INSIGHTS

Key Differences Between For-Profit and Non-Profit Entities

February 14, 2022

When forming your business, a key concept to understand is the difference between for-profit and non-profit entities. As their names indicate, one of the primary differences between the two has to do with their goals concerning profit, however, there are a number of other distinctions that influence how the two types of entities operate. Below, we take a closer look at how the two entities differ, how they are alike, and what you should consider when trying to distinguish and ultimately choose between the two.

Purpose

A common misconception is that for-profit entities attempt to make a profit, while non-profit entities do not. In reality, both for-profit and non-profit entities may generate profit and nonprofit entities, like for-profit entities, seek to maximize revenues. The real distinction lies in the purpose they attempt to serve with the revenues they hope to generate. For-profit organizations generate profits with the purpose of enriching the organization’s owners and shareholders. To serve this goal, they attempt to maximize profits to the highest degree, as the more profits they generate, the more profits they can then forward to the owners and shareholders.

Alternatively, non-profit organizations do not have owners and thus do not attempt to maximize the profits going to ownership. Rather, non-profits use the revenues they generate to promote a charitable, religious, educational, social or environmental cause and benefit society, commonly referred to as the mission of the organization.  Any net revenues (essentially profits) are retained by the nonprofit to advance its cause-oriented mission. Creating profits for ownership is thus not the purpose of a non-profit, but generating revenues is necessary to pay the costs of achieving the ultimate goal of serving humanity.

Funding

Another major difference between for-profits and non-profits are the traditional ways in which they generate funding. For-profits almost always raise capital by seeking out private investors and venture capitalists. These investors provide funding to start the company or keep it growing, and in exchange they are typically issued equity in the for-profit company with the hopes that they will make a return on their investment.

On the other hand, non-profits do not have ownership, and thus do not have equity to issue in exchange for investments. Rather, non-profits solicit donations from individuals or organizations who believe in the humanitarian purpose they serve. Although donors will not receive a share of the company’s profits, they still provide funding to help the organization further serve their humanitarian purpose and, in the case of taxable donors, to get the benefit of the income tax deductions that are available for such donations.

Like for-profit entities, non-profit entities may also borrow funds to advance their mission, either through commercial borrowing or the issuance of tax-exempt bonds or notes in accordance with applicable Federal and State laws.   In addition, non-profits can raise funds through capital contributions (which do not include an equity interest, but provide for repayment in the event of dissolution), and in certain jurisdictions through the acceptance of “subventions”, which may include an obligation to pay interest and carry some of the attributes of preferred stock in a dissolution or liquidation scenario.

Leadership and Employee Culture

For-profit companies often differ greatly from non-profit companies in the way they are run, the type of employees they value, and the overall culture they have surrounding their business. With a for-profit business, the company is typically run by an individual, or group of individuals, who seek to manage operations in a way that maximizes profits. Not only is this the primary purpose of the organization, but often times leadership has a strong financial stake in the company’s success themselves. Consequently, they value employees who contribute to the organization in ways that enhance financial success, such as providing services or developing products.

Non-profits however, are led by individuals who have no financial interest or ownership in the business. They evaluate business decisions and financial success only as a means to achieve their desired nonprofit mission-related objectives. Accordingly, they staff the company and build a culture with an eye towards their cause. This may even include the use  of unpaid volunteers, supplemented by only a few paid employees. Volunteers give time and effort not for their own financial gain, but rather because they believe in the non-profit’s purpose.

Taxation

In addition to these broader, more objective based differences, for-profits and non-profits also differ in the way they are taxed. For-profit entities are responsible for paying taxes on their net income, where-as non-profits are generally eligible for income tax, on the Federal, State and local levels, with certain exceptions. Since non-profits serve to benefit the community as a whole, the government gives them a break on taxes as a reward for furthering the greater good. It is important to note however, that while non-profits are exempt from paying certain taxes such as income tax, they may still be responsible for paying certain state and local taxes, such as sales and property taxes, just like for-profits, and to income tax on revenues generated from activities that are “unrelated” to their tax exempt purposes.

When ultimately deciding whether one of these entity types is right for you, you will have to make the potentially difficult choice between serving your drive to make money or your desire to benefit humanity. Well, what if I told you that you could potentially do both? Check back soon for our look at B-Corps, the crossroads between making profit and making change.