Traditionally, the divide between a for-profit or nonprofit organization was clear: for-profit businesses would engage in revenue generation and nonprofits would engage in charitable work to solve social issues and would largely stay away from revenue generation. The rise of social enterprises in recent years, however, has made that distinction less and less clear. Social entrepreneurs are finding innovative ways to challenge the traditional thinking about nonprofit organizations (by focusing on economically sustainable models) and for-profit businesses (by focusing on solving social issues). As you set out on your mission to change the world, you will have to decide if you want to form your venture as a for-profit or nonprofit–or perhaps some hybrid of the two. The answer will largely depend on your best guess as to source of funding and your activities.
Here are the advantages, disadvantages, and the process for forming each.
Option 1: Only For-Profit Company
A for-profit can be structured as a regular C-Corporation, an S-Corporation, a Limited Liability Company, a Benefit Corporation, or Flexible Purpose Corporation (CA only).
Advantages:
Ability to Take in Investments. Unlike a nonprofit, a for-profit company can have private owners. The ownership of the company, or its equity, can be divided and allocated among different individuals. For this reason, one advantage of a for-profit company is that it could allow you to bring in investors ranging from friends and family to angel investors and venture capitalists. The best legal structure for receiving investments is a C-Corporation. S-Corps have certain restrictions on who can own the company’s stock. It is unclear how being structured as a Benefit Corporation may impact your ability to raise funding from VCs and angels. While some investors are quite unfamiliar with this new entity type and have questions about the exposure to risk due to the company’s social obligation, there are impact investors who are drawn to triple-bottom-line businesses because of their emphasis on social impact.
No Limits on Revenue Generation. Unlike a nonprofit, there is no limit on a for-profit company’s ability to generate revenue through providing goods and services. This may be an important factor for enterprises that have a substantial expected source of revenue, as too much revenue can actually jeopordize your nonprofit status (see below).
Disadvantages:
No Ability to Receive Grants or Offer Tax Deduction to Donors. One big drawback with a for-profit company is that, unlike a nonprofit, it is not generally eligible to receive foundation and government grants (one exception is Program Related Investments). Similarly, a for-profit company cannot offer tax deduction to donors. While some individuals may donate regardless of the tax deduction, this effectively eliminates large donors since they almost always require a tax deduction as a condition for donation.
Taxes. Another drawback with for-profit businesses is that they pay taxes (see Fees/Costs below). This factor, while somewhat relevant, should not be an overriding factor in deciding your entity type, as the costs could be small relative to the loss of certain opportunities by selecting a nonprofit organization.
The Nitty Gritty:
Fees/Costs. The government filing fee to form a for-profit business can be a bit over $100. This is a one-time fee. In addition, a company will have to pay a minimum franchise tax in every state in which it does business ($800 in California and $350 in Delaware). This is an annual tax.
Formation. To form a for-profit business, you will have to do the following:
- Decide in which state you want to form your business. Here is some information on the factors that go into that decision.
- File your organizing document with the Secretary of State to formally register as a corporation, LLC, or other entity.
- Adopt all other necessary papers. Depending on the entity type, they may include bylaws, an operating agreement, consents of directors, stock issuances, confidentiality and invention assignment agreements, indemnification agreements, and others.
- Make any other applicable filings (such as a Statement of Information in California).
- Qualify to do business in any state in which you do business.
Option 2: Only Nonprofit Corporation
A nonprofit is generally still a corporation (a nonprofit corporation), although it can take the form of other types of entities as well. However, it is very different from a regular for-profit corporation. There are a great variety of nonprofits, and each can do different things, but the most common type of nonprofit is a 501(c)(3).
Advantages:
Ability to Receive Grants and Offer Tax Deduction to Donors. A 501(c)(3) nonprofit allows you to get government and foundation grants and to offer tax deduction to any donors. Other types of nonprofits (such as a social welfare organization under 501(c)(4)) are technically tax exempt but they do not have this capacity. This may be an especially important factor for businesses that operate in a field where there are a lot of opportunities for receiving grants (such as education) and questions as to the enterprise’s ability to generate enough revenue to sustain itself without grants.
Disadvantages:
Limit on Revenue Generation. Perhaps the biggest drawback with a nonprofit for social enterprises is its limitations on revenue generation. Here is our earlier article discussing how a nonprofit can sell goods and services. To summarize, a nonprofit can sell products or services. However, if those sales are unrelated to its exempt purposes (as described to the IRS in its tax-exempt application), those parts of the organization’s activities will be subject to tax.
