Common Nonprofit Startup Mistakes

Starting a nonprofit is hard enough without making these mistakes

Men and women sit around a conference table in a nonprofit boardroom
•••

SDI Productions/Getty Images

If you want to solve a social problem by starting a new charitable nonprofit, you may want to carefully think it through. Some may assume that starting a charity will be easy, but it can be a challenge no matter how well-intentioned one might be.

There are approximately 1.5 million registered charities in the U.S., but many fail to thrive, just as with small businesses. There is a lot of competition among nonprofits, as many charities address similar issues and may solicit donations from the same people.

Just having a passion for a cause will not be enough. Nonprofits require just as much foresight and knowledge about running an organization as any for-profit business. Here are a few of the most common mistakes nonprofit founders make. Avoid them, and you may be off to a great start.

Not Understanding the Difference Between Nonprofit and For-Profit

There are many types of nonprofits listed by the IRS under section 501(c). Still, the 501(c)(3) organization (aka "public charity") is what we usually think of when we set out to solve some social problem. Public charities are devoted exclusively to one or more of these specific purposes:

  • Religious
  • Charitable
  • Scientific
  • Testing for public safety
  • Literary
  • Educational
  • Fostering national or international amateur sports competitions.
  • The prevention of cruelty to children or animals.

501(c)(3) organizations receive special treatment from the IRS, such as providing a tax deduction to their donors for their contributions and exemption from federal taxes.

A charitable nonprofit organization is different from a for-profit organization. For example, the primary goal of a business is profit. However, charitable nonprofits pursue a social purpose first, and all income goes to that purpose.

Also, a for-profit business is owned by someone, either a person, a group of people, or shareholders. A charitable nonprofit, on the other hand, belongs to no one person or group. It answers to the public and exists for the common good.

How To Avoid This Mistake

Study other charitable nonprofits, interview their leadership, and review IRS documentation such as Publication 557. Consider consulting an attorney who specializes in nonprofit startups.

Make sure that a charitable nonprofit is the best way to accomplish your purpose. There are other ways to address a cause or solve a social dilemma than starting another nonprofit. You could volunteer at another nonprofit or set up a hybrid business organization such as a B Corporation.

Poor Research and Planning

Even though nonprofits exist for the common good, they share many characteristics of a for-profit business. And, just as businesses have business plans in hand before launching, a nonprofit should develop a plan as well.

A nonprofit business plan should include at a minimum:

  • A competitor evaluation: What other organizations will be offering similar services to similar audiences?
  • Sources of funding: What mix of fundraising, grant seeking, and the sale of products or services will your organization use to fund its activities?
  • Market research: What are the needs of your target population? Where do they live? What are the demographics?

How To Avoid This Mistake

  • Perform a survey of your likely clientele.
  • Consult public records about the area you plan to serve.
  • Talk to other nonprofits about their service areas and populations served to identify areas of potential cooperation or redundancy.
  • List likely donors and foundations that work in your geographical area or that fund causes similar to yours. Grants directories can be useful for this job.

Lack of Financial Knowledge

Another crucial error is having an unrealistic expectation about funding for a startup nonprofit.

Many founders do not anticipate what it will cost to start their nonprofit, much less have any idea of where to get the funds. Costs range from incorporation fees in your state to application fees for Form 1023 and tax-exempt status.

Besides needing startup funds, a charitable nonprofit must develop a fundraising plan that includes donations from individuals, potential foundation grants, and earned income from fees for services or products.

Every nonprofit must develop a basket of income that includes many sources. It is never wise to depend on just one or two revenue streams. Develop as many as possible.

How To Avoid This Mistake

Above all, startup nonprofits must be realistic. It takes time to develop funding sources, so many startups begin with a handful of donors or founders with deep pockets. Loans may be available but only with a solid business plan. Foundations do not usually fund startup nonprofits.

You may not be able to start fundraising from individuals until you receive your 501(c)(3) designation from the IRS. However, existing nonprofits can serve as fiscal sponsors to help you get off the ground. They can provide financial services, help with grants, and guide you through the wait for IRS approval. Fiscal sponsors can also allow you to try out your nonprofit idea before even applying for IRS approval.

Good planning beforehand is the key to a solid start for your nonprofit. Determine where your startup funds will come from and develop a strong fundraising plan that you can put into action quickly.

Thinking It's Easier to Start a Nonprofit Than It Is

It is harder to start a nonprofit than most people think. Incorporating at the state level and then applying for exempt status with the IRS entails numerous steps. Passion is not enough. Hard-nosed realism about what is involved and the time to achieve success will be critical for the long haul.

Raising funds to support a nonprofit also is complex.

While a business sells a product or service that customers choose to buy out of personal or business need, a nonprofit sells an intangible: helping a particular cause, person, or animal.

