Business Income for Nonprofits Tom Holland, Ph.D., Professor UGA Institute for Nonprofit Organizations Bob Sleppy, M.B.A., Director Nuci’s Space Nonprofits receive income from 1. Individuals with particular interest in the mission of this organization 2. Foundations and corporations – – – – Independent foundations Corporations and corporate foundations Community foundations Operating foundations 3. Public Sources (federal, state, local) 4. Sales of products and services National Average Income for Nonprofits from all Sources • Fees for products & services • Public (government) 50% (growing) 30% (declining) – grants & contracts for restricted purposes • Private Contributions – – – – 20% individuals give about foundations give about corporations give about bequests, wills, trusts, endowments 70% of that 10% 10% 10% Importance of Diversification • Over-dependence on any single approach carries risks – Reduced autonomy – Goal displacement – Volatility • Multiple sources and approaches help counteract those risks • Rate of growth in earned income is greater than in all other approaches (donations, grants) Risks in Government, Foundation, and Corporate Grants • Vulnerable to changing interests • Reductions in public support for most community programs. • Medicare and medicaid have seen rises, but many politicians call for sharp reductions in these. • Intense competition for all types of grants • Grants support a specialized project rather than support for whole organization • Require extensive staff time and skills • Pull organization toward compliance with grantmaker’s interests, bureaucracy, lower autonomy, rather than innovation and responsiveness to consumer needs. Expansion of Businesses into Nonprofit fields • For-profits growing in health care, education, prisons, adoptions, case management • Raising capital for start-up costs is especially difficult for nonprofits, due to non-distribution constraint. • Joint ventures: business and nonprofit collaborate, share strengths – Example: Lockheed and Urban Institute developing programs for disorganized families – Nonprofit must offer distinctive skills, such as knowledge and experience in an area of consumer need. – Careful negotiations to protect each partner while building on each other’s strengths Many nonprofit bring in earned income from • • • • • Joint ventures or social enterprises Membership dues Program activity fees Admission fees Sales of products or services – Gift shops – Concessions – Contracted services, such as training, maintenance – Uniforms, supplies, materials Social Enterprises harness the power of the marketplace to solve critical social and environmental problems generate profits to support their nonprofit missions may be integrated into their service programs or run as separate businesses Examples • Atlanta Justice Project operates a landscaping business where clients are trained for employment. • Habitat for Humanity sells contributed building materials for profit. • Nonprofit in Brunswick prepares people for employment. In addition to training classes, it runs a for-profit café, where food service trainees gain experience and skills. • Another in employment preparation operates a for-profit office cleaning business that makes money and provides skill development opportunities. More examples • BetterWorldBooks collects and sells books to fund its literacy programs. • Independent Transportation Network operates van and taxi services for purpose of helping people in outlying areas to get to health care and shopping. • Wisconsin Women’s Business Initiative operates catering and bakery businesses for purpose of making loans to women’s micro-enterprises. It employs women to run its retail and loan operations. • Fair Trade imports and sells food products for purpose of improving income for rural farmers in developing countries. Examples of Joint Ventures • Nonprofit and business agree on contract that business will hire trainees for entry level positions while nonprofit continues with training. • Company wants customers to buy and send in boxtops from its product, agreeing to give proceeds to nonprofit, which in turn publicizes the opportunity. • Dental association endorses a brand of toothpaste and allows use of its logo on products in return for contribution from the company. A Continuum of Organizational Forms • Pure nonprofit: all receipts from contributions for charitable services • Nonprofit operating business conducting charitable activities: nonprofit health or education organizations • Nonprofit operates business in areas related to its mission: university bookstores, job training programs • Nonprofit in partnership with for-profit: cause related marketing, corporate sponsorships • Nonprofit with stake in a for-profit business: nonprofit owns shares of for-profit affiliate • Not-for-profit firm: Organization legally organized as private business but distributes everything as wages • For-profit business gives pre-announced shares to charity: Ben and Jerry’s, Newman’s Own • For-profit in