I recently had a conversation with a friend who’s just been accepted into the Y Combinator startup seed fund. His organization, as is typical of the Y Combinator program, was given a very modest sum of money (less than $20,000). In exchange for acceptance into the program, he and his co-founder quit their jobs and worked full-time on their startup for three months. While chatting with him about his efforts, I got to thinking about some differences between non-profit startups and for-profit startups.

People talk a lot about the challenges of being a startup organization. They’re typically talking about traditional, shareholder-based for-profit companies. While a lot of the anecdotes of the startup world are useful to anyone who takes bold risks, lots of the popular lore about traditional startup organizations has baked-in assumptions that don’t translate well to non-profit startups.


Non-Profit?


By “non-profit” I mean 501©3 public charities or organizations that would likely be 501©3 public charities if they filed the necessary paperwork. Our organization, LocalWiki, is a 501©3 non-profit startup.

One big misconception about non-profit organizations is that they “don’t make money.” After all, they’re called “non-profits,” right?

Well, a non-profit organization can have a tremendous amount of revenue and even profit — though profit is usually referred to as a surplus or reserve. Unlike most conventional organizations, non-profit organizations exist solely to further a mission, not to enrich a set of people or earn a profit. This mission-driven focus has an effect on how the organization brings in revenue: You don’t want money just for the sake of having it — you want money because it can be used to further your organization’s mission.

For certain kinds of organizations — like those whose work centers around communities, education, sciences, or the arts — being a non-profit provides a familiar and trusted organizational structure. For the most part, people give money to these organizations because they believe in the organization’s mission — not because they want to purchase a particular product or service. There are non-profits who provide a paid product or service, but typically that product or service has an over-arching social, educational or artistic value (such as a ballet).


What You Get When You Give


One big difference between non-profits and traditional organizations is what the individual or group giving the organization money “gets” out of the transaction.

Typically, in a for-profit organization, someone will give the organization money and in exchange they’ll either get a widget/product of some sort or a share of ownership in the organization.

People give money to non-profit organizations because they want the organization to sustain itself or they want the mission of the organization to be furthered in some way. They may be purchasing some sort of service or product, but that thing is very connected with the charitable purpose of the organization — something, again, that’s got some kind of over-arching social, educational, scientific or artistic value.

No one can ever give a non-profit organization money and in exchange get a share or portion of that organization. Non-profit organizations don’t even have “owners” in the traditional sense — non-profit organizations are called “public benefit” organizations, and if a 501©3 organization folds, it’s generally forbidden from transferring its assets to an organization that won’t use those assets for a charitable or educational purpose. It’s essentially “owned” by the public as a whole. That’s the idea, at least.


Early-Stage Funding


This inability to “sell off” ownership of the organization in exchange for money creates a very different dynamic in the way that early-stage funding works.

Once an organization is established, you want to have a revenue stream. You want to have an idea of what you need to do to maintain that revenue stream, what you’re going to do to change that stream — and that stream should, in the future, bring in more money than you spend.

The main differentiator for non-profit startups versus for-profit startups is that the majority of for-profit startup organizations rely heavily on a funding arc that sees them get a small amount of initial “seed” funding and then hunker down and work as hard as they can to have a minimal viable product. This minimal viable product isn’t intended to sustain the organization (though, in exceedingly exceptional cases, it does); rather it’s meant to attract serious investors. In the startup world, this is typically called a Series A round. It can be anywhere between $1 million and $20 million.

This Series A allows them to then hire lots of people, obtain fancy office space, and provides a runway of maybe a year or two to demonstrate either a revenue plan that brings in more money than is spent (and pay out investors), or to develop a plan to expand the organization as quickly as they can in order to take it to the next stage and then obtain a Series B round. You see the ladder all the time — organizations such as Facebook have six distinct rounds of funding without ever having to demonstrate that they are a sustainable organization.


Effect on Funding Perception


With a for-profit startup, the way people typically think about funding is that you get a little bit of money and you work really hard and then someone cuts you a check for $500,000. Then you run off and, after a while, get another round of funding. There’s a popular perception of how much money is enough, early on, to get an organization started. And that perception doesn’t translate well to non-profit startups.

Why doesn’t it translate? It’s simple: Because non-profits can’t sell shares of their organization for money, they can’t quickly raise large amounts of money based on future promises. While established non-profits may have relationships with foundations and high net-worth individuals who can donate money for new programs or emergency funds, startup non-profits typically don’t have such outlets.

But what about grants? Aren’t those sort of like VC funding for the non-profit world? When you get a grant as a non-profit you’re acutely aware of the fact that at the end of the funding cycle you’re not able to simply go out and sell some portion of your organization to someone in exchange for your next round of funding. The end result is that non-profit startups have to be focused on organizational sustainability much earlier than for-profit startups.

Now, there are for certain non-profits that are more like these traditional VC funded startups in that they have a large amount of money from the outset. The Bay Citizen, a non-profit journalism startup, received a $5 million seed grant from philanthropist Warren Hellman for their first year in operation. However, as a public charity, the Bay Citizen can’t continue to take in the majority of their revenue from a single source for very long or they risk losing their public charity status. So, even a non-profit startup with strong, committed backing by a high net-worth individual will need to shift toward sustainable fundraising relatively early on.


Questions


I’ll end this post with a few questions:

What effect does this early focus on sustainable revenue have? In what cases is it a hindrance to accomplishing a charitable mission? It what cases does it assist in accomplishing a charitable mission?

Share your thoughts in the comments.