This is a longer version of an essay titled "The Nonprofit Motive" that was published in the April 7 issue of The Stranger.
Success or Failure
What if the Golden Rule were actually enforced?
What if we had to do unto others as we would have them do unto us? For one thing, there would no longer be a need for nonprofit organizations. There would be no need for an Anti Defamation League if there were no anti-Semitism, no need for an NAACP if there were no racism. No need for the Habitat for Humanity if there were no housing disparity, no need for the United Way if communities cared for one another, no need for arts centers if we valued artists, less need for emergency rooms if we didn’t shoot each other. As Lenny Bruce said cynically, “Without polio, Salk was a putz.”
But there is polio, and Jonas Salk was a hero. There is racism. There is housing disparity, there are people starving, there is illiteracy, there is a dearth of arts and culture. We shoot each other.
Alexis de Tocqueville, visiting the US in 1835, described our early “civil associations” (the precursor of the modern nonprofit) by saying that through them “the heart is enlarged, and the human mind is developed only by the reciprocal action of men upon one another.”
“There is nothing,” he continued, “that deserves more to attract our regard than the intellectual and moral associations of America.”
So eleven score years ago we brought forth not only a new nation but a new way of thinking about how people organize themselves. In 1865 Massachusetts codified one of these new structures and granted a charter to the first nonprofit corporation in the world (for the extra credit point, it was Harvard University, founded in 1636 but “emancipated” from the state in 1865). It was an entirely new way of thinking about business—as an ownerless, mission-driven entity that worked not for the glory of a man but for the glory of mankind.
So, two hundred years later, who works for these associations, these nonprofits? Who answers the call of renowned inventor, educator, thinker, and futurist R. Buckminster Fuller when he asked: “If [the] success or failure of this planet and of human beings depended on how I am and what I do… How would I be? What would I do?”
The people who live their lives in the context of these questions are the people who treat the Golden Rule as a rule. They’re the people who staff the world’s nonprofit corporations. These are the doctors working at hospitals, the educators working at schools and universities, the artists and administrators at our cultural institutions. These are the people who clothe the naked, feed the hungry, and house the homeless. These are the people who organize religion, who advocate for the health of the planet, whose experimentation and exploration expands our understanding of the universe.
The nonprofit corporation is the structure the world has for organizing these people. It’s the business structure currently available for this type of work.
And nonprofits are in trouble. Both from within and from without, there are pressures being exerted on nonprofits that they were never built to withstand. When the IRS and federal incorporation laws codified the nonprofit structure in the 1920’s and 1950’s, it was expected that nonprofits would operate differently from other corporations, that their funding structures would differ from normal corporate income streams, and that their hierarchical structures would differ. It was assumed that these differences would benefit the nonprofits. But today’s nonprofits are being hamstrung by the differences; in the worst-case scenarios, they are being destroyed by the differences. And if you like the idea that there could be businesses in the world that make decisions based on mission, not on profit; then this is important.
The Senate Finance Committee, lead by Senator Chuck Grassley (R-Iowa), is currently weighing input on how to best institute nonprofit sector reforms both at the level of federal law and IRS code. Representative Bill Thomas (R-California) chairman of House Ways and Means, recently completed a series of hearings on whether tax exemption was even justified for many nonprofits. Charles Rangel (D-New York) has challenged nonprofit universities and nonprofit hospitals as unjustified exemptions (he has a point—other recent studies cited by his committee show that for-profit hospitals actually performed more charitable work than their nonprofit counterparts in the period studied.
So an understanding of nonprofit structure, and an understanding of the future of this form, is anything but an academic exercise. We will, however, need to start with a bit of the academic:
You start a lemonade stand. You incorporate it as a for-profit business, like Coca-Cola or The Stranger or Enron. You own it. You’re the boss. In your first week, you make $10 more in revenue than you had in expenses. This $10 goes into your pocket (or, if you’ve got partners or investors or shareholders, into their pockets too) to be spent on candy, or CD’s, or strippers—whatever you like. You could also choose to reinvest the $10 back into the stand, buying a lemon-juicer to increase profit. In ten years, you sell your lemonade stand to Minute Maid for $10 million, and this money goes into your pocket, destined for more candy and strippers.
