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Top 5 WORST Reasons to Start a Nonprofit

Top 5 WORST Reasons to Start a Nonprofit

At Foundation Group, we love nonprofits.  And, we love working with our clients who are setting up these essential organizations all across the globe.

There are many great reasons to start a nonprofit.  As you’ve no-doubt seen in our marketing material, we’ve helped setup more than 25,000 of them since we got started back in the mid-90s.  This year (2023), we estimate that we’ll be involved with 800-1,000 new startups.  When I say that we love nonprofits, we mean it.

As you can imagine, we talk to thousands of people each year about their ideas for a new organization.  A lot of those ideas are great.  But others…well, not so much.  So, are there times when that idea of yours doesn’t (or shouldn’t) really translate into a nonprofit?  The answer is absolutely, “Yes!”  Here are the top 5 reasons we encounter to NOT start a nonprofit, in descending order.

5. Your Only Customers Will Be Other Nonprofits

We get this one more than you might imagine.  John reaches out to us because he needs our assistance with setting up a new nonprofit.  As our sales team engages with John, we discover that his idea for a nonprofit really sounds like a business.  The catch is, all of John’s potential customers will be nonprofit.  So that means his new company can be a nonprofit, too, right?

Probably not!

It’s true that nonprofits can sell goods and services.  Money generated by selling stuff in a nonprofit is called program revenue, and it’s a rich source of potential income.  But that’s assuming the selling of those goods and services directly furthers the exempt purpose of the charity.  The make-up of the clientele doesn’t have much impact at all.

For example, if a private school charges tuition to parents, the revenue generated by that is definitely the selling of a service.  It’s not a donation.  But it’s considered non-taxable program revenue because the tuition charged directly furthers the educational mission of the school.

By contrast, let’s consider a video production company.  They intend to sell services only to nonprofits.  You could make the argument that since the service helps the nonprofit customer, it’s furthering a charitable purpose.  However, video production is a clearly commercial activity, not an overtly charitable service.  That makes any “furthering” of a charitable mission indirect, at best.  And it’s the customer’s mission being advanced, most likely, not the production company’s.

A variation that we often hear is that the new organization will only sell to nonprofits, AND it will do so at below market rates.  Again, on the surface that sounds great.  But it’s still a commercial activity and the IRS isn’t likely to go for it.  In fact, the IRS says that they will only entertain such an idea if the product or service being sold is priced at 85% below cost or less.  That means the nonprofit would have to underwrite at least 85% of the cost through donations, which makes very little sense.

The landscape is littered with many adverse IRS rulings against such proposals.

4. It Sounds Like A Great Career Move

Another notion we hear a lot is that of a “2nd career”.  These conversations usually involve a potential client who has retired.  Some are still in their prime working years, but they were downsized.  They’re certainly not ready for the rocking chair and they’ve always had this idea for a nonprofit in the back of their mind.  Maybe starting a nonprofit is the ideal 2nd career move.

Maybe it is!  We’ve worked with literally thousands of 2nd career founders.  That in-and-of itself is not a bad thing.  So I’m not throwing a wet blanket on this entire category, but I do recommend a couple of things to consider.

First, starting a nonprofit isn’t like taking up pickle ball.  This isn’t a hobby.  Getting a new organization established takes real effort.  Effectively running it takes even more.

Second, it’s not easy to just walk away it if doesn’t work out.  If you realize pickle ball isn’t for you, just sell your rackets or take them to Goodwill.  If your nonprofit doesn’t pan out, there’s some work involved in winding down a legal entity.

If starting a nonprofit is the perfect 2nd career for you, by all means give us a call.  We are here to help.  Just take some time to consider what you’re actually doing.

3. A Nonprofit Could Help Your Company Reach Deserving People

If I had a dollar for every time I’ve heard this one…

Number 3 is subtle.  On the surface, it sounds charitable, but it really isn’t.  The pitch sounds something like this:

My name is Dr. Jane Jordan.  I run a dental practice just outside of St. Louis.  Most of my patients are middle-to-upper income families.  Our office is in a good area, but we’re only a few miles away from an underserved community.  Most of the people are uninsured and have no access to good dental care.  I want to start a nonprofit that will raise money to pay for their care at our practice at little-to-no cost to them.

