Establishing a Nonprofit Organization Tutorial
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Learn how to establish a nonprofit organization, task by task.
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What are the characteristics that define an effective nonprofit organization?
Grantmakers for Effective Organizations, an affinity group of the Council on Foundations, defines an effective nonprofit as one that has "the ability to fulfill its mission through a blend of sound management, strong governance, and a persistent rededication to achieving results." Establishing a nonprofit organization requires a full understanding of the key characteristics that will be important to future funders. They include a vital mission, clear lines of accountability, adequate facilities, reliable and diverse revenue streams, and high-quality programs and services.
As you embark upon the first steps of legally incorporating a nonprofit organization, drafting the bylaws, and building a board of directors, it is essential to keep these characteristics in mind.
- File the certificate of incorporation
- Select individuals to serve on the board of directors
- Develop vision and mission statements
- Establish bylaws and board policies
- Obtain an employer identification number (EIN)
- Open a bank account and establish check signing procedures
- File for federal tax exemption
- Follow state and local nonprofit regulations
- Find office space and obtain office equipment
- Recruit staff and prepare a personnel manual
- Establish a payroll system and procure necessary insurance coverage
- Develop an overall fundraising plan
In the United States, nonprofits can operate as unincorporated associations, charitable trusts, or corporations. There are fewer government reporting requirements for unincorporated associations, but they will find it more difficult to be recognized as tax-exempt, and they cannot receive grants from most foundations and corporations. Charitable trusts can be recognized as tax-exempt, but they do not offer their trustees the same protections from personal liability as those enjoyed by directors of not-for-profit corporations. While becoming and operating a nonprofit corporation requires considerable time and effort, the advantages of this form of legal organization make it the one most groups choose if they require substantial public support, and if they expect their operations to be ongoing.
The first step in becoming a corporation is drafting the legal incorporation document--the "certificate" or "articles" of incorporation--and filing the document with the appropriate office within your state government, usually the office of the Secretary of State or Attorney General. In some states, approval must first be obtained from any state agency that will be regulating the proposed programs of the nonprofit organization. State incorporation usually can be accomplished within a matter of weeks, although multiple or complex state agency reviews can considerably extend that period.
As you prepare the articles of incorporation, you will need to determine the name of the organization, where the organization will be headquartered, and its overall purpose. When preparing the "purposes clause," remember to state the goals of the organization broadly in order to provide program flexibility in the future, and do not include purposes that will trigger state agency reviews of the proposed incorporation unless your organization in fact plans to conduct those programs.
Prior to the incorporation process, you also will need to make a decision whether or not your nonprofit will be a membership organization. Members may have significant rights with respect to internal governance, such as the right to elect and remove directors, vote upon changes in the structure of the organization and amend bylaws. Becoming a membership organization can be beneficial. For example, prominent individuals from existing community groups affiliated with your organization may feel a strong sense of ownership in the effectiveness of the board of directors, and in the overall success of the nonprofit's mission if they are members. However, forming your corporation as a membership corporation also imposes legal obligations in preserving the rights of members to participate in the corporation's governance.
- How do I incorporate a nonprofit? Where can I find sample articles of incorporation?
- Where should we incorporate our nonprofit?
The board of directors is the governing body of a nonprofit organization. The responsibilities of the board include discussing and voting on the highest priority issues, setting organizational policies, and hiring and evaluating key staff. Board members are not required to know everything about nonprofit management, but they are expected to act prudently and in the best interests of the organization. They approve operating budgets, establish long-term plans, and carry out fundraising activities.
Finding desirable board members can be a difficult task. A good board member is someone who is interested in the organization's purpose, willing to work within a group, and be in a position to make financial contributions to the organization, or to find others who will. Inviting prominent members of the community to join your board can attract interest, excitement and prestige to the organization. It is also desirable if board members are well known in the field in which the nonprofit organization functions, and it can be extremely beneficial if they have expertise in areas such as real estate, nonprofit law and accounting. For example, having someone on your board who is savvy on real estate matters can be quite helpful when complex issues arise down the road, such as negotiating leases or purchase contracts.
Important points during this process:
- It is essential that prospective board members be told what is expected of them before they are proposed for election. Asking people to join the board without providing a "job description" is sure to create an ineffective board.
- Build a board slowly. Proceeding carefully can provide the necessary time for learning why an individual wants to become a board member, and deciding whether his or her agenda is compatible with the organization's.