And if the unrelated revenue is too substantial a portion of the organization’s income, then the nonprofit risks losing its tax-exempt status. Unfortunately there is no clear definition of what is “substantial” for purposes of this analysis. The permitted amount is dependent on the facts of each case, and it can range from 5% to 75% of income, although it is good practice to keep it at no more than 20%. See the IRS regulations for more information.
If possible, the best way to avoid the problem with generating substantial revenue is to craft your IRS tax-exempt application in a way that anticipates the activity as part of your exempt purpose. But letting the IRS know that you intend to generate substantial revenue may delay the processing of your application if the IRS wants to ask questions about it.
No Ability to Take Investments. Because a nonprofit does not have owners, there is no equity to give out. This means you would not be able to bring on equity investors such as angels and VCs (although loans are still available).
The Nitty Gritty:
Fees/Costs. A nonprofit does not pay tax, but the government filing fee for the IRS application is close to $1,000 (this is a one-time fee).
Formation. To accurately think of nonprofits, you have to envision a two-step process. First, the entity is formed with the state as a nonprofit organization. Second, the entity applies for tax exemption from the IRS. Until the organization actually receives a determination letter from the IRS, it is not a tax-exempt organization and cannot raise offer tax deductions to donors. To form a non-profit, you would:
- File your organizing document with the Secretary of State to formally register as a nonprofit corporation.
- Submit your IRS application for tax exemption (this is called the Form 1023), which can take a few months on the low end and a year or more on the long end (especially if the IRS has questions about revenue generating activities).
- Adopt your bylaws.
- Register with the California Attorney General.
- Follow ongoing reporting requirements.
Option 3: Both a For-Profit and a Nonprofit (Hybrid Structure)
Advantages:
Ability to Take Investments, Receive Grants, and Offer Tax Deduction to Donors. This will allow you to carry out the pro bono services of the organization under the nonprofit and the paid services under the for-profit business. The non-profit will have access to grants and donation, and the for-profit will be able to take on investors, so there’s access to more sources of funding.
No Limit on Revenue Generating Activities. As long as the revenue generating activities are carried out under the for-profit, there is also no limit on generating revenue.
Disadvantage:
Complicated Structure. The tricky thing about these hybrid structures is how they are structured. There are 2 options:
- Parent-Subsidiary. Have the nonprofit as the parent organization, and the for-profit as a subsidiary owned by the nonprofit. To do this, the non-profit would have to qualify as a “public charity”, which means that it has to get most of its funding from public sources to satisfy the public-support requirement.
- Brother-Sister. Operate the nonprofit as for-profit as entirely separate entities.
Under either structure, money can flow from the for-profit to the nonprofit, but not from the nonprofit to the for-profit. The for-profit entity can donate money to the nonprofit (and lower its tax liability by up to 10% of its net income). However, because all assets of a nonprofit must be permanently dedicated to charitable causes, a nonprofit could not give away its funds to the for-profit. However, the nonprofit can purchase goods and services from the for-profit at reasonable rates. This requires the enterprise to maintain very good records of the transactions between the two entities (see below).
The big drawback with this hybrid approach is that you would have to essentially run 2 separate organizations, each with its own boards, which might be a hassle administratively since it is best to avoid too much overlap of boards.
Costs/Fees. You would pay tax on the for-profit business’s activities, and the filing fees would include both of the fees described above in options 1 and 2.
Nitty Gritty
Typically, if an entity is unsure if it should go with a nonprofit or for-profit or the hybrid approach, one option is to start with the nonprofit entity (as outlined in option 2 above), and wait to form the for-profit entity (as described in option 1 above) when it becomes possible/necessary to generate substantial unrelated income or take on investors.
Get in touch with us to discuss the best way to structure your social enterprise.
DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.
This was a very worthwhile read for me, thanks so much for this logical and well-organized overview.
One thing I would like clarification on is when you say:
“The big drawback with this hybrid approach is that you would have to
essentially run 2 separate organizations, each with its own boards,
which might be a hassle administratively since it is best to avoid too
much overlap of boards.”
Could you please elaborate on the subject of sharing board members between the for-profit and the non-profit? If the hybrid is my idea, can I safely participate on both boards?