You start another lemonade stand. You incorporate this one as a nonprofit corporation, like the Seattle Art Museum, or Providence Hospital, or Habitat for Humanity. And because your nonprofit is doing something “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, or advancing the prevention of cruelty to children or animals” as part of your mission, you’re what the IRS calls a 501(c)3—and for the purposes of this article, whenever I say “nonprofit” let’s assume I’m referring to a 501(c)3 nonprofit. It basically just means that you’re a nonprofit that the IRS has vetted and signed off on.
So in its first week, the nonprofit lemonade stand makes $10 profit. But this isn’t your $10, because you don’t own the nonprofit. It owns itself. The $10 profit, in this case, still goes to the “owner”—the lemonade stand. This goes back to an overhaul of the federal tax code in 1954, which held up the “nondistribution of surpluses” to directors or staff as the primary definition of a nonprofit. The company, ideally, becomes stronger and stronger as it becomes more and more successful. In this way, the structure attempts to ensure that individual ego and greed are circumvented, that the greater good is served through the removal of personal gain. The lemonade stand remains driven by mission (serving great lemonade) instead of profit (lowering the overhead and quality of the lemonade to increase margins). Nonprofits are specifically designed to disincentivize the kind of profit-driven decision-making that turns a health spa breakfast food called Corn Flakes into a sugar delivery device called Frosted Flakes in less than thirty years, while creating a multigenerational Kellogg family fortune.
So what’s the advantage of choosing the nonprofit route for your business? There are tiny perks, like slightly reduced bulk mailing rates and an avoidance of some taxes, but the biggie is a golden ring we call “charitable deductibility.”
Nonprofit structure is generally chosen for businesses that are not capable of profit; businesses that aren’t even capable of breaking even—contemporary installation art, social services to the poor, health care, environmental protection, disease research, hospice care, etc. The structure exists because of, and was born out of, a belief that any business going into these areas deserves our help. So we get the grant, the donation, the donor directed investment, the appropriation, the in-kind gift, and all the other instruments that are really just other names for the tithing that was intended to make up the vast majority of a nonprofit’s funding structure.
And because we assume that “charitable, religious, educational, etc” missions generally jibe with what the government, in an ideal world, would be spending your tax dollars on—in an ideal world, the government would clothe all the naked, feed all the hungry, heal all the sick, support all cultural activities, house all the homeless, etc—you can write these donations off of your taxes. If you give $100 to one of these “exempt purpose” nonprofits, you can deduct $100 off of the income you report for your taxes (and therefore a percentage of it off of your taxes), because you’re helping make the world a better place (government’s job). Taxing that $100 would be double dipping. That’s “charitable deductibility,” and it’s why nonprofits can do the work they do for the money they earn.
Sounds like it ought to work. Except that it’s broken. The federal government is talking about how it’s broken; international funding agencies are talking about how it’s broken. Nonprofit journals and the nonprofits themselves are talking about how it’s broken. And because it’s broken but it’s continuing to run like it isn’t, the teeth are grinding off the gears and flying everywhere.
The Wall Street Journal argues (in an article by artsjounal.com editor and Seattleite Douglas McLennan) that nonprofits “are suffering from a persistent low-grade flu in the form of eroding audiences, sharply rising expenses and increased competition that may mask more serious structural problems. It may be time to wonder: Has the nonprofit business model … outlived its usefulness?”
Canaries in a Coal Mine
There are currently over 1.3 million nonprofit corporations in America, employing 11 million people with 5.7 million more working as volunteers. In other words, one in ten working Americans works for a nonprofit. In 1993 nonprofits accounted for $1.1 trillion moving through the economy, or roughly 10 percent of the GNP. So nonprofit America is serious business, with over 100 universities and colleges offering Nonprofit Management degrees and certificates (University of Washington, Seattle University, and Seattle Central to name a few locally), dozens of intra-sector support organizations, and dozens of professional journals.
Here’s a trick: Google the phrase “most nonprofits per capita” and take a look at some of the dozens of communities around America that claim the title. (Why communities would want to tout this as a selling point is beyond me, but the competition does encourage one to do one’s own research.) So, starting from scratch and taking the 2000 census numbers for the 100 largest cities in America (the cities proper, not the metro areas) from the federal government, and taking nonprofit data from IRS 990 forms filed by nonprofits in those cities (compiled by taxexemptworld.org), and dividing one by the other, you end up with a number ranging from 354 (people per nonprofit in El Paso, Texas) to 50 (the same in Washington, DC). But let’s take DC out of the running for a moment, as it’s obvious that the seat of federal government would also be a national hub for nonprofit offices (offices that may or may not provide services to Washington, D.C.). Then you have a number that ranges from 354 (for El Paso, city with the fewest nonprofits per capita) to 90 (for Seattle, Washington, the city with the most nonprofits per capita).
