How Is a Nonprofit Different From a For-Profit Business?
Getting Beyond the Myths
It's astonishing that one of the most frequent questions about forming a nonprofit comes from business owners who wonder if, since their business is not profitable, they can turn it into a nonprofit.
The term "nonprofit" leads to a vast misunderstanding of what charitable organizations do and the role they play in our society. It's not about having or not having a profit.
What makes an organization a nonprofit has to do with purpose, ownership, and public support. Charitable nonprofits typically have these elements:
- a mission that focuses on activities that benefit society and whose goal is not primarily for profit
- public ownership where no person owns shares of the corporation or interests in its property
- income that must never be distributed to any owners but is recycled back into the nonprofit corporation's public benefit mission and activities.
In contrast, a for-profit business seeks to generate income for its founders and employees. Profits, made by sales of products or services, measure the success of for-profit companies and those profits can be shared with owners, employees, and shareholders.
For-profit businesses can be either privately held or publicly traded. The latter sell stock and must abide by special rules to protect shareholders.
There are many types of nonprofits ranging from your local credit union to the Chamber of Commerce in your city. Some nonprofits depend on membership fees and sales of specific services or products. They all have IRS numbers starting with 501(c). Charitable nonprofits are designated as 501(c)(3) organizations, and there are about one million of them in the US.
Most 501(c)(3) nonprofits provide a service, but some are foundations that make grants to other nonprofits to help them pursue their missions.
The typical charitable nonprofit depends primarily on donations, grants, and mission-related earned income to fund its socially oriented activities. They are always public organizations and can be incorporated or exist as unincorporated nonprofit associations.
The workforces of nonprofits and for-profit organizations also look different. Businesses employ paid staff, while nonprofits may have a workforce made up of both paid staff and volunteers. In fact, in many nonprofits, volunteers outnumber paid employees.
Can you imagine your local Walmart inviting volunteers to come work in their stores? But that's precisely what charities do, and people respond in droves. That's because charities commit to doing socially beneficial work that everyone benefits from. To be able to serve the community, charities put most of their income into those services. Volunteers help them do that since they don't have to pay people for doing many jobs.
Nevertheless, the modern charity must employ some professionals to work full or part-time to keep the place running. They typically have a professional leader, fundraising and marketing staff, business staff such as an accountant, and highly trained people to carry out programs, such as education, health services, and therapeutic services.
Nonprofits may be exempt from many federal, state and local taxes when they become 501(c)(3) charitable organizations.
In recent years, some hybrid business organizations have appeared that blur the line between for-profit and nonprofit. Examples include B Corporations and businesses that have a social purpose.
Traditional Charitable Nonprofit Organizations Share These 4 Characteristics
Many people think that nonprofit means that the organization cannot make a profit. That is a myth. To survive, nonprofit organizations, just like businesses, must make sure that the organization's revenues exceed its expenses.
But, instead of seeking profit for profit's sake, nonprofits pursue public benefit purposes recognized under federal and state law.
A nonprofit organization is owned by the public. It belongs to no private person, and no one person controls the organization.
The assets of a nonprofit are irrevocably dedicated to the charitable, educational, literary, scientific, or religious purposes of the organization.
The cash, equipment and other property of a nonprofit cannot be given to anyone or used for anyone's private benefit without fair market compensation to the nonprofit organization.
In fact, a nonprofit's property is permanently dedicated to exempt purposes. When and if the organization dissolves, any remaining assets after debts and liabilities are satisfied, must go to another nonprofit organization—not to members of the former nonprofit or any other private individual.
Control of a nonprofit lies with a governing board of directors or trustees. The responsibility of that board is to see that the organization fulfills its purpose. Board members do not act as individuals but must serve as a group.
No one can be guaranteed permanent tenure on a board, and the board can, if necessary, fire an executive or remove board members.
This means that no one, not even the founder of the organization, can control a nonprofit. In some states, such as California, there are rules governing the pay of directors of nonprofits. Most nonprofit boards of directors are not compensated, except for expenses such as travel to and from board meetings.
Nonprofit organizations are accountable to the public and must file annual information returns with the federal and state governments.
IRS Form 990 must be made available to the public. Most nonprofits make them available at their headquarters and on their websites. The tax forms are also easily obtained through services such as Guidestar.
At the state level, nonprofits are usually overseen by the State's Attorney General's Office. That office commonly has the power to take a nonprofit corporation to court to make sure it complies with the law.