When building the board, it is important to recruit beyond your immediate circle of friends and acquaintances. Often, there is an assumption that professionals and businesspeople will not be sympathetic to the pursuits of a new grassroots organization. Despite these concerns, there are various strategies that can be employed to seek board candidates:
- Seek out the advice of local funders, such as foundation staff, United Way officials, and government officials who have an interest in your organization's mission
- Contact executive directors and board officers of large, established nonprofit institutions in your community for their suggestions
- Speak to religious leaders in your locale to see if they can recommend any candidates, particularly from their own congregations
- Ask for volunteers at any canvassing efforts, open houses, special events, and benefits that your organization sponsors
- What is the board's role in fundraising?
- Can the executive director also serve on our organization’s board of directors?
Vision and mission statements should articulate the essence of your organization's beliefs and values and define its place in the world. They establish the long-term direction that guides every aspect of an organization's daily operations.
To distinguish between the two, a vision statement expresses an organization's optimal goal and reason for existence, while a mission statement provides an overview of the group's plans to realize that vision by identifying the service areas, target audience, and values and goals of the organization.
The following examples from Biloxi AIDS Service Organization highlight the difference between vision and mission:
- Vision: Our ultimate goal is a world without HIV/AIDS.
- Mission: The mission of the Biloxi AIDS Service Organization is to help people both infected and affected by HIV/AIDS to secure adequate nutritional and health support to enhance their lives.
When drafting appropriate statements for your organization, you might think about answers to the following questions to guide you:
- What are the values or beliefs that inform your work?
- What would you ultimately hope to accomplish as a result of your efforts?
- How do you plan to work toward this broad vision?
- For whose specific benefit does the organization exist?
Bylaws define how a nonprofit organization will be managed and how it will run. They determine which staff and board members have authority and decision-making responsibilities and how those responsibilities should be carried out. They create a framework for the organization, and aid in resolving internal disputes. They also describe the rules for calling board meetings, and how and when board members are elected.
In addition to bylaws, it is advisable to have something at a lower level of formality, such as board policies. You might, for instance, adopt a Conflict of Interest Policy and set up a procedure for board members and officers to disclose whether they, or people close to them, may be in a position to benefit from something the nonprofit is doing. Having such a policy in place will assure funders that the chief officers of the nonprofit organization understand the importance of handling charitable dollars prudently and responsibly.
- What are nonprofit bylaws? Where can I find samples?
- What Can I Do If a Nonprofit Isn't Following Its Bylaws?
To open one or more bank accounts in the name of the organization (and to file Form 990 with the IRS after each fiscal year), you will need to obtain an employer identification number (EIN), also called a federal tax identification number. An EIN may be obtained by filing Form SS-4 with the Internal Revenue Service. Looking ahead, this step is necessary for withholding employee income tax once you begin to hire staff.
Obtaining an EIN usually takes no longer than 30 days, and there is no filing fee.
It is important to establish a prudent system of checks and balances when dealing with the finances of an organization. It is advisable to allocate finance work among several people so that no one person is in charge of handling all of the transactions related to money. For example, when dealing with the receipt of cash, there should be one staff member who receives and tallies the funds, but a different staff member who then is responsible for taking the money to the bank and making the deposit. You should arrange for bank statements to be sent directly to the executive director, in order to ensure that each transaction can be accounted for. In turn, the bank statements then can be forwarded to the staff member responsible for reconciling the account(s).
By proceeding in such a prudent fashion, the potential for misappropriation of funds is minimized. Such sound fiscal procedures will please auditors, as well as future donors.
Resources on the Web:
- Basic Guide to Non-Profit Financial Management | Management Assistance Program for Nonprofits
- Systems and Procedures | Nonprofit Accounting Basics
You will need to file with the Internal Revenue Service for tax-exempt status under Section 501(c)(3). Form 1023 is the multi-page form you will need to file. Within three to six months of submitting your paperwork, you ordinarily will receive a letter, granting tax-exempt status to your organization.
Organizations that achieve 501(c)(3) status are exempt from federal taxes, and contributions given to them are deductible by donors for income tax purposes. In addition, the overwhelming majority of private foundations in the U.S. award grants only to organizations that have this particular tax-exempt status. See:
- Package 1023, Application for Recognition for Exemption Under Section 501(c)(3) of the Internal Revenue Code
- Publication 557, Tax Exempt Status for Your Organization
Although you can complete Form 1023 without outside assistance, it is not advisable to do so. Success in securing both state incorporation and federal tax-exempt status usually requires the assistance of an attorney, and competent legal counsel often helps the process move along smoothly. If you have limited financial resources, you might contact a public interest legal organization that connects nonprofit organizations with volunteer business lawyers. There is a growing network of those providers in cities all over the United States, coordinated by an organization in New York called Power of Attorney. You might also seek help from local technical assistance or management support organizations that specialize in providing guidance to nonprofit organizations.
