Starting a Business for Micro and Hybrid School Entrepreneurs Part 2: LLC or Nonprofit?

In Part 1, we discussed whether you will be starting your program as a legal school or as a homeschool supplement. If you chose legal school, you will be following your state law for how to establish a school. If you did not, you are starting a business that operates outside of Department of Education regulation and you can essentially make it what you want. But the next question is usually…”How do I start a business?!” followed quickly by, “Do I make it a nonprofit or LLC?”

Now, both of these are businesses that can be started by filing a piece of paper with the state, getting an Employee Identification Number (EIN) from the IRS, and opening a business bank account. However, they are VERY different - for the founder especially.

A nonprofit is called that because the founder is NOT the owner and can NOT profit from the business. This does not mean the business itself can not run a ‘profit’ (have money in the bank, revenues exceed expenses), it means the money must stay with the business. Further, the founder can NOT govern the business-not legally anyway- while even drawing a paycheck. I’ll get back to this, but first let’s contrast this model with a Limited Liability Company (LLC). An LLC is a business that protects the personal assets of the founder/owner by creating an entity that is not the person himself (a sole proprietorship IS the person himself), but the business DOES belong to the owner and the owner CAN keep profits.

An LLC owner must pay personal or corporate taxes on any ‘profit’ the business makes. A nonprofit does not need to pay taxes and the profit stays with the business.

An LLC is simple to start. Essentially, it is incorporated with the state through a fairly simple filing, the founder then gets an EIN from the IRS, opens a business bank account, and starts doing business. Expenses can be written off and any profits can become the ‘pay’ the owner gets (subject to personal tax). There is also an option where the owner can put herself on payroll and collect a salary, have personal taxes withheld as with any job, and any remaining profit stays with the business and is subject to a corporate tax. That’s about it.

A nonprofit is a lot more complex. The fact that there is no owner means someone else who gets nothing in reward has to run the business. This is the charitable aspect of nonprofits and this neutral governing team is the Board. The Board is a group of volunteers who are responsible for compliance (legal and financial duties), appointing the executive team or person and keeping them accountable, and strategizing for the success of the organization.

The Board is governed by Bylaws, which act as a sort of Constitution if you will. The founder files as a nonprofit with the state to create the business entity (fairly simple), and then must collect Board members, who will then begin to carry out their duties including approving bylaws, etc. Within 27 months, the organization can then apply to the IRS for 501c3 status with a fairly complex form that will likely need an accountant’s help to complete.

So where is the founder in the nonprofit? Sometimes the founder will choose to serve on the Board. This way she gets a vote (but only one!) in governing decisions. Many times, however, the founder, since she has the heart and vision and energy for this mission, ends up doing the actual operational work. (Note that the Board should NOT be doing operational work! While in many nonprofits that are funded by donations and run by volunteers, the Board will often do a lot of volunteering and fundraising (and they should be!) it would be wise to have teams and committees responsible for different things to prevent burnout and keep things organized, but legally the Board is really only responsible for governance). In this case, burnout is a very real thing since it is essentially a full-time job to do operational work, and few people can work full time without pay! In this case, the founder often becomes the Executive Director, subject to Board oversight, but is able to be on staff as a paid employee.

In a hybrid or micro school, there are usually employees and there is usually tuition. A program can survive just fine without fundraising, in fact, as long as it is setting tuition such that operational costs are covered so a Board may not need to spend as much time with fundraising as some other nonprofits would require (that said, one of the major reasons you might start a nonprofit and not an LLC is exactly because you can use volunteers for some work and can fundraise or apply for grants!)

Because there are employees, it should be even easier to separate the duties of the Board out from operations than it is in nonprofits staffed entirely by volunteers. The Board should be strategizing the direction of the organization, evaluating and appointing the top one or two staff people, and making sure all legal and financial transparency and compliance is taken care of. But staff hiring, student and family management, curriculum management, events, and everything else that goes into daily operations should be carried out by staff.

A founder who ends up as head staff person can still attend Board meetings (but not vote), and there is a risk that the Board can take the organization a different direction than she intended, fail in their duties (making the organization non-compliant or burdening the founder with things she should not need to worry about), or even fire her. These things do happen and they can be very heartwrenching or burdensome for a founder. The good news is that proper education for the founder and the Board from the very beginning can lower this risk considerably. One of my top recommendations for brand new founders is to make sure you advocate for your own worth in a paid position (or hire someone and serve on the Board) and to TRAIN THE BOARD from Day 1 and consistently from then on.

A final note is that another reason a micro or hybrid school may choose a nonprofit over an LLC, besides the donation and grant advantages, is that they will often use church buildings to meet. In many states, a church can run into some trouble with its own tax exempt status if it collects rent from an LLC. Becoming a nonprofit can ease this and open up many more facility options if a church size is needed. If not, an LLC can certainly be a much simpler and ‘safer’ model of educational business.

Do your research and choose wisely and with the future in mind!