Hi Nick. I am happy to hear that you found the article helpful. I do not know your individual circumstances, but generally speaking, the board composition of the two different organizations as a whole should not be entirely the same. Specifically, each board should have a sufficient number of directors who have no interest in the other organization (i.e. directors who have no financial interest in the other organization, have no decision-making power in the other organization, etc.). These “disinterested” directors will need to fully understand any potential conflicts of interest involved in transactions between the two organizations and make decisions (outside of the presence or influence of the “interested” directors) to either approve or reject the proposed transactions. Each organization should have a conflict of interest policy (and perhaps separate committees of their respective boards) to deal with these situations. But with those safeguards in place, it is possible to have directors who sit on both boards.
Thanks again for that elaboration, Ryan – yes, it does sound as though ensuring the coordination of the non-profit and the for-profit could be quite the “hassle”!
In as much detail as I can provide, my idea for a hybrid organization would be a non-profit which provides educational services to the public, then (with client permission) provides data generated by those services to the for-profit, who utilizes that data to provide B2B services to the professional community. It would, of course, be absolutely essential to the business plan that the data was available exclusively to the sister corporation. If I were to make myself Chairman and Chief Executive of the non-profit and sold the rights to that data in perpetuity to the for-profit, does that mean that I could not at any time hold any stock whatsoever in the for-profit corporation for risk of being charged with a conflict of interest?
Generally speaking, it is possible for an individual to own stock in a for-profit that does business with a non-profit, but it would need to be properly documented and the appropriate process would need to occur to approve the transactions. I would be happy to speak with you through a free consultation where we can discuss some more details if you would like, but I prefer not to provide individual legal advice here.
Hi Ryan,
Very interesting article. My idea is to open an educational technology non profit to research the educational system and develop educational apps. Do you recommend following the hybrid root if we expect grants to conduct the research but would like to sell the products for profit?
Best,
Monica
Hi Monica,
Thanks for the comment and happy to hear that you found the article interesting. Generally speaking, I think the challenge will be ensuring that the overall structure does not violate the rules for non-profit (tax exempt) organizations. Under those rules, it is not appropriate to use a non-profit (tax exempt) entity for private gain (i.e. for the benefit of a for-profit company). So it may be difficult to use the development from a grant-funded project (a project of the tax exempt non-profit) to serve the purpose of selling products for-profit. However, I am happy to discuss the nuances of this relationship in more detail.
Hi Ryan,
Thanks for your prompt response. In reality I didn’t express myself correctly. The purpose and objective of the nonprofit with be to research and come up with technological tools and applications that will favor and improve education. There are actually many grants that support such initiatives. However, my doubt is if any of these created products could be ever sold for profit, or they would always be expected to be donated. What happens if a percentage of the profit always belonged to the nonprofit side?
Another question is if the for profit part of the organization did not share any part of the grants for its product development, if it could still be part of the primary nonprofit starter, or it’s recommended to just open two separate entities, even though similar in content, and overall goal (supply educational organizations with innovative technological tools) but, different in objects: one developing for donations and the other for sale? Somehow, it seems to me that this objectives could be blended.
Thanks again for your attention.
Monica
Thanks for the follow up questions, Monica. I would be happy to schedule a free consultation to run through these issues in more depth. Generally speaking, it may be possible to achieve some of what you are discussing, however, the bottom line is that you cannot use the tax exempt non-profit organization as a means to achieve private benefit. So if the development of the product is done by the non-profit, then that product generally cannot be sold for profit. But it may be possible for the non-profit to sell or license the product directly (as opposed to using a for-profit company to do so) as long as such sale is related to the non-profit’s tax exempt purpose and as long as the funds received are used in furtherance of that purpose. Please feel free to reach out via email (info@spzlegal.com) to discuss these issues further.
This was a wonderful read! I have a non-profit without federal tax exempt status as of yet(need to find funds to pay for the filing fee-but I do have my FEIN, DUNs, and SAMs). So this helped answer the various types of entities. My question is this….My non-profit is a college with on campus day care, community tutoring, and various other charitable activities for communities…I want to use my for-profit (elderly living community with various buildings – café, theatre, pharmacy,medical clinic but not for major preocedures, etc) in tandem with my non-profit college..I want to use the non-profit college to have the students be able to “work” at the for-profit facilities in order to obtain hands on training such as nursing, management, construction, etc…I do intend to put all of the facilities for nonprofit and for profit onto one property…..Will this be able to legally be done as a hybrid considering the nonprofit gives no money to the for profit? the only gain the for profit gets is volunteer workers to assist the hired workers in exchange for work experience and credit for the college students….Also, in doing it this way due to the for profit running facilities on land owned by the non-profit will the property still be tax exempt?