Interestingly, Seattle is not among the Google search results. Why wouldn’t Seattle want to tout their density of nonprofits? Either no one’s done the math this way before, or perhaps we’re not so proud of how a concentration of nonprofits affects our fair city. Our grade school class sizes are fourth largest in the nation, and our teacher salaries rank 97th out of the 100 largest cities (according to Forbes). Despite a great national reputation for biogenetic exploration, Seattle ranks 24th out of 25 major metropolises studied in quality of hospital care (according to HealthGrades) and we rank as the fifth worst city in America for nursing home care (also according to HealthGrades). Seattle ranks in the ten worst cities in America for number of homeless women and children (according to the U.S. Department of Housing and Urban Development). Oh, and just for good measure, Forbes magazine ranked Seattle as the “most overpriced city in America.” This counter-intuitive effect of nonprofits on a community is probably fodder for a whole other feature in this paper—how is it that with one of the nation’s highest densities of organizations dedicated to improving education, health, and homelessness, we rank so abysmally low in those same categories? Could a density of nonprofits actually be bad for a community? Someone should write that article.
Washington State is also one of only fifteen states in the union who are what I will call net exporters of grant money, according to my own re-crunching of 2003 numbers provided by The Foundation Center. This means that grantmakers in Washington awarded more money (collectively) than grantseekers in Washington received (collectively), by a ratio of more than three-to-one (meaning that the rest of the money was sent out-of-state). This is the second highest ratio in the country—only Nevada had a worse net export ratio.
So we have a burgeoning national nonprofit sector, and a local density of nonprofits that rivals any in the country. Yet as the sector grows, its component organizations are failing. Seattle has seen at least a dozen major implosions at local nonprofits in the last decade. Last year both ACT and Empty Space Theater had to pull the “if we don’t raise a million dollars God will kill us” act to stay alive. Recently the Union Garage Theater closed its doors, unable to raise the money necessary to meet stringent city building codes. The past decade has seen the loss of the Employment Opportunity Center, the Alice B Theater (the nation’s oldest queer theater), the Group Theater (the region’s only multicultural theater), Boomtown Café (a provider of hot meals to the homeless), the Bellevue Art Museum, the Bathhouse Theater, Travelers’ Aid, the SAW Gallery, Seattle Emergency Housing Services, 2VACT (encouraging youth participation in politics), and the Washington Literary Council, to name but a few.
Vicki Asakura, executive director of Seattle’s Nonprofit Assistance Center, says “I’ve seen the rise and fall of so many nonprofits. I’ve seen the fall of nonprofits that have been around for 20 or 25 years.”
While Seattle ranks first in nonprofits per capita, we rank nowhere near the top 10 in charitable giving to nonprofits per individual income (according to the Chronicle of Philanthropy). In a 2003 report from the Charity Navigator, Seattle also ranked worst in the country for fundraising efficiency—it costs the average nonprofit here 13 cents to raise a dollar; nonprofits in the most efficient cities do the same for under a penny. According to the same report, Seattle’s nonprofits increased expenses at the second-highest rate in the country, while their incomes grew at the third-slowest rate in the country. Not surprisingly, as a result 40 percent of our 35 largest nonprofits operated at a deficit in the year studied.
In 1999, Harvard (the first nonprofit) conducted a national study of nonprofits and found that 21 percent of nonprofit art museums operated at a deficit (the average amount was $32,000). Twelve percent of nonprofit theaters operated at a deficit. Fifteen percent of all nonprofits lost at least a quarter of their funding in the year studied. Over seven percent of all nonprofits declared insolvency and died. This compares to a corporate insolvency rate for the same period of about two percent.
For-profit companies outnumber nonprofits in America by a ratio of more than five to one, yet the nonprofits are out-dying the for-profits at a ratio of almost four to one.
This is counterintuitive, because it’s not easy to kill a nonprofit. The dissolution of a nonprofit can be a drawn-out, bureaucratic, and expensive process. The mission commitment among nonprofit stakeholders prolongs the death-spasms of dysfunctional nonprofits. Preserving failing nonprofits too is the fact that as subsequent generations of board members (remember that a nonprofit board’s “generation” is about four years) inherit the organization from others, it becomes harder and harder to be the generation that allows something to die on their watch.