Some of you got a little misty-eyed just reading that!  How wonderful that Dr. Jordan would consider that gesture.  But here’s how the IRS translates that:

My name is Dr. Jane Jordan.  I run a dental practice just outside of St. Louis.  Most of my patients are middle-to-upper income families.  Our practice is doing OK, but we see a great opportunity to expand our reach.  We’re only a few miles away from an underserved community.  Most of the people are uninsured and have no access to good dental care.  We want them as patients.  I want to start a nonprofit that will raise money to pay for their care at our practice at little-to-no cost to them.  That way, we can use charitable donations from the community to grow our client base and increase our income.

Using a nonprofit to increase the footprint of your commercial business is a non-starter.  Even if your motive truly is altruistic, the IRS won’t see it that way.  Alternatively, if you start a charity to cover the dental care needs of your target population regardless of the dentist they choose to use, then maybe.  But if it’s solely to pay for care at your business, it won’t work.

2. You Want To Help Your Niece

…or your nephew, or brother, or neighbor down the street, etc., etc.  You get the idea.

We hear this pretty frequently.  Someone reaches out because they want to start a nonprofit to help a specific individual or family.  Maybe that person is dealing with a cancer diagnosis.  Sometimes it’s a natural disaster or some other catastrophic event that is impacting this family.  It’s obvious that there is a situation where charity is appropriate. Therefore, starting a nonprofit to raise money to help the situation must be OK, right?

Unfortunately, the answer is no.  The primary reason is that a 501(c)(3) cannot have as its purpose the exclusive benefit of a named individual or group of individuals.  That would confer what the IRS calls inurement or private benefit, which is a fancy way of saying inappropriate personal gain.  Yes, the benevolent activity does satisfy a charitable purpose. But the exclusionary nature of a targeted charitable organization makes it so that discretion in giving (which is necessary) is restricted.  That’s fine if the recipient is another charity.  That’s not fine when it’s a person.

Also, from a practical standpoint, what happens when the need no longer exists?  The nonprofit doesn’t have an ongoing purpose and will either have to shut down, or repurpose its efforts.  There are a multitude of reasons why the IRS will not approve targeted charities.  Best to stick with a crowd-funding platform for needs like these.

1. You Heard There Was Grant Money Available

Our final entry in the “no-go” countdown is the allure of grant money.  You wouldn’t necessarily think that this one would come up that much, but it does.  We’ve talked to many potential clients over the years whose primary motivation for starting a nonprofit was because they heard, “There’s grant money available for that”…whatever “that” may be.

For starters, that’s just a terrible reason to start a nonprofit.  Most of the time, the wannabe founder isn’t particularly passionate about the cause.  They’re motivated by free money and they’re convinced it’s an income opportunity for them personally if they’re employed by this charity they’re planning to start.  That’s a lot of “they’res”!

That’s fine in the big picture, I suppose.  There’s no law that says you have to care about your cause.  But from an operational standpoint, you still have to successfully run the charity you start in order to qualify for and maintain the grant funding.  Kinda like our 2nd career example, you have to put in the work.

But there’s also the practical reality that these assumptions about grant funding are usually dead wrong.  Rarely is it based on research. More often than not, it’s based on hearsay.  Someone told them free money was available to anyone taking on this endeavor.  Truth is, grant funding is almost never available to startup charities.  Funders typically only grant money to an existing organization that has already established a track record of successfully addressing the cause it was started for.  There are exceptions to that, but they are unicorns.

Conclusion

When you’ve been in business as long as we have, you hear it all…the good, the bad, and the really, really bad.  This list was just a sample of the “bad” stuff we hear on a regular basis.  Fortunately, most people who reach out to us to start a nonprofit do not fall into these categories.  They’re good people with a big heart, looking to make a difference in their community.

We’re glad we get to help!

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Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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