Non-Profits and the Rules of Business

There are many well-meaning people who want to start a non-profit.  From my experience speaking with clients and potential clients, these non-profit start-ups are the result of a passion for a cause, to honor a lost family member or friend and many other worthy causes.  However, for any first time non-profit entrepreneurs, the reality of running a non-profit can sometimes come with surprises and unintended consequences.

Many of the basic rules of business apply to non-profits and, no matter how worthy the intent of the organization, a non-profit must manage many of the same issues around which a for-profit small business must navigate; however, non-profits have more restrictions.

  • Formation and Taxes.  A non-profit is still a business.  It must be properly formed, it must register for a business license and, in many cases, it will still pay taxes.  While non-profits are exempt from most income taxes (assuming they are formed correctly and obtain the proper exemptions), they still must pay sales taxes, employment taxes, etc.  Keep in mind that just because you form a non-profit organization in the state in which the organization will operate does not mean that the organization is a 501(c)(3) under the Internal Revenue Code.  Those are two very different issues.
  • Ownership and Control.  Nobody owns a non-profit.  These organizations are formed for the benefit of the public so, essentially, the public owns them.  In many cases, non-profits are required to have a board which is vested with the authority to manage the organization.  If the founding executive director loses the backing of the board, he or she can be removed.  Many former small business owners or corporate folks have a difficult time changing to this mindset.
  • Risk.  A non-profit is subject to the same risks as any other small business.  That is, it can be sued just like any other business and litigation costs or a judgment easily consume all of the capital available.  If the non-profit has employees, it will be subject to the same employment laws as any other small business.   The best way to control these risks is to (a) run the operation professionally like a small business and (b) get good insurance.
  • Funding.  In some ways, funding is easier than in the for-profit world and in many ways it is more difficult.  Non-profits, if they are set up correctly, can receive donations and, therefore, do not need a business with a revenue source (although many non-profits do have a separate revenue source via a retail store or gift shop or other such operation).  However, there is much competition for charitable donations, especially in an economic downturn, and it is very difficult to obtain a loan.  And, because non-profits are not privately owned organizations, they cannot sell stock or other ownership interests.  Moreover, if a non-profit does seek and obtain 501(c)(3) status, for example, it subjects itself to all of the limitations that are built in to the Internal Revenue Code (which are beyond the scope of this article.

Forming a non-profit is often a noble exercise which, if done properly, can be used as a vehicle to help people and improve society in many ways.  However, the founders must be realistic with their expectations and understand that, in many ways, the experience comes with most of the problems and risks commonly associated with a small business start-up (and some additional risks and restrictions).