So what’s killing our nonprofits? Is Seattle, and are these nonprofits, the canaries in the coalmine, warning of a danger that could infect the entire sector? What mechanism has set Utopia aflame?
The Outer Tensions
1. Nonprofits vs. The Money
To hear nonprofit directors and fundraisers tell the story, there’s far less money for nonprofits now than there was 30 years ago. The truth is that even in adjusted dollars, thanks in large part to impossible-not-to-make-money market growth through the 1990’s that drove record-breaking foundation giving, there was more money pouring into the nonprofit world in the year 2000 than ever in history. (Although overall giving to nonprofits has turned down, with the market, almost 4 percent since 2000.)
But for individual nonprofits, there is less money coming in. There are dozens of reasons for this. Primarily, it’s because there are more nonprofits looking for a slice of the pie now than ever in history. “The number of nonprofits seeking funds is trending up far faster than the dollars are,” says Grantmakers in the Arts Executive Director Anne Focke. As the competition for money increases, the amount available per nonprofit decreases, and the amount an organization has to spend to raise the money increases, decreasing net fundraising. Funding trends have also created a chasm of scale in the nonprofit world: according to Elizabeth Boris in Philanthropy in the Nonprofit Sector, the top four percent of nonprofits were responsible for over 70 percent of the sector’s income. The bottom 40 percent accounted for less than 1 percent of the total.
“Over the next few years,” according to a 2003 study by The Foundation Center, “foundation funding for all fields will likely continue to decrease.” Early numbers show foundation giving actually increasing marginally in 2005. The irony is that this increase was driven primarily by health-care nonprofits being allowed by the government to convert to for-profit structures (meaning, mostly, to be acquired by for-profits), with the stipulation that in the conversion they make a one-time gift to foundations who will give the money back to other nonprofits.
With the increased importance of grants created by the increased demand, “there is enormous influence being exerted on structure and on programming by grantors,” says local nonprofit consultant Claudia Bach, owner of AdviseArts (which is, by the way, a for-profit company). “The influence this money exerts is often very positive, but can also be negative, sometimes pulling the organization away from its mission in favor of what the grantors want to see happen.”
“The level of private giving has been consistently declining for decades,” points out nonprofit management writer Lester Salamon. From the 1960’s through to today, individuals’ gifts to nonprofits have been shrinking not only in dollar terms (adjusted for inflation) but, more importantly, as a percentage of national income. People are consistently making more money every decade, and they’re consistently giving less of it to nonprofits.
Meanwhile, government funding of nonprofits has dwindled severely in the past 30 years. “It’s extremely unlikely that any of us will see budget increases for granting,” says Michael Killoren, Director of the Mayor’s Office on Arts and Cultural Affairs, who had just returned from a national forum on state and local arts giving. “A lot of it is structural; the feds have starved the states, and the states have put the pressure on local governments. It’s a tough climate right now, and I don’t know that anyone has the answer. Of course, we’re going to ask for more money, but it’s going to be tough—everyone’s going to be asking for more money.”
Nonprofits are earning more money than ever (a point we’ll get to in a minute), but the contributed revenue stream, the tithing that has to exist for the nonprofit structure to make sense, is disappearing.
2. Nonprofits vs. Government
Many point directly to the outright failure of government as a major reason for the rise of the nonprofit sector in the past 40 years. So nonprofits’ relationship to government has always been a little weird, and is constantly changing.
Nonprofits have many worries when it comes to government. Chief among them is the fear that government may not continue to have the money for and the interest in the nonprofit sector that the sector requires.
The 1993 Government Performance and Results Act made all government agencies (and any nonprofit recipients of government contracts and grants) demonstrate measurable results for their money—in part, forcing nonprofits to measure the quantifiable over the qualitative. Performance has been prioritized over mission in this new accounting, a seeming contradiction to the core of nonprofit structure. In academic accounting circles (ah, to run in the academic accounting circle…) “social accounting” or “environmental accounting” has been taught and advocated for thirty years as a way to allow qualitative program-based accomplishments to appear on balance sheets and cash flow statements. To date, only a handful of nonprofits have adopted this model (and then only as supplemental to their standard accounting reports). The IRS has never recognized this alternative reporting model.
