Nonprofit organizations are often the cornerstone of the community. Starting a nonprofit can be an impactful way to pursue social change locally or nationally. But there are a few steps involved. If you are eager to start a nonprofit, this guide will explain how.
What is a nonprofit organization?
Nonprofit organizations typically serve a public, charitable, or faith-based cause. On paper, "nonprofit" is a legal status conferred by each state. A nonprofit is typically a 501(c)(3), a specific designation of the Internal Revenue Code that confers nonprofit status to social, religious, or educational organizations.
Every organization must adhere to specific regulations and guidelines to achieve and maintain nonprofit status. This often means refraining from certain activities that lie outside the scope of the nonprofit's mission. Nonprofit businesses don't distribute dividends to organizational members, for example, nor can they generate revenue that exceeds the needs of their stated mission.
In exchange, nonprofit organizations retain tax-exempt status, though again, this demands that the entity meet eligibility requirements at both the federal and state levels. And even if the nonprofit business achieves tax-exempt status, additional operations may be subject to income tax. This usually applies to nonprofits that carry out trades or services or earn income unrelated to the nonprofit's purpose.
LLC vs. nonprofit
What is the difference between an LLC and a nonprofit? A limited liability company, or LLC, is an entirely different legal structure from a nonprofit entity. An LLC is created to generate profits for owners and stakeholders, and an LLC may not receive tax-exempt status.
Nonprofit organizations may generate money, but most nonprofits use these funds to further a specific social or charitable cause. Most nonprofit organizations are classified as a 501(c)(3) and receive state and federal tax exemption status.
Foundation vs. nonprofit
What is the difference between a foundation and a nonprofit? Often, the two have similar interests, and charitable foundations can also receive tax-exempt status. However, there are some key differences, namely:
- Foundations are funded by a single, large endowment (often from a family or corporate entity)
- Foundations may contribute to multiple other nonprofits
- Foundations may not be classified as public charities
In other words, a foundation can technically be a nonprofit organization. Still, foundations must meet the above criteria, which don't apply to other nonprofits.
Is a nonprofit right for you?
Starting a nonprofit organization can be incredibly rewarding. It can also be challenging. Before you launch a new nonprofit, decide whether a 501(c)(3) organization is right for you. Think about questions like:
- What need am I trying to address in my community?
- What experience do I already have in meeting that need?
- What other organizations are already working on the same problem?
- Have I received input from those who'd be impacted by a new nonprofit?
- How much money would it take to fund my nonprofit's services?
- What other resources would I need to launch my future nonprofit?
You may be surprised to find out that other nonprofits are already addressing the needs you're passionate about. And they may need your help.
It may be better to start a different kind of business entirely and financially contribute to the common cause. If you're local, volunteer. Many nonprofit organizations are eager to have "all hands on deck" to fulfill their mission statement and impact their community.
Common types of nonprofits
Wondering how to start a nonprofit? The process may depend on the type. According to the Internal Revenue Service (IRS) and the National Council of Nonprofits, there are 29 different types of business entities that request tax-exempt status under the 501(c)(3) section of the Internal Revenue Code.
These organizations include religious entities, charitable organizations, and educational services.
The most common types of nonprofit organizations are:
- Arts, culture, and humanities
- Environment and animals
- Health and human services
- International and foreign affairs
- Public and societal benefit
- Religious and faith-based
- Membership benefit
Note that while these nonprofits and charitable organizations may fall broadly into the 501(c)(3) classification, there may be sub-categories for certain types of business entities, typically related to their source of income:
- 509(a)(1): Nonprofits that exist for public benefit and are funded by the public (churches, hospitals).
- 509(a)(2): Nonprofits that earn income from tax-exempt purposes (museums, zoos).
- 509(a)(3): Nonprofits controlled by other nonprofits (university foundations).
- 509(a)(4): Nonprofits that test for public safety.
Again, nonprofit corporations can be highly diverse. According to recent estimates, the United States is home to 1.5 to 1.8 million nonprofit organizations.
How to start a nonprofit business in 6 steps
Setting up a nonprofit organization is a lot of hard work, but if you build your organization over time, you'll be more likely to find success. Here's how to establish a nonprofit organization in just six steps.
1. Start with research
There are two main types of research that you'll need to pay attention to.
Start by assessing the needs in your community. Visit the Census Bureau to collect data regarding your area. Investigate successful nonprofit owners to learn what's working and the challenges you may need to navigate. You might even interview those who'd be impacted by your nonprofit's mission to assess potential interest.
As with for-profit business startups, your organization's success will depend on your ability to cover your startup costs. How much money will it take to get your organization off the ground? While you're not at the fundraising stage just yet, assessing your fundamental needs will help you better connect with major donors and supporters in future steps.
2. Lay the groundwork for your organization
Once you learn more about your aims, it's time to start laying the groundwork for your organization.
Mission statement and business plan
First, create a mission statement that relates to the aims of your business. It should be short, clear, and directly related to the need you identified in step 1.
