and recognize problems in time. 

Of course, nothing can guarantee that 100% of potential problems can be removed from the equation. Yet, it’s important for sponsors to understand what they are sponsoring and to set legal boundaries. Likewise, organizations should implement due diligence checks before entering sponsorship agreements.