It’s very fashionable these days to declare yourself a social entrepreneur, working for the good of society, the environment and a better life. Most social entrepreneurs don’t like to talk about making money, but often they still ask for help finding investors. As an adviser, I have to tell them they should be looking for philanthropists, who look for social value rather than financial returns.
It fact, social ventures really need profit to survive and prosper without donations, just like any other business. Delivering social value always costs money. Thus I’ve never understood why so many of these assume they can operate as non-profits. The labels of non-profit and for-profit are merely tax designations, and using the wrong label only complicates matters for the entrepreneur.
On the surface, the non-profit label appears attractive, since these entities should be simpler, easy, safe, and exempt from U.S. federal income tax (Section 501(c) of the Internal Revenue Code). Most countries have similar exemptions for similar organizations. In my experience, however, starting and running a non-profit is actually far more difficult for the following reasons:
Having a tax-exempt business is expensive. Obviously all founders wants to minimize their taxes, yet the initial setup for non-profits is bureaucratic, takes up to two years of time, and costs thousands. For comparison, I was able to set up a simple for-profit Limited Liability Company (LLC) in a month for less than $100.
Retaining a qualified team is challenging. A non-profit has all the same business issues as a conventional organization, and many more. Yet right or wrong, the pay scales are usually lower, so more experienced professionals are pulled away. Managing volunteers and seeking donations is an even bigger challenge.
No equity investors for a non-profit. Professional investors are looking for a reasonable financial return, and non-profits by definition are outside this realm. This fact makes finding money for staffing, advertising, and manufacturing very difficult. You can always use crowdfunding, but don’t count on going public or merging with a for-profit.
Multiple financial watchdogs. In addition to the Internal Revenue Service (IRS), other organizations, including the Charity Watch, regularly analyze and publish the ratio of funds in to those applied to the causes supported. All perform in-depth evaluations of spending practices, and can jeopardize your strategy.
Advertising is expensive. In a for-profit business, everyone understands that you have to spend money to make money. Yet in a non-profit, the watchdog organizations and even strong supporters don’t always appreciate money spent to get the word out, and expect low amounts to be spent on wages and facilities.
Funding is dependent on the economy. When times are tough, strong supporters withdraw their contributions to focus on their own challenges. Thus non-profit businesses have a very limited ability to survive when needs and interests of consumers change. Very few social entrepreneurs can claim to be “recession proof.”
Innovation is hard to find. Many non-profits still don’t have enough computers to automate manual processes, much less take advantage of the latest applications to keep up with innovation in their industry. This is a result of the difficulty in funding, operational constraints, and the availability of strong leaders.
Even worse, I sometimes hear entrepreneurs espousing the creation of dual entities, one for-profit and one non-profit, to capitalize on the advantages of each. I don’t recommend this approach, due to the temptations for violating the ethical and legal constraints on both. Professional investors, as well as the IRS, will frown on any combination of these two entities.
Thus my recommendation to social entrepreneurs is to treat the development of your business sustainability with the same passion as you apply to your cause. There need not be a conflict between these two priorities. It takes a sound and profitable business to provide the long-term value proposition that you envision for society. Anything less is a loss for all concerned.
*** First published on Entrepreneur.com on 06/03/2016 ***