Once you draft your mission statement, it's time to start working on your nonprofit business plan. Your business plan will keep you focused on your central mission. It'll also be necessary when you request funding from potential stakeholders. Make sure to include:
- An executive summary
- A description of your nonprofit's services
- Market analysis and sales strategies
- Management team/board members
- A financial plan
When you draft your nonprofit business plan, your executive summary should include your mission statement. It's fine if you don't know every detail at this point; fill in your business plan as your organization comes together.
Choose a name
Your organization needs a name. Keep it simple, memorable, and different from other nonprofits in your community. To see if a business name has already been taken, visit the United States Patent and Trademark Office (USPTO) website.
Appoint a board of directors
Next, decide how many board members you want to govern your organization. This includes appointing board members to help you operate the business, establishing the frequency of board meetings, and how you'll make decisions as a team. Nonprofit founders can also work to draft bylaws and make other management decisions that impact the company's mission.
3. Choose the right legal structure
For-profit businesses must register as a specific legal business entity. The same is true for nonprofit organizations. You have the option to register as a:
- Nonprofit LLC
- Nonprofit corporation
- Unincorporated nonprofit association
Most nonprofit business owners start as nonprofit corporations and then pursue 501(c)(3) status with the IRS.
4. Incorporate your nonprofit and file for tax-exempt status
Next, you need to incorporate your nonprofit entity based on your state's unique guidelines.
How do I file my nonprofit organization's article of incorporation?
While states differ in their procedures, you generally have to register your business name and file your articles of incorporation. This will also require you to:
- File for an Employer Identification Number (EIN)
- Complete registration forms
- Draft nonprofit bylaws and policies
- Establish your street and mailing address
- Designate an agent
- Pay filing fees
Once you've formed your nonprofit corporation, you can conduct normal business activities such as opening a bank account or applying for insurance.
Apply for tax-exempt status
Tax exemption may apply to specific 501(c)(3) organizations. You can apply for tax-exempt status by filing the IRS Form 1023-EZ. Just remember that federal tax-exempt status demands that your business be classified as a charitable organization. There's also a filing fee when you request tax-exempt status.
5. Raise money
Now that you've performed your due diligence, it's time to raise money to support your nonprofit organization. You can raise support in several ways, including:
- Grant funding from government grants or private foundations
- Fundraising events
- Collecting donations from local businesses
- Collecting online donations through crowdfunding platforms
- Collecting dues from membership programs
Outside donors can make tax-deductible contributions to your organization. In some cases, your members can deduct their donations from their federal income tax.
Remember that even tax-exempt nonprofits may still have to pay income tax on any money collected that isn't directly connected to the organization's mission.
6. Maintain your tax-exempt status
Tax exemption isn't a guaranteed right of a nonprofit organization. On the contrary, a successful nonprofit must maintain careful financial records to maintain its tax-exempt status. This includes documenting its annual revenue and filing its tax forms annually.
How do nonprofits prepare financial statements?
Nonprofits must keep careful records of all donations, grants, and funding they receive and any records of operational expenses. Nonprofits must prepare financial statements that include:
- Statement of financial position (also known as a balance sheet)
- Statement of activities (also known as an income statement)
- Statement of cash flow
- Statement of functional expenses
Looking for tools to help you prepare financial statements? Check out our free financial reporting package templates.
Additionally, you must file Form 990 if your annual revenue exceeds $50,000 or Form 990-EZ if your annual revenue is below this benchmark.
How BILL can help nonprofits
BILL can help your nonprofit succeed by providing an integrated and automated financial operations platform specifically designed for nonprofits. Manage accounts payable, receivable, spend, and expense; and keep track of your data through a centralized, cloud-based platform.
“As a nonprofit, if you are spending too much time on payables, BILL is a no brainer. For the cost vs the value, we’re saving both time and money. It really blew us away.” —Sean Saunders, Deputy Director, Church Community Housing Corporation
These tools can make it easy to track payments associated with each grant or donor as you start your nonprofit organization. To learn more, explore these tools today.
How long does it take to start a nonprofit business?
When you start a nonprofit, startup time can vary depending on how long it takes to file articles of incorporation and other requisite forms. For instance, the IRS typically takes two to four weeks to process form 1023-EZ.
How to start a nonprofit organization with no money
You can start a nonprofit by securing funding from grants or outside donors or by charging fees for membership programs.
Can you make money from nonprofit organizations?
Nonprofit organizations can't generate an actual profit. However, they may still raise money to fund the organization's central mission, which can extend to payroll for founders and employees.
How do nonprofits make money?
Nonprofits can generate money from donations and membership programs and even charge money for products or services. But remember, if you earn income that doesn't directly tie to your mission, you may still be required to pay federal income taxes.
Can a nonprofit charge for services?
Yes, a nonprofit can charge for its services and even branded products. However, all proceeds must tie back to the mission rather than be used to generate a profit.