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Should Your Social Entrepreneurial Idea be a Business or a Nonprofit?

Plenty of social entrepreneurs are looking to 2010 as the year to launch their own business. The desire to take control of the future while doing good has a strong pull - the only question left is whether the startup should be a nonprofit or a for-profit entity.

There is a common misunderstanding that any business can be registered as a nonprofit and thus be eligible to avoid federal taxes (and qualify for grant funding) as long as the profits are used for charitable purposes. This is incorrect. Section 501(c)(3) of the IRS code restricts tax-exemption to businesses whose primary activities are directly related to one of the stated purposes under the code. Thus, a typical plumbing business will not qualify as a nonprofit even if every penny of profit goes to charity. However, if the plan is to collect contributions from the public, apply for grants, and provide plumbing services to the needy at a greatly reduced (or no) cost, you may be able to develop a business plan that will qualify to be exempt.

The primary benefit of qualifying for 501(c)(3) status is that it encourages the public to contribute to the organization by allowing them to deduct their contributions from their own income taxes. Thus, if your business idea won't need to collect donations from the public to operate, there is little advantage to organizing as a nonprofit. The exemption from federal taxation is good, as well, but a for-profit LLC isn't subject to federal taxes either. In either case, the money that you personally take home is taxed as regular income, whether it is a stipend or salary from a nonprofit or profits from a for-profit LLC. Therefore, there is no personal financial incentive to organize as a nonprofit corporation.

Some social entrepreneurs hope that by organizing as a nonprofit they will be able to secure plenty of grant funding to launch and run their business idea. While it is true that there is far more grant money available for nonprofit organizations than for-profit businesses, it is not as easy to secure as you might think. With over 1.5 million nonprofits operating currently in the US, and more launched every day, grant funding is spread quite thin. In addition, nonprofit grants rarely fund entire operations or startup expenses. Grants are a critical part of running a nonprofit, but they are not a legitimate argument for choosing nonprofit status over a for-profit business.

Launching either type of business requires a lot of work, but managing a growing nonprofit requires extra attention to maintain its exempt status. In addition, once the nonprofit is organized, it is no longer yours. Nonprofit corporations are owned by the public and exist for the public good. Your role will likely be as a board member or executive director (the highest ranking paid position), but at the end of the day the full board of directors is responsible for all decisions of the organization. Nonprofits are also relatively restricted in their ability to change direction if and when the need arises.

The bottom line in deciding between for-profit and nonprofit organization is the type of business you are planning to launch. In most cases, the right answer is obvious. If your idea can be run as a for-profit business, it most likely should be. Nonprofit organizations are intended, by design, to fill some societal need that is unmet by the government and private industry. Thus, legitimate nonprofit ideas are generally those that clearly need public contributions and/or grant money to function successfully.

About the Author

LaunchX.com is dedicated to training entrepreneurs to turn their good ideas into great companies. The LaunchX System provides step-by-step education in the mindset and skill set entrepreneurs need to succeed. Our program includes intensive seminar training, key business software, and specialized workbooks that teach you the fundamental skills you need to achieve your financial and worklife goals through entrepreneurship. Register today for our introductory course and see what LaunchX can do for you!