Resources on the Web:
Once you receive tax-exempt status from the federal government, it is likely that you will need to file separately for state and local tax exemptions. Most states and many localities require nonprofits to register with the Charities Registration Bureau of the state or locality where they'll be fundraising. If your organization plans to fundraise actively in several states, you may need to register in each state in which you will be soliciting from the public.
Nonprofit organizations that are exempt under Section 501(c)(3) may qualify for exemption from state sales tax as well as from property taxes (if property is owned). Check with your State Department of Finance or Taxation to secure the necessary forms. For property tax exemption, apply to your local (county, town, or city) tax assessor's office. Your organization also may qualify for a nonprofit bulk-mailing permit, which would dramatically reduce your cost for third-class bulk mailings. You can obtain a permit by applying to the main office of your local post office.
Resources on the Web:
Finding office space can be a challenge, and there are many complex challenges involved with negotiating a lease. These often include the cost of utilities, renovations and charges for building maintenance. The process often runs quite smoothly, however, if you have a board member with experience negotiating leases.
As you obtain office equipment, you will need to consider whether you should rent or buy. If you buy, there will be significant up-front costs or financing costs. Regardless of whether you rent or buy, you will need to evaluate the quality of the equipment, as well as the service contract and associated cost.
It is essential for your organization to have solid staff in place to carry out programs and administrative functions. While volunteers can be helpful to an organization, depending on the size of your budget, future donors may question the commitment level of your staff if you rely too heavily on volunteers. The consensus among funders is that paid staff are more reliable than unpaid volunteers.
Finding competent staff is extremely important, and in some ways it is even more challenging than recruiting board members. Initially, your staff will be smaller than the board, and the staff is going to need to encompass all of the qualities that you seek for the board as a whole. You will want senior staff to be charismatic, articulate, well connected, and organized. They also will need to be good managers, experienced fundraisers, and have a solid understanding of the organization's goals, and effective ways in which they can be implemented.
As you build up your staff, you will need to prepare a personnel manual, which outlines policies related to overtime, annual and sick leave, health insurance and retirement benefits. While this document is not critical in the initial stages of setting up a nonprofit organization, it can prove to be quite handy when your staff begins to grow past the one-or-two-person stage.
Resources on the Web:
- Human Resources Management (posted by the Management Assistance Program for Nonprofits)
- Personnel Policies, Handbooks and Records (posted by the Management Assistance Program for Nonprofits)
- U.S. Employee Laws (posted by the Management Assistance Program for Nonprofits)
You will need to make payroll arrangements to compensate your full time and part time staff, as well as independent contractors. It is important to distinguish the role of independent contractors from that of part time staff. Independent contractors are hired to perform very specialized, short-term projects for the organization (i.e. accountants, lawyers, consultants), whereas part time staff are permanent or long-term employees of the organization.
Funds that are earmarked for payroll tax must never be used for any other purpose. Be very careful, since committing such an error may result in substantial penalties from the Internal Revenue Service. In addition to salary, benefits are an important part of the compensation package, and your state government will insist that you have certain coverages. These ordinarily include workers' compensation and disability insurance.
Resources on the Web:
- Employee Benefits and Compensation (Posted by The Management Assistance Program for Nonprofits)
There are many different ways to maintain a viable, financially stable nonprofit organization. It is important to develop funding from a mix of individual and institutional sources, as well as earned income generated from special events, products, services and membership fees.
Individuals extend their support in a variety of ways: they make contributions and pledges in response to direct mail requests, phonathons, appeals on the Internet, door-to-door canvassing, and face-to-face solicitations. Institutions that provide both financial and in-kind support to nonprofits include foundations; businesses and corporations; local, state and federal governments; and religious institutions.
Today, diversification of support is vital, and no organization can hope to finance its work successfully from any one source. Even if it does succeed in obtaining that one large, elusive grant, there's no guarantee the grant will be renewed each year, and the organization's future will not be secure. Moreover, funders like to see that an organization's funding is diversified, for this shows broad-based agreement that its mission is important and worthy of support.
Resources on the Web:
- How do I find foundation grants for my nonprofit?
- Find Web sites for researching prospective individual donors
- Where can I find information on government grants?
As you begin the process of establishing your nonprofit organization, it is important to remember that before you begin the process of fundraising, your organization must be able to demonstrate the key characteristics of a successful nonprofit organization:
- a vital mission
- clear lines of accountability
- high-quality programs and services
- reliable and diverse revenue streams