Hi Lynn,
Good to hear that you found the article worthwhile. From the information you provided, it sounds like there is a possibility that you could structure the venture as a hybrid. However, there are a couple issues you will want to make sure to address:
1. As explained in the article, you cannot use the non-profit as a means to achieve private gain (especially after you obtain tax exempt status, or as part of the model when you apply for tax exempt status). This includes gain beyond just an exchange of money. For example, if you used the non-profit to pay for the facilities that were used by the for-profit, then you could run into issues. Likewise, if the for-profit obtains the gain of not having to pay property taxes, then an issue would arise. As another example, if you use the non-profit as a way to send unpaid labor to a for-profit, then you could potentially run into issues because the for-profit is obtaining private gain from the non-profit.
2. In addition to the issues related to private gain, you may run into issues with your model if the for-profit is not paying for the labor provided by the students. Take a look at this article when you get a chance: https://spzlegal.com/employment/hiring-interns/.
Happy to chat through these issues in more depth.
I suppose I was misunderstood lol. The students wouldn’t be workers, interns, or replacing workers. They would instead, be getting hands on training at the for profit facilities for experience and credit hours. Much like a massage therapy school requires students to work hands on at a local massage therapy office as credit requirements -I think it’s 2 hours a week? They’d be studying and training hands on with actual employees and not guaranteed a job after graduation. They wouldn’t be learning in areas they aren’t studying in…if they’re studying agriculture they won’t be learning hands on at the nursing station or pharmacy. I suppose I’d have to put the college campus on a different property than the fully sustainable living community though in order to eliminate the property issues. Thank you for the prompt response back. I was hoping if they were able to be on same property it eliminates the students having to drive all the way to a different property for their hands on credit studies…I’m hoping to eliminate issues with degrees not getting a job without experience…
Hi Lynn. There may be ways to achieve some of these goals within the parameters of what is permitted under the law, but you will definitely want to watch out for applicable employment laws as well as laws related to private benefit and tax-exempt status. However, I would prefer not to get into individualized legal advice on the issues on this platform. But please feel free to reach out for a free consultation if you are interested.
Hello, could the same person be the part-time General Manager of a for-profit company and the part-time Executive Director of a not-for-profit organization, both of which are closely related (hybrid model) ? If yes, what conflicts or issues do you foresee ?
Hi Marcial,
Thank you for the comment. You present a good question here. The short answer is that you can have the same person be involved in the management of each of the entities, but you need to have the appropriate safeguards in place. The analysis is very similar to the response to Nick’s question below. Specifically, each entity should have a board with a sufficient number of directors who have no interest in the other organization (i.e. directors who have no financial interest in the other organization, have no decision-making power in the other organization, etc.). These “disinterested” directors will need to fully understand any potential conflicts of interest involved in transactions between the two organizations and make decisions (outside of the presence or influence of the “interested” directors or officers) to either approve or reject the proposed transactions. Each organization should have a conflict of interest policy (and perhaps separate committees of their respective boards) to deal with these situations.
And as described in other responses below, on of the main issue to watch out for is ensuring that the non-profit with tax exempt status (assuming it has tax exempt status) is not creating private gain for the for-profit or for any individual. So you need to be careful about the flow of money and other benefits from the non-profit to the for-profit.
I hope that is helpful!
as stated before, Great concise article.
I am in healthcare, and left traditional practice to launch a digital practice. I help people hit the government dietary nutrition guidelines. It is proven that an effective dietary approach can stop many disease processes. We use technology to slowly track and then change behavior/diet.
I am creating a digital product to help people make the necessary changes. I plan on giving a % of every sales to a non profit I am going to set up. A second program will accept donations and provide supplements at cost(multivitamins, fish oil, vitamin d3) to populations with a proven need. Two of these groups are the hispanic community and people with mental illness. I have 2 charities that I will likely be partnering with to complete this part of the mission. (My little sis has major mental illness, thus the reason Im called to serve this group).
The for profit side will be supplement sales, consulting, and testing for food allergies and vitamin and mineral status.
The long term goal is to scale the model to other clinicians. Making their businesses more successful while furthering the mission.
Now, Im trying to identify what needs to be tweaked to stay compliant while also building a healthy ethical and legal business model.
