I think the essential question here bears further clarification: what does it mean specifically that nonprofits are different than for-profit entities, and what are the ramifications of those differences?
One might argue that the essential lack of a profit motive is one factor that makes the nonprofit sector different. In the for-profit world, the profit (or net income) line serves the purpose of delivering value to owners and investors. It may be a logical trick (feel free to comment as you see fit), but I tend to see Net Income analogous in the for-profit world to something Contingere calls "Value of Benefit Delivered." In the nonprofit world, donors are really investors - they are looking for a return on their gift; just not in dollar terms, but in terms of delivering benefit to a cause, mission or institution they care about. The Value of Benefit Delivered is therefore the amount of each donated (invested) dollar that fulfills the need (return) required from the donor.
It is important to note that an investor in a for-profit company doesn't expect to be paid out of the Revenue line or even the Gross Margin line - a savvy investor understands that it takes money to build strong companies worthy of investment. Simplifying a bit, the investor is therefore paid out of the Net Income line - what's left over after the sales are made and the costs of paying for a strong, sustainable company have been paid.
I think nonprofits (and the regulators and 3rd party watchdogs looking over their shoulders) should rethink a critical point: are client programs, research, advocacy costs, capital costs of opening a new school at a university, etc. General and Administrative expenses? I for one don't think so, because, and I think this is the critical shift in thinking - those items listed are the return the investor seeks. Therefore, rather than counting those direct mission delivery costs as General and Administrative expense in a traditional income statement, these direct mission delivery benefits are paid for by the net income generated by the nonprofit.
If you think about the investor's (or donor's) motivation, it is to spend their money to realize some return - the difference between the for-profit and the nonprofit sectors is that the for-profit return is measured in dollars, while the nonprofit return is measured in a sense of doing good through the Value of Benefit Delivered (plus a nice tax write-off).
This leads to a second difference, and this is truly a difference that works to the detriment of the nonprofit industry: the lack of transparency in financial reporting from nonprofits - there are reasons only 25% of the U.S. public believes the organizations in the nonprofit sector do a "very good" job of supporting their respective missions, and one of the most onerous is this lack of reporting transparency.
In publicly traded companies - and I think we should consider, given the amount of money flowing to the nonprofit sector and their preferential designation in the tax codes, that they should be measured by a standard of transparency more like publicly- rather than privately-held companies - detailed, audited financials following very strict guidelines should be in place to ensure appropriate levels of transparency. The nonprofit sector can either voluntarily adopt these guidelines or have them mandated by various regulatory agencies; if given a choice I would always pick to choose my future rather than have someone else do it for me.
Many on the for-profit side are nodding their heads vigorously (one wealthy individual said to me that the reason he only donates to capital campaigns is because he knows exactly where his money is going). Others may be saying "What? There is an issue with the way nonprofits report their financial results?" For those in the latter group, try an experiment: ask an executive in the nonnprofit sector how much of each dollar you donate goes directly to mission delivery - the chances are very high they will say something like "our cost of funds raised is [a number between 10 and 25%]
So what's going on here? Are the nonprofits misleading us? While one could argue that 75% of the American public think so, I would argue that, no, nonprofits are just following IRS guidelines regarding how their financials may be reported to retain their nonprofit designation. More importantly, they are using this "loophole" as a basis for reacting to a groundswell of criticism from 3rd party watchdogs about those "financials." The nonprofit sector has lost the initiative with respect to transparency, and therefore are on the defensive about ratings posted by organizations such as CharityNavigator.com (we'll have LOTS MORE to say about them in an imminent post).
The problem here is that as businesspeople we think this is a very straightforward question: take the revenues you generate each year, subtract the Cost of Funds Raised (Cost of Sales), subtract General and Administrative expenses, leave an amount for reserve (Retained Earnings), and what is left over should be the value of the benefit delivered. Simple, right?
Not really, for two reasons. The first reason is that the IRS allows for something called Functional Allocation - so someone whose entire job is to raise funds can allocate part of their salary to Education and Awareness (a Direct Benefit Delivered), because they can count x% of their time spent talking about the organization as Education and Awareness; if a brochure for a fundraising event talks about the organization, then only part of the cost of that brochure counts as fundraising costs. So nonprofit fundraising costs, if you remove this "functional allocation" allowed by the IRS, are substantially higher than what is currently being reported.
To give the for-profit analogous situations, I have sales people who talk about our company all the time - I do not divide their time between selling and "Education and Awareness;" similarly, the full cost of a brochure goes into my marketing line under operating expense. Period. But over 3,000 nonprofits that generated $250K or more in philanthropic giving in a recent study reported absolutely no fundraising costs. Manna from heaven . . .
The second reason for explaining this lack of transparency is that, if a nonprofit must count Value of Direct Benefit Delivered costs in G&A, then the costs of funding the mission as an ongoing concern are intermingled with the costs of delivering direct support for the mission.
We'll talk more about this issue of transparency; in my opinion nonprofits should report their financial results (in addition to the manner mandated by regulators) in the form of
Revenue
- True all-in fundraising costs (no functional allocations)
---------------------------------
Gross Income
- General and Administrative Expense (excluding true mission delivery costs)
- Strategic Initiative costs (analogous to "Capital Expense")
- Management Reserve
---------------------------------
Funds available for direct mission delivery (Net Income in the for-profit world)
- Total Value of Direct Benefit Delivered
---------------------------------
$0
A final difference for now (we will discuss more, but these are the cornerstone issues) is the perception that the for-profit world is full of savvy businesspeople motivated by money, but the nonprofit world is full of people, typically with lower levels of experience, that are very mission-driven, without a profit motive. Steve Wozniak, the inventor of the Apple and Apple II computers, had no desire to make money or build a big business - he just wanted to build cool things; that sounds pretty mission driven to me. I can tell you from experience that I have worked for and with very savvy business executives; I have also worked for and with business executives who couldn't read a financial statement to save their company (literally).
I've also seen senior nonprofit executives who have little visibility beyond their narrow silos of concern, be it special event fundraising, direct mail fundraising, etc. to understand how their efforts integrate and support the larger efforts of their nonprofit as a whole. On the other hand, I have worked with very strong, savvy nonprofit executives who understand their business, the rapidly changing business environment in which they must operate, and are searching, just as GE and P&G are searching, for growth in an increasingly competitive and difficult market.
So in the end, philanthropy is a business - an interesting and very unique business, but a business nonetheless. And it is a business funded by people from the for-profit world - and the more successful the for-profit businessperson, the more support s/he provides to the nonprofit.
We think, therefore, that it is time to quit explaining why nonprofits are different than for-profits, and rather spend time bridging the gap between the two. Because the nonprofit sector is serving a critical role in the economic landscape that no other entity, be it government or private industry, is willing to fulfill, and it needs the dollars earned by savvy investors in the for-profit world to provide the financial resources for support. These two constituencies must come together with a common understanding of the economics, issues and mechanics of the nonprofit industry if they are to effectively partner to fufill the needs required of the sector. I also think that to create arbitrary distinctions between what nonprofits do and what business does defeats the goal of a common understanding so necessary to secure and ensure the financial support the sector requires.
For the greater good . . .
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