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How to Convert Your For-Profit Business into a Nonprofit

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Converting a for-profit business to a nonprofit entity could be a smart move if charity and community impact has become your focus as a business owner. But making the change requires more than applying for tax-exempt status.

The process would largely depend on your state’s laws regarding business conversions, and not every company can become a nonprofit organization without a good reason for doing so. Only certain types of businesses can turn into a tax-exempt entity, a procedure that requires filing paperwork with state organizations and the IRS.

Keep reading to learn what it takes to turn a for-profit enterprise into a nonprofit organization, and if it’s the right move for your business.

Reasons to convert a for-profit business to a nonprofit

Although there are several tax-exempt designations within the IRS’ Internal Revenue Code, most nonprofits fall under the 501(c)(3) umbrella for charitable, religious and educational organizations.

The benefits of 501(c)(3) status include exemption from federal income tax, as well as the ability to receive tax-deductible charitable donations. Organizations with the 501(c)(3) designation are also more likely to receive recognition from grant-making institutions and foundations.

Before you can be awarded tax-exempt status, you would need to meet the IRS’ criteria. Organizations may not be formed to benefit private interests, and no portion of the organization’s net earnings can benefit a private shareholder or individual. Nonprofit employees can earn a salary though.

Meeting these requirements could be difficult as a for-profit business, unless you’ve had charitable intentions from the start, said Gene Takagi, an attorney with NEO Law Group, which represents nonprofit and tax-exempt organizations.

“Consider making that conversion if the existing for-profit entity really has a goal that’s not financial…but is really all about providing a public service or public good for charitable or welfare purposes,” he said.

Here’s an example: A neighborhood store that sells the work of low-income artists started as a for-profit business to get equity investments from community members but was unable to generate substantial interest and capital. Turning the business into a nonprofit organization would allow the owners to collect philanthropic donations to keep the store open. Because the business had a charitable, community-focused intent from the start, it could be approved for tax-exempt status.

But if a business seeks 501(c)(3) status for less charitable reasons, the IRS could deny the request, Takagi said. For instance, a failing business looking to get out of tax obligations couldn’t become a nonprofit without making operational changes.

“You’re really going to have to make a good case to the IRS,” he said. “It’s got to look different than what you were doing in the past.”

Converting for-profit to nonprofit: 5 steps to follow

Nonprofits are highly scrutinized, and business owners may be faced with more regulations than they’re used to, said Brenda Asare, president and CEO of The Alford Group, a consulting firm that advises nonprofits.

“Those processes are in place to dissuade people who may want to come into this sector to take advantage of other people philanthropically,” Asare said.

To make sure you correctly convert your for-profit business to a nonprofit, here are a few steps to follow.

1. Check entity conversion laws in your state

When you form a business, you must set up a certain entity, or structure, which determines the number of owners a business can have, the owners’ personal liability and taxes the business owes. Common entities include sole proprietorships, limited liability companies (LLCs) and corporations. Nonprofits are usually formed as corporations, though they are able to receive tax-exempts status.

When changing your business to a nonprofit, you would have to convert the current structure to a nonprofit corporation structure. Depending on where you live, only some entities may be eligible for conversion.

In Louisiana and California, for example, corporations, LLCs, general partnerships and limited partnerships can convert to another type of entity through the state’s Secretary of State office. On the other hand, New York does not permit statutory conversions for business entities. Instead, business owners must establish a new entity, then merge the two companies into one.

Check with your state’s Secretary of State office to make sure you would be permitted to change entities.

2. File conversion paperwork

Because nonprofits are corporations, they must be incorporated through the local Secretary of State. If your for-profit business was formed as a corporation, a conversion could be as simple as amending your incorporation documents, also known as articles of incorporation. You’d need to file incorporation forms again to make the conversion, which would typically range in cost from $50 to $150. Additionally, because a nonprofit corporation does not have ownership, as a board of directors shares responsibility of the organization, existing shareholders of the for-profit business would have to forfeit ownership.

If your business is not a corporation, you would need to file new articles of incorporation with your Secretary of State. The articles of incorporation would call for the organization’s name, the purpose of the nonprofit and a designated registered agent to receive lawsuits and correspondence on behalf of the organization.

