Starting your own organization involves knowing what your goals, mission and purposes are as well as how you want to use the money your organization earns. There are three main types of organizations to choose from that use profits differently to achieve objectives.
Knowing the differences between them can help you set up your organization for its intended purpose and success. In this article, we explore the differences between nonprofit, not-for-profit and for-profit organizations to help you decide which one you should start.
What is a nonprofit organization?
A nonprofit organization (NPO) is one with a mission and purpose to serve society and benefit the public. This kind of organization collects payments or donations for providing services, but it uses profits to further advance the organization as opposed to investing in business growth or the individual wealth of the owner.
Nonprofits qualify for specialized tax exemption with the IRS, so they don't have to pay taxes on the money they receive through fundraising. This also means these organizations must publicly disclose how much they earn and how they use funds.
NPOs can operate with educational, public safety, public health, research, religious or other beneficial purposes. Some nonprofit organizations include:
- Universities and colleges
Here's an example of a nonprofit organization:
St. Paul Charity Hospital provides emergency medical services, diagnostic testing and surgical treatments to patients in and around the city. They use payments from insurance and donations to improve medical technologies, expand the hospital's campus and services, pay the staff and treat patients.
Read more: What Is a Nonprofit Organization?
What is a not-for-profit organization?
A not-for-profit organization (NFPO) is an organization that funnels all profits back into the organization's operations and doesn't provide financial wealth to its owner(s). These organizations do not have to serve the wider public good and can just serve the needs and objectives of their members, though some not-for-profit organizations serve beneficial public purposes.
Some NFPOs include:
- Charities and foundations
- Public welfare organizations
- Sports clubs
Here's an example of a not-for-profit organization:
Sunset Valley Sports Club provides its members access to athletic and exercise equipment, tennis courts, a swimming pool and health, wellness and exercise courses. Membership fees and donations all go back into improving the organization and maintaining its operations.
What is a for-profit organization?
A for-profit organization, more commonly referred to as a "business" or "company," provides products or services to the public and uses profits to invest in growing the organization and earning wealth for its owner(s) and shareholders.
Here's an example of a for-profit organization:
Dove's Coffee sources coffee beans, roasts and grinds coffee and sells its products directly to consumers online and to retailers. This for-profit organization uses profits to increase its owner's and shareholders' wealth as well as to grow the business.
Differences between nonprofit, not-for-profit and for-profit
Here are the key differences between these three types of organizations:
Purpose and mission
All nonprofit organizations benefit the public using fundraising, donations and other financial payments, while some not-for-profit organizations may also benefit the public. However, most not-for-profit organizations use profits to achieve the owner's organizational goals.
For-profit organizations only focus on achieving business objectives and growing the wealth of their owners and shareholders. Many for-profit businesses also donate money or partner with charities, foundations, associations and other nonprofit or not-for-profit organizations to serve the public good.
Tax exemption status
These three organization types make an income that they then use to pay staff, fund development projects and meet business objectives. However, each type handles its taxation differently.
- Nonprofits: Nonprofit organizations qualify for tax-exempt status under the 501(c)(3) status.
- Not-for-profits: Not-for-profits qualify for some tax exemptions when they earn a 501(c) status like 501(c)(7). For example, some not-for-profits qualify to not have to pay sales tax or property taxes.
- For-profits: These organizations don't qualify for 501(c) tax exemption, but may get tax deductions for things like business expenses, employee salaries and benefits and donating to charity.
Related: Nonprofit vs. Not-for-Profit
Sources of funding
Nonprofits typically gain revenue through fundraising efforts, donations, membership dues and grants. Some not-for-profit organizations may also receive donations, membership dues and grants, but some NFPOs also earn profits from sales, depending on their function and operations.
For-profit businesses receive funding from owner contributions, investors, shareholders, business grants and loans. Then, they gain revenue through sales profits and investment dividends.
Both nonprofits and not-for-profits can have a mixture of volunteers (who don't earn an income) and employees (who do earn an income with the organization). They use funds to pay employees first and then funnel the rest of the profit back into maintaining the organization's operations.
Dividends and shareholders
Nonprofits and not-for-profit organizations do not pay dividends or earnings on investments in the organization. For-profit businesses pay dividends to shareholders, whether the company is publicly traded on the stock market or funded by private investors.
Scope and scale
Nonprofit organizations can have a wide scope of the populations they serve and can scale up to regional, national or international organizations. Not-for-profits typically have a smaller scope of the population they serve, though they can scale to regional, national and international populations after growing financially and in popularity.
For-profit businesses can start and stay small, or they can start small and grow into a large corporation that serves people nationally and internationally.
Which organization should you start?
Here are some reasons to start each of these types of organizations:
Why start a nonprofit
You might consider starting a nonprofit if you want to:
- Serve your community or a certain population as opposed to building personal wealth
- Receive donations and hold fundraising opportunities
- Be a tax-exempt organization
Why start a not-for-profit
Consider starting a not-for-profit if you prefer to:
- Serve a small part of your community or a certain group as opposed to building personal wealth
- Receive membership dues, donations or gains from sales of refurbished products
- Have some tax exemptions
Why start a for-profit business
You might start a for-profit business instead of a nonprofit or not-for-profit because you want to:
- Sell products or services to consumers and use the profits to gain wealth
- Get funding from private investors
- Become a publicly traded company
Switching from one organization type to another
It's possible to start one type of organization and then convert it to a different type of organization. However, how complex the process is and whether it's likely to be approved by the IRS depends on which type of organization you start with and to which type you're converting.
Going from nonprofit to for-profit
You may convert your nonprofit organization to become a for-profit business to get better access to loans and other funding or to not have to run your organization within the strict regulations of the 501(c)(3) status and other nonprofit organization rules.
This process involves providing the IRS a written statement of nonprofit conversion that includes:
- Why you're terminating your nonprofit status
- A liquidation plan for your organization's assets
- What the organization's fair market value is
- A list of anyone who will receive assets during distribution
Going from for-profit to nonprofit
The process of converting a for-profit organization to a nonprofit is similar to starting a brand new nonprofit organization. However, the IRS wants to make sure that businesses only make this conversion to actually use their funds to serve a beneficial purpose for the public rather than to just avoid paying taxes.
This conversion process involves steps like:
- Writing a mission statement for your nonprofit organization
- Creating bylaws that will govern your nonprofit
- Filing articles of incorporation with a note about keeping the same name as your current for-profit organization