Explore eight attributes that distinguish nonprofits from businesses.
Nonprofits contribute billions of dollars to the economy and undertake a vast array of missions. Your neighborhood community theatre, your state university, or your friend’s animal rescue operation—perhaps these organizations come to mind. Nonprofits are likely part of your community and your life, but how much do you know about why they exist, how they are governed, and what distinguishes them from businesses? Learn more with these fast facts.
A business, on the other hand, can benefit the personal financial interests of an individual, shareholder, or group. That does not mean that nonprofits have no economic interests. They have assets, earn revenue, and pay their employees just like businesses. But all profits from a charitable organization must be reinvested into the organization, whereas profits from a business can benefit owners or other individuals. If a nonprofit violates this basic principle in the US, referred to as inurement, it could risk losing its tax-exempt status, which is monitored at local, state, and federal levels.
The most common type of nonprofit in the US is called a charitable organization—or a 501(c)(3) under Internal Revenue Service (IRS) code. Chances are you have probably seen this code somewhere or even looked for it when filing your taxes because 501(c)(3) organizations can provide donors with a tax deduction in exchange for a contribution. The IRS recognizes eight distinct purposes for 501(c)(3) organizations: charitable, religious, educational, scientific, literary, public safety testing, fostering sports competition, and preventing child and animal cruelty. Registered charitable organizations do not have to pay many local, state, and federal taxes—but businesses do. [Is my donation tax-deductible? Learn more.]
The nonprofit sector has long been part of the American social fabric. Tax exemption has been provided to US charitable organizations since 1894 based on the concept of shared social responsibility. Today, nonprofits continue to fill gaps that the public and private sectors are unable or unwilling to address. Through the nonprofit sector, you can select which services you deem the most important and support them with a charitable donation (rather than a mandatory tax). The public has also historically entrusted the nonprofit sector to ethically address certain social and structural issues because it is free of the financial and personal interests that underlie actions in the private sector.
In the private sector, staying in business is pretty straightforward: You sell enough services or products to make a profit. Things are a little different for nonprofits. Some nonprofits—like charitable hospitals and universities, for example—collect fees from patients, students, or members. In fact, fees represent the largest source of funding for the US nonprofit sector. The second largest source of funding? Government grants. Approximately 10% of the nonprofit sector’s overall revenue comes from charitable giving. This includes donations from individuals, as well as foundations and corporations. Every nonprofit’s mix of revenue differs. While fees or grants may be the primary source of income for one nonprofit, charitable gifts may the primary source for another.
One of the most prevalent misconceptions about nonprofits is called the overhead myth. It is the misguided but common notion that you can judge the worth and impact of a nonprofit by how much (or how little) it spends on so-called overhead. In the nonprofit sector, vital activities and operations—including staff compensation, advertising, and fundraising—fall into the overhead category. Many donors make judgements about a nonprofit’s impact by comparing the amount spent on direct services and programs vs. spending on overhead. In fact, 62% of all Americans believe the typical nonprofit spends more than it should on overhead. To address complex social problems, nonprofits, just like businesses, need to recruit and retain top talent, invest in growth, and raise enough money to fulfill their missions. There are better ways than overhead of understanding the impact of your donation, including looking at the nonprofit’s record of achievement in your community, seeing how transparently it operates, and finding out how responsive it is to the needs of the people it exists to serve. You should be able to discover most of this information online or through your personal interactions with a nonprofit, including volunteering, an in-person visit, or a phone call.
While continuous growth is the most common measure of success for a business, success for a nonprofit is not always as straightforward. Progress toward a social mission can be tricky to measure. Take the example of the Harlem Children’s Zone, a nonprofit with a mission to improve the lives of poor children in New York City. As reported in the Stanford Social Innovation Review, the nonprofit grew rapidly in the 1990s, expanding to serve 6,000 children through 16 different programs. The boom led to an important question: Would success mean more geographic and programmatic expansion? Ultimately, the nonprofit’s leadership team determined the answer was no. They decided to narrow their focus to achieve the greatest impact possible. Their programs were limited to children 18 or younger who lived in a 24-block area of central Harlem. Leaders defined important non-growth related measures of success, including high program participation rates and fewer interventions for young adults in their service area.
Did you know that a nonprofit board is ultimately accountable to you, the general public? It ensures all decisions align with the organization’s charitable mission and provides financial, legal, and administrative oversight, including management of the nonprofit’s chief executive officer. Board members are usually unpaid volunteers. Corporations are also governed by boards, but there are some key differences. For-profit board members can be paid shareholders, and one of their main objectives is to increase the corporation’s profits (from which they can personally benefit, as well).
Just as some corporations do, some 501(c)(3) organizations engage in lobbying, or efforts to influence legislation. As the American Bar Association’s Nayantara Mehta points out, “Having a say in policy discussions is not just an appropriate role for nonprofits, it is vital. If nonprofits are not speaking on behalf of their often-vulnerable communities, chances are nobody else is either.” Nonetheless, nonprofits do have to keep some lobbying restrictions in mind. A 501(c)(3) organization cannot support or oppose candidates for public office, and the IRS may revoke its tax-exempt status for excessive lobbying. More specifically, 501(c)(3) private foundations are heavily taxed on their lobbying expenditures, which acts as a limit to lobbying, and 501(c)(3) public charities are only permitted to lobby up to a certain dollar limit or percentage of overall activities each year.
Now you know how nonprofits are governed and what sets them apart from businesses. Nonprofits exist for your benefit and the benefit of society as a whole. It is clear: They are a vital part of our world in so many ways!
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