Thanks for the comment, Ryan. It sounds like you are involved in a very meaningful field of work.
Overall, it sounds like your model of having a for-profit that donates a percentage of sales to pre-identified charities is doable. The primary issue to watch out for is to ensure that you are not using there is not private benefit coming from the non-profit charities to the for-profit company. So, for example, it would likely not be proper for you to use grant funds provided to the non-profit to develop the digital product that will then be sold by the for-profit.
In addition, it would be prudent to look into rules around commercial co-ventures for this type of arrangement where a for-profit will provide a portion of proceeds to a charity. This type of arrangement is regulated in most states. In California, this activity is regulated by the California Attorney General. See the following link for more information: https://oag.ca.gov/charities/faq#f3.
I hope that is helpful. Please feel free to reach out if you would like to schedule a more detailed conversation.
I did not know the term/concept commercial co-venturer. Thank you for putting that on my radar. Ive bookmarked your site for future reference. Also I have your email if/when need to schedule.
In briefly scanning FL statutes, there was 25k listed, so maybe a bond is needed amongst other things.
RE: private benefit, The only place I could think where this may happen is if issued the ad grant from google. ——> MAybe Ill just not specify the charity until I get these formalities put to bed. Which will likely be 6-12 months. The only question is should I wait to start the 501c3? It seems that the program I want to do, may have a bunch of red tape and It may not be able to be executed effectively now.
Hi Ryan,
I am unfortunately not familiar with Florida’s regulatory scheme with regards to commercial co-ventures so I won’t be much help on that front.
Running a 501(c)(3) organization is not a simple process and it involves significant expense, so I would definitely suggest holding off on setting that up until you are sure that the model you have in mind will work under the rules for such organizations.
Ryan,
I am establishing a service to the disabled community by selling their art online on various media. The mission is twofold: (1) to provide extra income to disabled artists, via a contract in which they get a % of the profit of each item sold. (2) to provide a service to those artists that may be receiving disability benefits whereby we would essentially provide the financial means for them to be able to set up financial vehicles such that the income does not affect their benefits. To that end I am donating a portion of the profit to a fund dedicated to do just that. I have been asked for a way to donate. To that end, I would suspect I would need a non-profit, but the goal is to maximize income to help the artists. I thought of having a hybrid model where there would be a non-profit parent company [Disabled ventures] that would take donations and provide the financial help to the disabled artists, and a for-profit company [Creative Disabled Ventures] where the artists can earn the income. I also am thinking of other for-profit companies [like an Engineering Disabled Ventures] that would sell devices targeted to help disabled people. I read in your article that money can flow from for-profit to non-profit, but not the other way around? How would I be able to reduce my overhead cost of the for-profit [potentially using non-profit money] in order to maximize the artists’ profits from their sales? After all that is the goal of all this, to make sure the artists get as much for their work.
By the way the for-profit is up and running here: creativedisabledventures.com
Thanks!!!!
Oliver Passemard
Hi Oliver,
Thanks for the comment. Unfortunately, a non-profit cannot be used as a way to reduce overhead for a for-profit company as that would be providing private benefit in violation of rules governing tax exempt status for non-profits. However, it does sound like you may be able to structure the overall venture in a way that incorporates both for-profit and non-profit activities, but you would need to very carefully structure it in a way that ensures that the activities are separate and properly accounted for. I am happy to continue the conversation if you would like to send an email our way to setup a consultation, but would prefer not to go into details on a public forum.
Thanks!
Hi Ryan,
Thank you for this article; as stated already, it has been very helpful. However, I have a couple of questions I was unsure about…
I have just moved back to North Carolina after living in a small village in Malawi, East Africa. I was deeply moved after living in the area for a few years. I have a background in International Development and would like to set up a non-profit to bring educational scholarships and social programs (such as adult literacy classes, nursery & youth programs, and permaculture training) to the area.
Employment and extra income is also desperately needed in the area, so I have developed and trained a women’s group to create fashionable recycled jewelry and sustainable crafts. I would like to set up a for-profit business where I buy the items from the women’s group directly at wholesale and then sell in North Carolina (in shops and online store). Ideally I would like to combine the non-profit and for-profit efforts into one website as they both contribute to the village’s overall empowerment. Does this sound plausible?
Also, I will be quitting my current career to focus on these projects and am worried about being financially stable with these programs in mind! Do non-profit directors make any income? Or should I depend on the for-profit part of the hybrid for income?
Thanks for your time!