direct competition with nonprofit: For profit hospitals, education companies • Pure for-profit business: No charitable outputs Creative approaches • Identify some aspects of your nonprofit that could become income producing activity. Frame that activity so it clearly advances the mission. • If not clearly supporting mission, consider setting up a separate, wholly-owned for-profit subsidiary organization. IRS has rules for how to do this. Does not jeopardize nonprofit’s tax exemption. • Cause-related marketing: partner with a business where nonprofit provides publicity and recognition to business in exchange for contributions to nonprofit. Company A does well by helping charity B. Tie activity to Mission • After Girl Scouts began cookie sales, IRS challenged the income as unrelated to mission. • Girl Scouts responded by re-framing activity to be training opportunities for girls to learn about running a small business. Other possibilities • Target the activity so it is not carried on regularly, thus exempting income from taxation. • Structure the income in ways that are not taxable to nonprofit, such as having the venture put money into an endowment fund for nonprofit, generating dividends or interest income to nonprofit. Advantages of Earned Income • Less vulnerable to changing public attitudes and interests • Fits with cultural assumption of paying for what you get • Greater control over activities • Greater predictability of income • Fewer restrictions on use of income • Better support for whole organization, autonomy • Promotes responsiveness, innovation, accountability • Clearer advancement of mission, reduced risk of mission-drift Risks from Earned Income • Is enterprise closely and clearly related to and supportive of organization’s mission? • If not tied clearly to mission, activities can come to displace mission, esp. in organizations serving the poor. • Public image and trust: are profits more important than mission? • Enterprise runs risk of losing money • How extensively should nonprofit operate like a business? Mission vs. market challenges Public Perceptions • Popular assumptions that most businesses are efficient and responsive to consumer demands. • But, businesses seen by some as shirking community citizenship, dampening altruism. • Nonprofits often seen as inefficient, often unresponsive, self-serving more than consumers. • Government programs also distrusted. • Planning any social enterprise must take such perceptions into account. Partnerships between Nonprofits and Businesses • Sometimes called joint ventures or “causerelated marketing” • Offers a service that benefits both partners as well as consumers • Examples – Bookseller sponsors a literacy nonprofit’s reading project in return for publicity – Restaurant offers % of profit from an evening’s dinners to hunger project – Nonprofit trains entry level staff for local businesses Benefits of Partnerships Nonprofit gains Financial support Public credibility Business expertise Business gains Favorable public image Increased sales Staff engagement and loyalty Extended staff skills Risks For either: failure by other to fulfill promises For nonprofit – – – – Potential exploitation (nonprofit usually weaker) Compromised integrity of mission Diminished public trust Unexpected discontinuation For business – Negative publicity about nonprofit – Stockholder disapproval Mitigate risks by written contract • Clearly state the purpose of the joint activity • Specify the activities to be carried out by each partner, when, by whom, with what $ • Identify exclusions: what will not be allowed or done • Structure: how activity will be organized, controlled • Accountability: how records will be kept about time, income, expenses, division of income between organizations Guidelines for forming partnerships: both partners should • Already have excellent community reputations • Identify mutually acceptable options to meet agreed upon goals • Offer and be known for high quality programs, services and staff • Define the specific areas for collaboration • Make expectations both ways clear and documented. • Set out conditions for assessing, continuing and terminating partnership • Prepare business plan • Secure the resources needed to implement project Nonprofit should ensure that • The project directly furthers its mission • Agreement allows nonprofit to act on its mission independently of joint venture • It can block venture activities that jeopardize its tax-exempt status • It has legal counsel to draw up agreement Filing Requirements for Nonprofits • Federal and state recognition as 501c3. • Annual financial reports on IRS form 990 sent to IRS and state • Annual submission of form for state recognition and for state tax-exempt recognition • State registration for charitable solicitations (Ga. form C-100) I.R.S. distinguishes related vs. unrelated business income • Nonprofits can generate income as part of programs, through separate for-profit companies, or joint ventures with businesses. • IRS distinguishes income as