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June 23, 2008

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WANT TO KNOW how to start up a nonprofit with deep pockets? Here's a hint: Make sure it's also a multimillion-dollar business.

Consider Rubicon Programs, a Richmond, Calif., nonprofit that provides jobs, housing, and life skills to poverty-stricken, formerly incarcerated and disabled individuals. The organization, which was founded in 1973, has started two businesses and helped more than 40,000 individuals find jobs and live independently.

However, even after Rubicon started its first enterprise, Rubicon Landscape Services, 25 years ago, the idea of using earned income to support the organization didn't exactly register. "It was primarily a training opportunity," says Rubicon President Rick Aubry. In addition to providing real-world training grounds for the organization's aid recipients, the landscaping program served as a resume builder. But while the organization's social mission was helped out by the enterprise, its finances suffered.

Five years later, "we had to do a 180-degree turn in our thinking," Aubry says. Rather than merely facilitate training, Rubicon began to focus on turning the landscaping program into a business. By significantly increasing the number of landscape customers, "the business revenues became [Rubicon's] primary source of income," he says.

That changeover, according to Aubry, marked Rubicon's greatest period of growth. From 1986 to 1992, the organization's operating budget surged from less than $1 million to more than $6 million. To generate even more revenue, over 10 years ago, Rubicon added Rubicon Bakery. Today, the two enterprises earn about $7 million in revenues, which goes back into the nonprofit. That money has helped Rubicon build 200 units of affordable housing and operate mental health and workforce services in a dozen cities throughout the San Francisco Bay Area.

Rubicon's struggle with sustainability is shared by many nonprofits. Most charitable organizations stay small and battle for funding. Fewer than 150 of more than 200,000 U.S. nonprofits opened between 1970 and 2003 reached $50 million or more in annual revenue, according to a recent study from the Bridgespan Group, a nonprofit consulting firm based in Boston.

While becoming mammoth, complex organizations is hardly the goal of any nonprofit, widening its reach or expanding its influence certainly is. As such, John Elkington, co-author of "the Power of Unreasonable People: How Social Entrepreneurs Create Markets That Change the World," says that "a new generation of changemakers is emerging that sees for-profit ventures as intrinsically more scalable than nonprofit entities."

For this reason, many nonprofits are leveraging principles more associated with business than with philanthropy. Others, like Rubicon, are developing hybrid business models that combine both nonprofit and for-profit ideals and systems. Still, a number of social ventures are skipping the traditional nonprofit route entirely and starting up as for-profits, instead.

To better position your social venture for growth, some consultants and social venture academics recommend adding a revenue-generating business. Here are a few ways to bridge the profit gap:

Mission-Related Enterprises

When starting up a business within your organization, it's best if that business also furthers your organization's mission — especially if your organization is a 501(c)(3), says Jeffrey Hurwit, a nonprofit attorney in Boston. According to the Internal Revenue Service, which governs this special designation, income derived from the sale of products or services that gets funneled back into the organization is considered "related" business income and therefore nontaxable. The actual day-to-day work of such an enterprise must also support a social mission to receive this special tax treatment.

In one respect, says Hurwit, "it is a little bit more palatable for an organization to risk starting up a business if the income is not going to be taxable." However, he adds that it's also easier to start up and run a business that's related to what an organization already does or intends to do.

For Robert Egger, the founder of the DC Central Kitchen, a nonprofit corporation that provides meals to underprivileged Washington, D.C., residents and trains homeless and formerly incarcerated individuals to work in the food-service industry, starting up Fresh Start Catering, a revenue-generating catering business, made sense. In this business, he says, "you can develop a product, contract food services and start a catering business; I've done all three."

In the past two years, Fresh Start has brought in over $1 million dollars in revenue, according to Glenda Cognevich, DC Central Kitchen's chief financial officer. And since Fresh Start employs DC Central Kitchen's trainees and routes all of its profits back into its nonprofit parent, the organization doesn't pay federal income tax. Nor does it pay federal unemployment tax. The nonprofit does, however, pay state unemployment tax and all other payroll taxes, says Cognevich.

Unlike donations that have been earmarked for specific purposes, this type of income has the added benefit of being "unrestricted," says Hurwit. So if a nonprofit isn't meeting its operating obligations — for instance, providing reasonable salary raises to employees — the organization may use income generated from a business to pay for that.

Standalone Businesses

While not paying taxes is attractive, a social venture might consider forming a for-profit standalone business. The profits from such an enterprise — while taxable — aren't required by law to be funneled back into the nonprofit, according to Hurwit, the nonprofit attorney in Boston.

But typically, a good chunk of profits will go to the nonprofit's coffers. For instance, VisionSpring, a New York nonprofit that provides eyeglasses to the poor, started a for-profit, high-end reading glasses company in 2001, designating that 5% of its pretax profits be sent back to the nonprofit. (VisionSpring, formerly known as the Scojo Foundation, sold the for-profit business this year to concentrate on its mission and other business opportunities.

This type of business structure, notes James E. Austin, an emeritus professor of business administration at Harvard Business School, may lure investor dollars to the venture. The reason is, he says, "those outside investors have an opportunity to get a return on their capital." Rather than offering one type of return, which is typically social in nature, nonprofits via a for-profit enterprise can also offer financial returns. As such, these nonprofits can sometimes attract more capital to grow that enterprise and thus further their mission. For more on raising social venture funding, click here.

There's another advantage to starting up a standalone for-profit business: It can conserve a nonprofit's 501(c)(3) status. In some cases, a nonprofit might create a for-profit arm (unrelated to its social mission) that becomes a big money-maker. If that unrelated revenue begins to exceed 25% or 30% of the nonprofit's total revenue, the nonprofit, says Hurwit, "may run into danger of losing its tax-exempt status."

("Starting Up," a weekly column written by Diana Ransom for smSmallBiz.com, follows entrepreneurs through the early stages of launching a business. Write to her at dransom@smartmoney.com.)

Other recent Starting Up columns:

• Starting Up: Nonprofit Vs. For-Profit Social Ventures
• Starting Up: Funding Your Social Venture