Other requirements when forming a nonprofit corporation include appointing a board of directors to make decisions about the organization’s activities, finances and legal compliance and drafting bylaws that regulate the board’s management and activities. The board of directors would also approve your compensation as the executive director or CEO of the organization, including your salary, health insurance and paid leave.

3. Apply for tax-exempt status with the IRS

You would need to submit IRS Form 1023 to apply for tax exemption under the 501(c)(3) code. Additionally, you would need to include a statement of your receipts and expenses, a copy of your articles of incorporation, a written description of your organization’s activities and a copy of your bylaws. You may need to apply for tax exemption at the state level as well.

For instance, nonprofits in California must file Form 3500A with the California Franchise Tax Board to be exempt from state income taxes. Organizations in Texas need to file Form AP-204 with the Texas Comptroller of Public Accounts, while nonprofits in Florida must submit Form DR-5 to the state’s Department of Revenue.

Timing is key when forming a nonprofit and requesting 501(c)(3) status, Takagi said. Make sure your organization is compliant as a nonprofit — meaning you have a charitable purpose, board members and bylaws in place — as soon as you make the entity conversion. This could help you avoid getting turned down for tax-exempt status and owing taxes to the IRS, he said.

4. Decide what to do with your business assets

After you convert a for-profit corporation to a nonprofit organization, all existing business assets would be held in a charitable trust, which means assets could only be used for the organization’s charitable purposes going forward. Intellectual property could be included as well, such as books, music or art.

You could take assets out of the business before making the conversion if you want to limit the assets that are put into the nonprofit, Takagi said. Then, any assets you decide to put into the nonprofit at a later time could be categorized as a charitable donation.

If you’re concerned about a delay in receiving tax-exempt status, you may not want to lock all of your assets in a charitable trust right away. You could form a separate nonprofit and continue running your business to maintain access to your assets, Takagi said.

“It might be more practical in some cases to not convert but run them side by side for a little while,” he said. “Then either merge or dissolve the company and then donate assets to the nonprofit at that time [when] you already know the nonprofit has 501(c)(3) status.”

5. Set up your fundraising strategy

Once you no longer run a for-profit business, you must begin collecting charitable donations to keep the operation afloat. Nonprofits need to generate a profit, despite their title, but those profits must be reinvested in the organization rather than distributed to owners and shareholders, as a business would do.

State laws regulate fundraising activities. You may be required to register with a state entity before you begin soliciting donations from local residents, and you may need to register in multiple states if your donor base crosses state lines. For example, nonprofits in North Carolina must obtain a license from the Charities Division of the Secretary of State’s office. Depending on your state, you could be required to renew your registration each year to continue legally accepting donations.

Private and public grants and individual donations are common funding avenues for nonprofits. Donors would likely want to understand the organization’s mission and target market before giving money. A misconception about the nonprofit sector is that organizations can easily secure money with few strings attached, Asare said. However, donors often scrutinize nonprofits before making a contribution.

“Nowadays, there aren’t many places you can get money without the expectation that organization is making an impact,” she said.

Donors could be suspicious of a nonprofit that was formerly a for-profit business, Asare said. Be prepared to explain how you plan to spend donations to show you’re not seeking personal financial gain.

“I think a good measure would be looking at what percentage of the dollar is going to the services and programs,” she said. “This is something donors are interested in and they will ask.”

Ongoing requirements after making the switch

After you’ve made the change from for-profit to nonprofit, you’d need to meet ongoing requirements to remain compliant as an organization. From filing certain tax forms and reports to paying particular taxes, here are some requirements to keep on your radar:

Form 990: Most tax-exempt organizations are required to file IRS Form 990 each year. Nonprofit entities must describe the organization’s activities, governance, financial information and accomplishments to justify its tax-exempt status.

Organizations that have generated at least $200,000 annually or have assets worth at least $500,000 must file Form 990 yearly, while organizations with fewer assets and a lower income can file Form 990-EZ, a shorter version of the form. Form 990-N, which is even shorter, is available to nonprofits with gross receipts of $50,000 or less.

Employment taxes: Nonprofits with employees must pay employment taxes, which include federal income tax withholding and Social Security and Medicare taxes. You could be responsible for federal unemployment tax as well.

State filings: States often require nonprofits to file reports each year. These reports could include corporate filings, financial reports, fundraising registrations and state tax-exemption forms. Failing to file annual reports with your state office could result in penalties or loss of your tax-exempt status.

