Angel investors and venture capitalists don’t invest in non-profits. The simple reason is that it’s impossible to make money for investors when the goal of the company is to not make money. Yet I still get this question on a regular basis, so I’ll try to outline the considerations in common-sense terms.

A non-profit organization is generally defined as an organization that does not distribute its surplus funds to owners or shareholders, but instead uses them to help pursue its goals. Examples include charitable organizations, trade unions, and public arts organizations. In the US, a non-profit is technically any company who qualifies as tax exempt through IRS Section 501(c).

Obviously, these companies still need money to get started, or finance growth, just like a for-profit company. What options do they have available to them, since they can’t sell a share of the company (no equity investment)?

1. Individual and institutional donations. For a non-profit, bootstrapping is self-funding from donations and fund-raising. The advantage is no time and effort is spent searching and preparing for the other alternatives, and no repayment terms or collateral are required. There is no discussion of equity, or return on investment.
2. Loans from a bank or other financial institution. Non-profits can apply for a bank loan or line-of-credit, just like any other individual or company. However, like anyone else, they will first need some collateral, or someone to guarantee the loan, and some evidence of a viable business, like receivables and inventory.
3. Personal loans from individuals, employees and board members. Personal loans are certainly an option, but should be avoided if possible. As in any company, they can lead to employee problems, or messy legal issues. A non-profit can also issue bonds to board members and members as a way of borrowing funds from those same people.
4. Government grants. The grant source often gets overlooked, but it should be a major focus these days when relevant due to the Obama administration initiatives on alternative energy and healthcare. The down side here is that real work is required to put in a winning application, and the award may be a long time in coming.
5. Private endowments. This is a funding source for non-profits that is made up of gifts and bequests subject to a requirement that the principal be maintained intact and invested to create a source of income for an organization. Endowments are usually limited to a specific area of interest by a philanthropist, and have many qualifications, so be careful.
6. Bartering services. Bartering occurs when you exchange goods or services without exchanging money. An example would be getting free office space by agreeing to be the property manager for the owner. This could work to get you legal or accounting services, but won’t get you cash to pay employee salaries.

Hopefully you can see from this list that the people and processes involved in financing a non-profit have little in common with angel investors, or the venture capital process. You still start the process with a business plan, but then you look for a philanthropist rather than an investor.

Some non-profit entrepreneurs think they can skip the whole plan, rather than just the sections on valuation, equity offered, and exit strategy. All other sections, starting with a definition of the problem and the solution, opportunity sizing, business model, competition, executive team, and financial projections, are just as critical for non-profits as for-profits.

A non-profit is still a business, maybe even tougher than for-profit to run successfully, so the best angel is a great entrepreneur at the helm for fund-raising, as well as operations. In addition, the best non-profits turn out to be the angel, rather than require one. That’s a higher calling.

A common misconception I often hear in the startup world is that non-profits are easy and safe, since they don’t have to pay taxes, and they don’t have to make a profit for their shareholders. In reality, from the feedback I get from non-profit executives, exactly the opposite is true.

Colloquially speaking in the United States, a non-profit corporation or association is one which has been exempted from Federal income taxes by meeting the criteria set out Section 501(c) of the Internal Revenue Code, most notably religious, educational, and charitable entities. Other countries have similar exemptions for similar organizations.

Yet even a non-profit has to make a profit on everything it sells, in order to cover operating expenses (salaries, offices, equipment, research, travel, etc.), unless it relies wholly on donations. Even then, the business and leadership efforts to solicit and manage donations cost real money, and may be more difficult than the marketing and sales jobs of most startups.

Here are the common reasons I hear that make starting and running a non-profit actually more difficult than starting and running a conventional business:

1. Creating a non-profit 501(c) business is a long and arduous process. You can start an LLC for-profit in less than a month, often for less than $100. A non-profit 501(c)(3) status requires filing IRS Form 1023. The form must be accompanied by an $850 filing fee, and may take as long as two years to complete successfully.
2. Professional investors are not interested in non-profits. Even non-profits usually require startup funds for facilities, people, and inventory. But because they can’t project excellent returns on investment, no investors will likely be interested. That means you need to grow organically, find a philanthropist or solicit donations early.
3. Reputable non-profits need to keep their operating expenses low. This usually means keeping wages low, and no fancy facilities. Thus it’s hard to attract top-notch talent, premium locations, and first-class marketing campaigns. Managing volunteers, and running any organization with these constraints is a challenge.
4. Results are always subject to public scrutiny. Most startups, as private companies, don’t have to disclose their salaries and spending habits to anyone other than the IRS. Non-profits have to answer to watchdog organizations like Charity Navigator for how much of their proceeds actually make it to the causes they proclaim to support.
5. Some laudable non-profit missions are hard to sell to supporters. A common complaint from many non-profits is that both government and private funders would rather spend their dollars on ‘sexy’ causes such as children’s charities, cancer, and heart disease, rather than long-term causes like global warming and erasing hunger in Africa.

Unfortunately, misuse scenarios, like the lavish lifestyles of leaders and scams, have given the non-profit environment a bad name, making things even tougher. Organizations supposedly supporting veterans, the police, firefighters or children are particularly suspect, with real but not impressive data like the following from a recent Charity Navigator report:

Despite these challenges, my advice is still to follow your heart and your passion when starting a business. You shouldn’t choose a non-profit, or a for-profit, because one seems easier, or one can make more money. Do it because you love the cause, the service, or the product, and the challenges will get lost in the satisfaction you feel along the way.