Socially-minded entrepreneurs often ask me whether they should become a nonprofit. Usually, this is shorthand for a 501(c)3 tax designation. 501(c)3s are exempt from federal tax and can accept tax-deductible donations from private foundations and public charities. Before you say, “Yay, free money!” understand some of the downsides.

Cost is a hidden burden. Nonprofits have extensive compliance responsibilities. You’ll need to retain a specialized accounting firm to prepare financial statements and file quarterly reports. You’ll also establish a qualified board of directors that must meet regularly. Administrative overhead, including your compensation, should be less than 25% of the organization’s operating budget. Guidestar is the gold standard for evaluating nonprofit operational quality. Funds must go substantially toward the mission and not any private individual or shareholder. (Although, the HBO series The Righteous Gemstones poses some colorful workarounds.)

If you’d like to accept the occasional grant, you can use a fiscal sponsorship. A qualified 501(c)3 can accept the grant on your behalf and provide the tax paperwork. Learn more about the range and requirements of nonprofit structures from Investopedia.

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