The requirements for nonprofits may seem excessive, but policies are in place to ensure that organizations are honest about how the program uses donated money, Asare said. Compliance standards act as a safeguard to make sure money is going toward services and not into the pockets of the people in charge.

“The window is closing on some of that bad behavior,” she said.

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Guide to Small Business Funding for Women

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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As the number of women-owned businesses grows across the U.S., women entrepreneurs are increasingly in need of funding for their businesses. While there aren’t specific small business loans for women, there are many lenders and organizations that offer small business help for women entrepreneurs, including SBA loans, term loans and business lines of credit, among other resources.

Small business loans for women: 3 options to consider

SBA loans

Best for: Businesses looking for long-term financing and businesses struggling to get loan approval.

The Small Business Administration (SBA) offers small business help for women that includes business training, counseling and assistance in accessing financing. The SBA can also help you if other lenders have deemed your business too risky. Since SBA loans are guaranteed by the Small Business Administration, lenders may be more likely to approve your application and even offer lower interest rates and longer repayment terms.

The SBA offers multiple loan types, with amounts ranging from $500 to $5.5 million. Requirements to qualify for each loan type are unique, and eligibility varies depending on the lender and the loan program. However, SBA loans are available for most business purposes.

Term loans

Best for: Businesses that can clearly project how much cash they’ll need or for startup capital when a business doesn’t want to forfeit any ownership to an investor.

A term loan is a typical loan arrangement that allows you to borrow a lump sum of money and pay it back in installments, with interest. Interest rates and other fees can vary greatly from one lender to the next, but you’ll likely need to present your business plan, expense sheet and financial projections in order to apply for a term loan at any bank or credit union.

Some lenders are committed to offering small business term loans to women. Learn more about these lenders and their loan product options below.

Business lines of credit

Best for: Businesses that need ongoing access to capital or that have an open-ended project.

A business line of credit is an account that allows you to draw money up to a set limit. Similar to a credit card, each time you pay down your balance you can draw up to the limit again, and fees and interest payments are based on your account balance. Unlike business credit cards, which generally have higher interest rates, business lines of credit tend to have lower interest rates and allow you to make cash withdrawals without any limitations and write checks from your account.

You can take out a business line of credit through a bank, credit union or online lender. Qualification is based on your personal credit.

5 best small business loans for women

To select the top five small business loans for women, we looked at a number of lenders and chose a mix of online and traditional bank lenders. While traditional lenders may be more difficult to qualify for, the two we have listed are among the most active SBA lenders, making them a potentially compelling option for women business owners.

Additionally, the lenders we selected had to meet the following criteria:

  • Transparent websites. These lenders clearly list necessary information on their websites so small business owners can easily find what they need.
  • Wide range of amounts and term lengths. Many of these lenders offer a range of loan products as well as amounts and term lengths, which means they can cater to a range of small business owners’ needs.
  • Lender credibility. These lenders have all been in business for at least a decade and have established themselves in the space through things like positive customer reviews and high approval counts.

1. Kabbage

Type of financing

Rate

Amount

Min. credit score

Best for...

Business line of credit

Monthly fee is 1.25% to 10.00% of principal

Up to $250,000

None

Ongoing access to capital

Although Kabbage often refers to its financing product as a loan, it is technically a line of credit, one the company says is commonly used by women business owners for inventory purchases, office expansion, marketing campaigns, equipment purchase and hiring employees. Kabbage’s monthly fees for business lines of credit start at 1.25% and are only charged based on the amount you draw.

Kabbage offers a simple online application process, and you can manage your line of credit account from a mobile device.

2. Smartbiz

Type of financing

Rate

Amount

Min. credit score

Best for...

SBA loans

5.04% to 10.29% APR

$30,000 to $5,000,000

650 for a $30,00 to $350,000 loan

675 for a $500,000 to $5 million loan

Faster processing on SBA loans

According to Smartbiz, 30% of its 7(a) SBA loans are granted to women-owned businesses. The national average is only 14% for SBA lenders.

Smartbiz helps expedite the application process by submitting your application to an online marketplace of multiple SBA lenders at once. Prequalification is available within five minutes, and funding is available in as few as seven days upon approval.

3. Wells Fargo Bank

Type of financing

Rate

Amount

Min. credit score

Best for...

