The Social Entrepreneur’s Dilemma: For-Profit or Nonprofit?

Social entrepreneurship is the incorporation of financial and social goals into the structure and mission of an enterprise. As social entrepreneurs have gained prominence over the last four decades, the line between what constitutes a for-profit entity versus a nonprofit entity has become blurred. The rise of social entrepreneurship poses new considerations for today’s entrepreneurs when deciding which legal designation to pursue, including capital-enterprise fit, company culture, and how to effectively serve the enterprise’s target market.

Definitions and Legal Designations

For-profit organizations generate profit by selling a good or service, whereas nonprofit organizations[1] further a social cause by providing a public benefit.[2] Nonprofits qualify for tax-exempt status under § 501(c)(3) of the Internal Revenue Code.[3] To form either a for-profit or nonprofit, an entrepreneur must elect a specific business structure, whether it be a corporation, limited liability company (LLC), partnership, or sole proprietorship, in the state where the organization will operate.[4] Once the business is formed, the entrepreneur must apply for an Employer Identification Number from the Internal Revenue Service (IRS); during this step, an entrepreneur who wishes to form a nonprofit selects their tax-exempt status.[5] 

A business entity may change its legal status after it has been formed. To convert an entity to a for-profit entity, an entrepreneur must submit a “statement of nonprofit conversion” to the IRS.[6]  In contrast, an entrepreneur may convert their entity to a nonprofit by either submitting a mission statement, bylaws, and articles of incorporation to the state’s Secretary of State and/or fulfilling state-specific filing and reporting obligations.[7] Delaware, for example, does not require nonprofits to register in the state, but any nonprofits that solicit or accept donations in other states are subject to filing and reporting requirements.[8] This conversion process may present complications, such as the IRS discouraging the switch to a nonprofit in order to prevent tax avoidance.[9] Although an entity can change legal status after formation, some experts encourage companies to make a fully-informed decision prior to formation and maintain their original legal status in order to prevent objections from donors or lost investor and consumer trust.[10] These considerations have become more relevant than ever as social entrepreneurship has altered the purpose and function of for-profits and nonprofits in recent decades.

Blurring the Line Between For-Profits and Nonprofits

Historically, the distinction between for-profit and nonprofit organizations was clear: if an entrepreneur wanted to sell a good or service and generate a profit, they started a for-profit company.[11] If they wanted to address a social or environmental issue, they created a nonprofit.[12] This clear-cut distinction changed during the rise of social entrepreneurship in the 1970s-80s, when various businesslike nonprofits and mission-centered businesses emerged.[13] Notable among these nonprofits is Grameen Bank, which performs the business functions of a bank but requires no collateral to get credit and aims to alleviate poverty.[14] Additionally, Greyston Bakery, a prominent mission-centered business, hires workers who face barriers to employment and funnels its earnings to a nonprofit foundation.[15] These and other entities have influenced modern perceptions of the respective purposes of for-profit and nonprofit organizations.

As a result of the rise of social entrepreneurship, venture philanthropists and impact investors have become influential in funding entrepreneurs who seek financial and social returns from their for-profit businesses.[16] For-profit businesses can now also acquire the legal designation of a public benefit corporation in the majority of states or become a certified “B Corp” to demonstrate to shareholders that they aim to act in the best social, environmental, and stakeholder interests.[17] Additionally, nonprofits are now able to provide goods and services that can compete with for-profit businesses.[18] Entrepreneurs deciding which legal entity to pursue or whether to switch their business entity status must take these developments into consideration.

Considerations

An entrepreneur should, among other factors, consider capital-enterprise fit when weighing the costs and benefits of for-profit or nonprofit designations. This involves testing for market size, growth rate, and competition; nonprofits often enter underdeveloped, emerging markets, but that may or may not be the case for for-profits.[19] Additionally, the entrepreneur should consider the type of funding available; for-profits typically involve private investors, whereas nonprofits are funded by individuals, foundations, and corporations.[20] 

Another consideration is company culture. Typically, the problem-solving focus at most for-profit companies is profit generation and strategy, whereas nonprofits are often more community-oriented.[21] There is also significantly more turnover in a nonprofit; employees are typically paid less than market value and temporary volunteers often play a significant role in the organization’s operations.[22]

Finally, the entrepreneur must consider who they want their organization to serve and how to effectively do so. This requires a balancing test of customer access and affordability with profitability.[23] If customers cannot afford the product or service the entrepreneur seeks to provide, the entrepreneur should consider additional sources of revenue that could sustain a successful for-profit business. If an alternate revenue stream is infeasible, an entrepreneur may then want to consider pursuing nonprofit status in order to receive tax-exempt donations to sustain its ability to provide to its target market.[24]

Although the line has blurred between for-profit and nonprofit organizations, the rise of social entrepreneurship has opened up opportunities for organizations to promote the public benefit while simultaneously generating profit.

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[1] Nonprofits are not to be confused with not-for-profits, which are distinct entities that do not operate for the public good and that will not be discussed in this article.

[2] Emily Heaslip, Nonprofit vs. Not-for-Profit vs. For-Profit: What’s the Difference? U.S. Chamber of Com., https://www.uschamber.com/co/start/strategy/nonprofit-vs-not-for-profit-vs-for-profit (last visited March 11, 2024).

[3] I.R.C. § 501(c)(3). See also Exempt Organization Types, U.S. I.R.S., https://www.irs.gov/charities-non-profits/exempt-organization-types (last visited March 11, 2024).

[4] Heaslip, supra note 2.

[5] Id.

[6] Id.

[7] Id.

[8] Delaware’s Alternatives to Corporations, Del. Div. of Corp., https://corplaw.delaware.gov/delawares-alternatives-corporations/ (last visited March 13, 2024).

[9] Amanda Gracia, How Nonprofits Obtain and Maintain Their Nonprofit Tax Status, A.B.A. (Dec. 7, 2021), https://www.americanbar.org/groups/gpsolo/publications/gp_solo/2021/november-december/how-nonprofits-obtain-maintain-their-nonprofit-tax-status/.  

[10] Cait Brumme and Brian Trelstad, Should Your Start-up Be For-Profit or Nonprofit?, Harv. Bus. Rev., https://hbr.org/2023/05/should-your-start-up-be-for-profit-or-nonprofit (last visited March 11, 2024).

[11] Id.

[12] Id.

[13] Id.

[14] Welcome to Grameen Bank (The Pioneer Microcredit Organization): Bank for the Poor, Grameen Bank, https://grameenbank.org.bd/ (last visited March 11, 2024).

[15] Id.

[16] Id.

[17] Id.

[18] Id.

[19] Heaslip, supra note 2.

[20] Id.

[21] Id.

[22] Id.

[23] Brumme, supra note 10.

[24]  Id.