The gain for donors is also intangible: feeling good about giving, pride in helping, or satisfaction at improving a community.

In addition, a nonprofit must adhere to numerous rules about its operations and fundraising. There are reports to be filed, guidelines to be followed, and several ways to lose one's tax exemption from the IRS. The National Council of Nonprofits calls this "the heavy lifting" once you have gotten approval from the IRS.

How To Avoid This Mistake

Before starting the process of establishing a charitable nonprofit, consider consulting an attorney versed in nonprofit startups. An attorney can help with incorporation and preparing the application for IRS recognition. Nonprofits that use legal advice often find that their application for 501(c)(3) status from the IRS goes through the process more easily and quickly.

Learn as much about fundraising as possible. Identify potential donors and make sure that you have people on your board who have connections with potential donors and are willing to approach those donors. Learn about fundraising in other states that require registration. Do a crash course on what foundations look for in nonprofits to whom they give grants. Check out any potential government grants that might apply to your organization.

Not Building an Effective Board

If there is one thing that could make or break your new nonprofit, it might be not recruiting an adequate board.

Your first board members represent your "circle of influence." They should be people who have resources, influence, and lots of other contacts.

Your board members should believe in your organization's mission and be willing to sell that mission to others.

Decide how many board members you will need. State law may dictate a minimum number of board members under its incorporation rules. Try to avoid an overly large board where it may be difficult to reach an agreement and a minuscule board where you lack diversity or a range of expertise.

Determine whether board members will be paid or serve voluntarily. Typically, charitable nonprofits have unpaid board members. The exceptions might be large institutions such as a hospital or nationally known art gallery.

How To Avoid This Mistake

Educate yourself on what a nonprofit board must do. Their duties range from legally defined fiscal responsibilities to the ability to raise funds from major donors.

You will want board members with a range of expertise as well. Think about what your organization will do and have appropriate people on the board who can serve as informal consultants. Do you need an attorney? A marketing specialist? Someone with contacts in the local government? A tax professional? Do you need educators or health professionals?

Make sure you have a range of ages and that your board is diverse. You'll want a wide range of opinions from people who represent various aspects of your community.

Frequently Asked Questions

How do I earn income while starting a nonprofit organization?

It may take some time to get an income stream going when you start a nonprofit. Before launching, find people interested in your cause and who might be willing to provide initial funding for startup costs.

Those costs include filing for state incorporation and applying to the IRS for tax-exempt status as a 501(c)(3) organization. After incorporating, you will have 27 months to file Form 1023 with the IRS for tax-exempt status. Meanwhile, you may need to use your own funds for some startup expenses. Keep overhead low with as little infrastructure as possible and use volunteers rather than paid staff if possible.

If your financial plan includes charging a fee for services or selling a product, you may begin doing so once you incorporate but while waiting for 501(c)(3) status. Most charitable nonprofits do have "earned income."

For instance, if you launch an educational organization to help parents learn how to cope with autistic children, you will likely charge for that service.

What is the advantage of starting a nonprofit?

A nonprofit has many advantages that include the following:

  • Its purpose is usually clear and unambiguous.
  • Donors may receive a tax deduction for donations making it more attractive to large donors.
  • Enjoys exemption from federal taxes and many state taxes. Donations are not taxed.
  • When incorporated, the nonprofit enjoys liability protection for employees.
  • There is no distribution of funds to members, directors, or officers.
  • The organization can be run by both volunteer and paid staff.
  • Incorporated nonprofits are long-lived. The organization can exist as long as its purpose stays relevant and it can earn revenue. It is not dependent on the founders and can continue to exist beyond anyone's lifespan.
  • Nonprofits can scale up to achieve more impact through bigger programs, greater geographic reach, and a larger staff.

What is the total cost of starting a nonprofit?

The cost of starting a charitable nonprofit varies depending on location, the ambition of its purpose, infrastructure needs, and personnel.

Initial costs include incorporation at the state level and filing for tax exemption with the IRS. The first varies from state to state, while the IRS sets the second.

Check with your Secretary of State's office for exact incorporation fees. Also, Harbor Compliance, a firm that helps with business startups, has a chart listing current fees in each state. Incorporation fees run no more than a few hundred dollars. However, many organizations use legal services to help with this task. So, consider legal fees if they apply.

You will use a version of IRS Form 1023 to apply for tax exemption from the IRS. The long-form 1023 is $600, and for Form 1023EZ, it is $275.

Again, some organizations use an attorney to help prepare their Form 1023, so include those fees if applicable.

After those costs, the other startup costs will vary depending on what your organization plans. Do consider office space and equipment, personnel (paid or volunteer), marketing costs, research, postage, accountant fees, and website design.