As you learned earlier, a social entrepreneur is an innovator seeking social benefits. But the story doesn’t end there. Social entrepreneurs can be found in the for-profit and non-profit sectors. Non-profits have traditionally been tasked, along with government, with providing public benefit. But an increasing number of for-profit companies are also tackling social and environmental issues. If your innovative spirit, business skills and social values align, you may wonder whether you should run a non-profit or for-profit organization.
Non-profit doesn’t mean “no profit”
If your business serves a cause or does a public good, it can earn a profit and still be a non-profit organization. The US government rewards some organizations that perform services to the community by letting them operate tax-free. This is to recognize the fact that the government itself would have to spend more money to tackle social problems without the help of these groups. Many charitable groups rely solely on donations for funding, and pay no taxes on the money they take in. However, groups that want to fund their cause by selling items or providing services for a fee can make profits (i.e., “earned income”), benefit from this tax status, and call themselves non-profits, too. Non-profit groups with earned income strategies often refer to their money-making activities as “social ventures” and to their founders as “social entrepreneurs.”
Money to the mission
“Non-profit” is short for “not-for-profit,” meaning that money earned (through any means) is reinvested towards a mission. This contrasts with for-profit companies which divide income, after expenses, among owners or shareholders. In a good year, the owners of a for-profit company get richer, while a non-profit has more resources to devote to its cause. Non-profits are considered to be owned by the public, and cannot be used for the personal gain of individuals.
The most common type of charitable organization is a “501(c)3,” as identified by the IRS. Companies that meet this classification are exempt from state and federal income, sales, and property taxes. However, they must have a clearly defined mission from which they operate. All income must be generated in a way that relates to the mission, and after expenses, must be devoted to that mission. This prevents charities from using their tax-free status to compete with other merchants who have higher expenses due to taxes. 501(c)3 organizations cannot support political causes as part of their operation.
A non-profit must have a board of directors. As with for-profit companies, which maintain boards to insure that management acts according to shareholder interests, non-profit boards insure that management works in the best interest of the targeted community.
Profit and mission
You can incorporate socially beneficial elements into your company, but still run it as a for-profit. This allows you to use profits to motivate owners, financers, and employees (through stock options) and have market discipline while keeping a strong focus on mission-related results. You can consider yourself a for-profit, socially responsible business, or a for-profit social venture. If you want to focus on your ideals, articulate them in your corporate mission statement and find ways to measure progress beyond financial statements. See the Plan section for ideas.
Now that you know how the IRS defines for-profit and non-profit companies, consider other factors besides tax benefits to decide where your company fits. In their paper “Blurring Sector Boundaries: Serving Social Purposes through For-Profit Structures,” J. Gregory Dees and Beth B. Anderson at The Fuqua School of Business of Duke University consider the following:
- Public view of organization/mission
- Availability of financing
- Incentives for employees and owners
- Ability to stick with mission
- Market discipline
The non-profit sector has a reputation for being mission-oriented—having this status makes the organizational focus more believable to the public. Their inability to reward owners, employees, and financiers with financial returns tied to performance may restrict sources of money and people, but removes the temptation to sacrifice the cause for higher profits.
Economists believe that a well-functioning market is the best way to determine the value of an entity. For-profit companies issue stocks that are publicly traded, which enables their worth to be determined by the stock price. The stock price represents the investors’ appraisal of the future value of the company’s profits. Fluctuations send a signal to managers that the market thinks they’re making good or bad decisions. This feedback is termed market discipline. Arguably because investments in for-profit entities can be publicly traded, they must be more attentive to their owners and the signals in the market. Some see a disadvantage in the fact that non-profits cannot get these signals as efficiently from the stakeholders that “own” them.
Board basics: Overview of a nonprofit board