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Don’t Assume A Non-Profit Will Reduce Failure Risk

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A common misconception I often hear in the startup world is that non-profits are easy and safe, since they don’t have to pay taxes, and they don’t have to make a profit for their shareholders. In reality, from the feedback I get from non-profit executives, exactly the opposite is true.

Technically speaking, in the United States, a non-profit corporation or association is one which has been exempted from Federal income taxes by meeting the criteria set out Section 501(c) of the Internal Revenue Code, most notably religious, educational, and charitable entities like the Salvation Army. Other countries have similar exemptions for similar organizations.

Yet even a non-profit has to make a profit on everything it sells, in order to cover operating expenses (salaries, offices, equipment, research, travel, etc.), unless it relies wholly on donations. Even then, the business and leadership efforts to solicit and manage donations cost real money, and may be more difficult than the marketing and sales jobs of most startups.

Here are the common reasons I hear that make starting and running a non-profit actually more difficult than starting and running a conventional business:

  1. Creating a non-profit 501(c) business is a long and arduous process. You can start an LLC for-profit in less than a month, often for less than $100. A non-profit 501(c)(3) status requires filing IRS Form 1023. The form must be accompanied by an $850 filing fee, and may take as long as two years to complete successfully.

  2. Investors are not interested in non-profits. Even non-profits usually require startup funds for facilities, people, and inventory. But because they can’t project excellent returns on investment, no investors will likely be interested. Also, they can’t sell shares on the stock exchange to raise money, even though both the NYSE and Nasdaq are non-profits. That means they need to grow organically, or find a philanthropist.

  3. Reputable non-profits need to keep their operating expenses low. This usually means keeping wages low, and no fancy facilities. Thus it’s hard to attract top-notch talent, premium locations, and first-class marketing campaigns. Managing volunteers, and running any organization with these constraints is a challenge.

  4. Results are always subject to public scrutiny. Most startups, as private companies, don’t have to disclose their salaries and spending habits to anyone other than the IRS. Non-profits have to answer to watchdog organizations like Charity Navigator for how much of their proceeds actually make it to the causes they proclaim to support.

  5. Some laudable non-profit missions are hard to sell to supporters. A common complaint from many non-profits is that both government and private funders would rather spend their dollars on ‘sexy’ causes such as children’s charities, cancer, and heart disease, rather than long-term causes like global warming and erasing hunger in Africa.

Unfortunately, misuse scenarios, like the lavish lifestyles of leaders and scams, have given the non-profit environment a bad name, making things even tougher. Even reputable organizations, supporting veterans, the police, firefighters or children, often raise eyebrows, with alarming real data like these from the 10 Inefficient Fundraisers report from the Charity Navigator website:

  • American Lung Association of the Mt. Pacific - 98% spent on fundraising
  • Faith’s Hope Foundation – 94% of donations spent on fundraising
  • Cancer Survivors' Fund – 90% spent on fundraising
  • Firefighters Charitable Foundation – 88% spent on fundraising
  • The Committee for Missing Children – 87% spent on fundraising

These numbers vividly show that non-profits with good causes can fail to achieve satisfying results, in the same way that for-profit startups often fail, even with good products. Despite these challenges, my advice is still to follow your heart and your passion when starting a business.

You shouldn’t choose a non-profit, or a for-profit, because one seems easier, or one can make more money. Do it because you love the cause, the service, or the product, and the challenges will get lost in the satisfaction and results you achieve along the way.

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