If you’re considering forming a nonprofit organization, then you’ve come to the right place. At this point, you’ve decided that you want to form a business and you probably know what objectives and values your business will embody. Now the big question: does your startup vision align more with a nonprofit structure or a for-profit structure? Let’s dive in.
Cons: A nonprofit starts out like all other businesses, in that the entity must be formed before the 503(c)(3) or 501(c)(6) tax exemption process begins. Nonprofits are usually formed as a corporation first and then move to the Form 1023 or 1023 EZ stage (see section 2 of our nonprofit formation resource here).
That said, make sure you’re prepared for the lengthy and intensive road to nonprofit formation. A typical Form 1023 application package consists of 50-100 pages of materials and can take over 100 hours to prepare. The application fee itself can be costly.
Additionally, filing Form 1023 is only one part of the process! In California, and many other states, newly minted nonprofits must also register with the state Attorney General’s office and the Franchise Tax Board after receiving their tax-exempt determination letter.
Pros: If you decide to move ahead, reach out to your lawyer peeps so they can help you with the paperwork!
Cons: Nonprofits do not have shareholders, like normal corporations, so they are not owned by anyone. Thus, it can be a little risky as the founder of the nonprofit because you basically don’t have as much control as with a for-profit entity.
Pros: Because the nonprofit is governed by an all- or a mostly-volunteer board of directors (more of nonprofit boards of directors here) who are tasked with steering the nonprofit toward its charitable purpose, you essentially have a team of super-volunteers to help spread the organization’s mission and purpose.
Cons: None! *You may commence happy dancing now.*
Pros: Regarding taxes, there are nothing but pros for nonprofits. By their nature, nonprofits are tax exempt, meaning that all taxes on revenue, property, income, etc. are not taxed by the government. In addition, all donors who help support the nonprofit can claim their donation on personal tax returns and get some potential tax breaks. In this way, it is a double tax benefit.
Cons: As a counterpart to the enormous tax benefit for nonprofits, there are some substantial limitations on the activities that nonprofits can engage in. Limitations apply to revenue and marketing (see below), as well. For more detail on the limitations nonprofits have regarding lobbying, see our article here.
Pros: The opportunity to create change and do good in your community!
Cons: Nonprofits commonly get revenue from the following sources: donations, private and governmental grants, and even product or service income. You may be thinking: “Great! That’s a lot of ways to get cash!” However, there are some important regulations placed on nonprofits by the IRS.
For example, any product or service sold must be directly related to the nonprofit’s “charitable purpose”. Any revenue “unrelated” to that charitable purpose may be subject to taxation and penalties from the IRS (a.k.a. unrelated business income tax, or “UBIT”, which is explained more in our article here).
Regarding donations, it can be tough to earn this sort of revenue because, in many ways, your organization is more subject to the whims of the public than a for-profit business. Why? Because donors aren’t really getting anything tangible (usually) for their money. Grants, though, can be a great source of “free” money, but they are often hard to obtain because of competition and lack of significant funding.
Pros: If your mission is compelling, and you have a strong funding strategy in place, people will give your organization money!
Note for 1023 EZ applicants: If you are thinking that you want to go for the EZ application (because, you know, it’s less costly and time-consuming!), just be cautious that there is an annual revenue cap of $50,000 for the first 3 years of operation. So, if there’s even a slight chance that your nonprofit will make more than that, then you should do the regular form.
Pros: In today’s marketplace, the average consumer is typically receptive to socially-conscious businesses, which is great news for nonprofits. Being a nonprofit can attract consumers who want to feel good about where they spend their money. For more on the ins and outs of “cause marketing”, see our article here.
Cons: However, often nonprofits aren’t selling anything. So, what then? You can’t go around marketing nothing! This is where creativity and great storytelling comes into play because you are selling your cause. You are selling the idea or the mission that your nonprofit was born to address, which can be challenging.
Checklist: The Best Fit For Your Startup
The objective is to find a business structure that will work for your startup. To get a snapshot of what might be the right route, let’s run through the following checklist:
- Will you be able to satisfy the Public Support test? This test essentially requires that at least 1/3 of your organization’s financial support come from the general public, and not from a few private sources (note: if you envision your organization’s financial support coming from a single, or a few, private sources, see our article here).
- Do you have a clear purpose and mission? If so, write it down in less than 25 words; if not, figure out the organization’s purpose before you proceed.
- How will you achieve your purpose and mission?
- Is there currently a similar, local organization? If so, you can volunteer with the organization to ensure you enjoy the work or consider approaching them to be the fiscal sponsor (more on this here) of your cause.
- Is there a need for your purpose and mission? A “needs analysis” asks whether your organization’s mission and purpose align with a need in your specific community.
- Have you finished a business plan? If not, create a business plan. The process of putting pen to paper allows you to think more clearly, solidify your mission, plan for the next steps, and recognize obstacles.
- How much will it cost? How will you fund the organization?
- Will you be able to generate more revenue than your operating costs?
- Who will be on the Board of Directors (here is some guidance on this process)?
- Who will manage the day-to-day operations?
Wrapping It Up
As you can see, there’s a lot to consider! In the end, it is up to what aligns best with your startup’s mission and goals. There are many pros and cons to forming your startup as a nonprofit, so feel free to reach out!
Revised by: Zachary Avina – 03/07/18
- Nonprofit FAQs – Getting To Tax-Exemption
- Should My Business Be an LLC or a Corporation?
- Can My Nonprofit Charge Fees?
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