either – Related to mission, hence non-taxed – Unrelated to mission, hence taxed – See IRS publication # 598 for specific rules. • Examples – Job training center contracts with local businesses for building maintenance – College sponsors international tours • Tests for mission-related business income – Is the business clearly related to the organization’s mission? – Would the nonprofit continue the business if it did not make profit? IRS has 3 part test for taxability of organizational income • 1. Activity operates as a business • 2. Activity is carried out regularly • 3. Activity is not substantially related to the nonprofit’s taxexempt purpose/ mission. IRS rules about business income for nonprofits • To be exempt, the activity must be directly and substantively contribute to carrying out mission and purposes. If not, n.p. may lose its tax-exempt status. (See www.stayexempt.org and www.irs.gov) • “It’s making money for our organization” does not qualify. • May be structured as an unrelated business activity, making income from it taxable, but after-tax gains go to nonprofit without another tax (see IRS regulations about Unrelated Business Income Tax) • Why is business income taxed? Gives nonprofit unfair advantage over similar for-profit company offering same service/product. • Paying U.B.I.T. does not jeopardize nonprofit’s 501c3 status. State Taxes • Nonprofits are exempt from federal and state income taxes, as specified by state laws. – Exception: unrelated business income taxes – Must apply for state corporate income tax exemption • Nonprofits are not exempt from payroll, employment tax withholdings. • They are not exempt from collecting state sales taxes on business income. Any income producing project requires a Business Plan • Description of the venture, including primary features, advantages, benefits • What the organization plans to do with it • Justification that the plan is credible, including supportive research • Strategic goals and justifications • Market analysis – – – – – – – Who the users are Benefits they see from the venture How and why will they will use it Likely demand for our product or service What users are willing to do and pay to get it How will competitors react How the venture will be promoted More on basics of a business plan • Staffing plan, including the expertise needed to create and then operate the venture • Management plans: how the expert staff will be organized, coordinated, led, paid • Financial plan: costs to establish the venture, operate it, budgets for first several years, expected amounts and sources of revenues, when it will break even and then return profits • Analysis of current organization, its resources and programs, staff expertise, & how present situation will contribute to success of new venture More on business costs • What will be our costs in hiring, paying, training staff? In obtaining office space and utilities? • If selling a company’s product or service, must we purchase it first? Inventory costs? Return costs? How will shipping and handling be paid? • If on consignment, any restrictions or penalties on returns? Questions before beginning • Do we have a realistic, persuasive business plan that will lead to net profits? • Do we have the competencies to run a successful business? • Will the time and effort be worth the income produced? • How will we ensure that the project will support and not restrict or interfere with our mission? More Questions • Are there competitors for our planned products or services? How will they react? • Why would the public buy from us rather than those competitors? • How will we persuade our contributors and the public of the need for our project? • How will we protect our organization’s reputation, esp. if the project is not successful? • What will we do if costs begin to exceed income? Summary • Earned income is a major and growing source of income for nonprofits • It offers advantages of stability, control, predictability, accountability • Partnerships with businesses can support nonprofits’ new ventures needing expertise from both • Win-win for both if carefully handled • Distinction between mission-related and unrelated business income important for taxes • Either form requires careful business plan Resources www.managementhelp.org click on Social Entrepreneurship and on Business Planning www.nonprofitsassistancefund.org click on Nonprofit Business Plan www.bplans.com click on Free Business Plans www.sba.gov/smallbusinessplanner/index.html click on Small Business Planner and on Tools Exercise • Talk with leaders of nonprofit organizations that run business enterprises that produce income to help support their organizations and missions. • Identify some aspect of your organization’s programs that could generate income to support your mission. • Is a partner needed to bring in needed resources? • Use one of the template business plans to develop a plan for the proposed enterprise. • Discuss your draft plan with others and incorporate their suggestions for improvement.