Charitable nonprofits fill a vital role in American life. They have often filled the holes in our social welfare safety net, enriched our cultural lives, and guarded our health.
Many well-meaning people dream of starting a charity, but it may not be as easy as they think. Startup charities often fail because their founders underestimate what it takes, the money involved, and how difficult it may be to compete.
The number of tax-exempt nonprofits, also known as 501(c) organizations, has proliferated in recent years. According to the National Center for Charitable Statistics, as of 2016, there were approximately 1.5 million such organizations registered with the Internal Revenue Service (IRS) in the U.S. This marks an increase of 4.5% from 2006.
What Is a 501(c)(3)?
There are many classifications of "nonprofits" within the IRS tax code. You probably do business with some of them without even realizing they are nonprofits. For instance, your daycare center might be a nonprofit as well as your local credit union.
A subset of 501(c) nonprofits is the 501(c)(3), which includes "public charities" and "foundations." Public charities are the kind most of us support with our donations, such as the American Red Cross, our favorite museum, the local university, or a nonprofit medical center.
How Does a 501(c)(3) Work?
Public charities must serve the public good and be supported primarily by the general public.
Public charities must be religious, educational, charitable, scientific, and literary; or groups that test for public safety; organizations that foster national or international amateur sports competition; or organizations engaged in the prevention of cruelty to children or animals.
Also, public charities must receive most of their income from the general public, foundations, or government.
Because the number of 501(c)(3) charities has grown so much, there is fierce competition among charities to raise public funds by fundraising or applying for grants from foundations and government entities.
Just as there is a high failure rate among business startups, charities can go under quickly. That's why the founders of new charities must think long and hard about why, where, and when it makes sense to start a new organization.
Unfortunately, not everyone who starts a charity has thought out his or her idea. Don't make the mistake of just jumping into the nonprofit arena. Think carefully before starting your charitable nonprofit and follow these steps.
Having a passion for your cause is essential, but remember that a nonprofit is primarily a business, and you need to be realistic in starting one.
However, unlike a business, you won't be selling a product or service but rather asking people to help others. Doing so demands sophisticated approaches to persuading donors to support you.
Is there a need for your organization? Or, could you team up with another existing nonprofit that has the same mission, perhaps as an affiliate? Many national charities do have affiliates or branches that operate similarly to business franchises.
Another nonprofit can even serve as your fiscal sponsor instead of or until you can become registered and begin to raise funds on your own.
Before you jump into starting a nonprofit, ask yourself some important questions, such as do I have an appropriate mission? Is my idea for a nonprofit even needed in my community? Do I have a base of community support? Do I have startup funds?
Nonprofits are very similar to for-profit businesses in many respects. For instance, you need to have at least as much money coming in as going out even to survive, much less succeed in your mission. Many nonprofit startups launch on a wing and prayer rather than a well-thought-out plan.
Just as businesses need a business plan, so do nonprofits. That plan must explain your organizational structure, describe the services you will deliver, outline your audience, delineate a marketing plan, and describe how you will fund your activities.
Those are the minimum requirements, and the plan can include much more. You'll use it to convince donors to give, foundations to provide grants and convince a lender to give you a loan.
Also, you'll need a strategic plan that can change over time. At a minimum, the strategic plan will set out your goals and objectives, mission and include a Strengths, Weaknesses, Opportunities, Threats (SWOT) analysis to help you assess your business strategy.
Make Sure Your Organization Will Actually Qualify as a Nonprofit
You might have a great idea, but are you sure it will qualify as a charitable cause? There are many types of nonprofits designated under section 501(c) of the tax code. Which one is yours? It may not be what you think.
For instance, membership-based nonprofits are designated as 501(c)(6) organizations. These nonprofits are primarily business associations or sports or sports leagues, Although, like the 501(c)(3), they don't pursue profit; they exist to serve their members' interests, not the general public.
Similarly, a 501(c)(7) nonprofit is a social club that serves its members. These organizations provide recreational opportunities to their dues-paying members. Recreational facilities include clubhouses, golf courses, swimming pools, and tennis courts.
A subcategory of the 501(c)(3) is the foundation. Whereas the public charity receives most of its money from the general public, a foundation is funded by private money derived from a family, a corporation, or it can be a community foundation.
All of these organizations receive federal tax exemption because they do not pursue profit as a primary end. There are many types of nonprofits, so make sure you know which type your proposed organization will fit.
Nonprofits are heavily regulated, both by the states in which they reside and by the federal government.
Regulation is needed to protect donors from fraud and ensure that nonprofits continue to serve the public good. Just because you are "nonprofit" doesn't mean that you can't get into some serious trouble.
One of the first decisions to make about your nonprofit is to incorporate it or not. Most organizations will want to do so because of the benefits incorporation brings, from limited liability protection to enhanced community status. Incorporation takes place at the state level and precedes applying for federal tax exemption.
You'll also apply for an Employer Identification Number (EIN) from the IRS. All businesses need an EIN, whether or not you have employees. It serves as your organization's "social security number." You'll use that number extensively to conduct business.
Fundraising is a sophisticated, complex, and competitive endeavor. But it is unavoidable for a nonprofit. Don't make the mistake of thinking that all you need is a bake sale or a fancy dinner to raise the money you'll need to fund your organization adequately.
Successful charities build a diverse basket of income sources to ensure financial stability. Some baskets, such as annual giving by individual donors, might be more important, but all work together for adequate support.
The two largest income sources for charities are individual donations and income from mission-related earned sources. According to GivingUSA, in 2019, individual giving accounted for 69% of charitable giving.
The second major source of income for charities is earned income. That is the money from the sale of services and products, tickets to performances, and more. For instance, hospitals earn income from patients and their insurers. Universities earn income from tuition, athletic events, and bookstores.
Earned income has become part of nonprofit financial planning, although the amount of such income varies greatly. Large nonprofit entities earn the most, while smaller ones earn much less or may have only one source of earned income instead of multiples sources.
Other income streams for nonprofits include grants from foundations and government and corporate philanthropy.
It cannot be overstated how important your board of directors is to your nonprofit's success. It is legally responsible for keeping you on track with your mission, helping you secure the funds you need to accomplish that mission, and providing much of the expertise you will need.
An incorporated nonprofit must have a board of directors, and corporate regulations define its duties. The nonprofit board oversees the organization's operations and is responsible for ensuring that all staff and volunteers act legally and ethically.
Boards have several legal duties, such as the Duty of Care, the Duty of Loyalty, and the Duty of Obedience. The board hires the executive officer and empowers them to hire and supervise staff.
The board must make sure the organization remains financially solvent by evaluating financial decisions, approving budgets, and reviewing reports. More informally, members of the board help fundraise, spread the word about the organization's good works, and recruit future board members.
Your first board of directors may consist of those who help you get started, such as early donors, founding members, and interested community members. Later, the board will recruit more members to replace the original ones or to enlarge the board.