Equipment Express Loan

5.50% to 9.50% APR for vehicle loans

6.00% to 12.25% for equipment loans

$10,000 to $100,000

Not disclosed

Purchasing vehicles or equipment

In 2013, Wells Fargo Bank committed to lending $55 billion to women-owned businesses by the year 2020. The bank offers several small business loan products, including its Equipment Express Loan. The interest rate on the bank’s secured vehicle loans starts as low as 5.50%.

However, you’ll need to be an existing customer of the bank to apply. Wells Fargo small business loans are only available to customers who have had a checking or savings account with the bank for a minimum of one year.

4. Celtic Bank

Type of financing

Rate

Amount

Min. credit score

Best for...

Express Loan

Variable

$20,000-$150,000

Not disclosed

Wide variety of loans

Celtic Bank is perhaps best known as an SBA lender, but the Utah-based lender offers a variety of loans well-suited to all types of businesses, small to large. The Celtic Express loan offers loans between $20,000 and $150,000 for up to 120 months.

To be eligible, the business must be a for-profit, owner-operated enterprise. Loan proceeds may not be used for construction or tenant improvements. Newer businesses are considered, but you must have a location identified and be able to start operations at funding.

5. OnDeck

Type of loan

Rate

Amount

Min. credit score

Best for...

Short-term loan

11.89% APR and up

$5,000 to $500,000

600

Business owners with lower personal credit scores

OnDeck is an online lender that has funded over $6 billion in small business loans for women. The lender offers business loans for women with bad credit, with a minimum credit score requirement of just 600. However, its APRs start relatively high, at 11.89% and up.

In order to qualify for a loan with OnDeck, your business must be at least a year old and earn at least $100,000 a year in revenue. Those who qualify may receive funding within as little time as 24 hours.

Alternative financing options for women-owned businesses

Grants for female business owners

Small business grants can provide you with funds to start or expand your business — and, unlike loans, they don’t have to be repaid. Grantors who fund women-owned businesses include the federal government, local governments and private funds. The amount of money available and the requirements to qualify will vary depending on the source of the funds.

Here are a variety of women-owned business grants to consider:

  • Amber Foundation Grant.Grants of $4,000 are awarded on a monthly basis to women-owned businesses of all kinds. Monthly grant winners are eligible for an additional $25,000 grant at the end of the year.
  • Cartier Women’s Initiative. This grant is for women-owned, women-run businesses focused on sustainable social and/or environmental impact. Applicants in a select group receive one-on-one business training and cash awards of $30,000 or $100,000.
  • Girlboss Foundation Grant.Grants are available up to $15,000 for women entrepreneurs working in the areas of design, fashion, music or the arts.
  • NASE Growth Grants. The National Association for the Self-Employed (NASE) offers $4,000 grants for female business owners. You must become a NASE member to apply.
  • SBA. Though there technically are not Small Business Administration grants for women (or anyone else), the SBA does facilitate federal grants for all types of business owners through the Small Business Innovation Research and the Small Business Technology Transfer programs.

Equity financing opportunities

Venture capital firms and individual investors, sometimes known as “angel investors,” differ from lenders. Instead of offering debt, these venture capitalists offer to make a long-term investment in your company in exchange for equity. They may also require some form of ownership and/or a seat on your company’s board of directors.

Here are some investing groups and firms that cater to women-owned businesses:

Additional resources for women-owned businesses

  • SBA Women’s Business Centers: The SBA offers over 100 office locations throughout the U.S. where women can receive free training, workshops, mentorship and more. Use the SBA directory to find your nearest location.
  • Women-Owned Small Businesses (WOSB) Federal Contracting Program: This federal program sets aside contracting opportunities for women applicants in industries where women’s businesses are underrepresented or disadvantaged. Those industries include construction, manufacturing, publishing and more.
  • National Women’s Business Council (NWBC): This federal advisory committee advises the president, the U.S. Congress and the SBA on matters affecting women entrepreneurs and women-owned businesses. The NWBC hosts round-table events around the country to gather input and promote women’s STEM-focused and rural-owned businesses.
  • DreamBuilder: This free online program offers interactive courses for women on how to start, build and finance your business. Courses are available in Spanish and English.
  • National Association of Women Business Owners (NAWBO):NAWBO is an advocacy organization that promotes networking events for women entrepreneurs, provides online resources and has local chapters throughout the U.S.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.