Also not helping is the current lessening of the tax load on the wealthiest Americans, deincentivizing the charitable giving that provided useful tax breaks for so many patrons in more Democratic times. In the past century, the tax load for the wealthiest Americans has been as high as 94 percent of total declared income (in 1944). “Now that was an incentive to declare less income,” says one major area donor, “and the most effective way to do that is to give to nonprofits.”
3. Nonprofits vs. For-Profits
Across the sector, in whichever area you choose to look, it’s the same story—nonprofits are losing market share not only in obviously commercial areas like entertainment, but in traditionally charitable areas like child care, health care, social services, education… Nonprofit childcare jobs declined 14 percent against corporate competition in the 1990’s. Forty percent more health care workers work for for-profits than did in 1990. Lockheed Martin has entered into the social services realm, offering services as master contractors to manage caseloads. Neil Gilbert, writing for the Yale University Press, says “there is an emerging view of the welfare state as a market with profit-making potential, which is ready for conversion to capitalist doctrine.”
Fidelity and Merrill Lynch have both set up “donor services” divisions to compete with community foundations like the Seattle Foundation; in just five years the Fidelity Charitable Gift Fund amassed more money than the country’s oldest and largest community foundations.
Nonprofit structure hampers nonprofits’ ability to compete with for-profits in the commercial realm. Most often people point to the disadvantage that a lack of personal equity in a nonprofit engenders—nonprofits can’t capitalize quickly to respond to change. Your for-profit lemonade stand can snag a million-dollar contract if you can find another $100 in the next month to buy the juicing machines it will take to meet the contract. You’re tapped out, but it’s a cinch to raise the money—you can offer practically a guarantee that someone’s $100 investment will return to them as $200 in a month. Your nonprofit lemonade stand is confronted with the same opportunity, but you’re not allowed the opportunity to capitalize—you can’t artificially and immediately increase your assets through investment. You’ll have to grow the business by $100 through your programs and your fundraising, and by the time you do (six months? a year?) the opportunity has passed.
“Today the U.S. government no longer considers nonprofits to be entitled—or even best qualified—to provide social services” says William Ryan, a Cambridge-based consultant to foundations and nonprofits. “The point is not whether nonprofits can survive opposition from for-profits. Many have already adjusted to the new competitive environment. The real issue is whether nonprofits can adapt without compromising the qualities that distinguish them from for-profit organizations.”
4. Nonprofits vs. The Public
Lester Salamon argues that one of the fights nonprofits have in front of them is changing the public perception of nonprofits as “the Norman Rockwell stereotype of selfless volunteers ministering to the needy and supported largely by charitable gifts.” This perception fostered public trust for decades, but now that the public sees billion-dollar nonprofits in the economy, the image of the church-basement aid society scares them.
Nonprofits have traditionally held the public’s trust (more so than for-profits) because there’s no one in the organization motivated by individual selfishness; now that’s being turned into a reason not to trust nonprofits. Our old friend Harvard, the planet’s first nonprofit, now argues, essentially, that neither nonprofits nor government are to be trusted. Regina Herzlinger (professor of economics at Harvard), in the Harvard Business Review, says “they lack the three basic accountability measures that ensure effective and efficient business operation: the self-interest of owners, competition, and the ultimate bottom-line measure of accountability.”
“The thing that’s kept the Center on Contemporary Art in its infancy for 20 years now is the fact that its bylaws have always said we have to have a certain percentage of artists on our board of directors,” says CoCA’s board president John Gascon. “Now, thankfully, we’re starting to change that, starting to get more corporate minds on the board, people who understand how to run a business.”
Gascon’s comments represent a national trend, as pointed out by Salamon: “Greater efforts are being made to recruit business leaders onto boards, further solidifying the dominant corporate culture.” Which leads us to…
The Inside Tension: Leadership Lost
A 1999 study found that 24 directorships were open at major museums across America—a 15-year high.
Also in 1999, another study of nonprofit Executive Directors (published as “Leadership Lost”) found that two-thirds of respondents were in their first position as Executive Director, half of these had been there four years or less, and a third indicated they’d be leaving within two years. Seventy percent of these respondents wanted their next job to be anything but director of a nonprofit. Most disastrously, only 14 percent of these directors’ predecessors left to take another nonprofit CEO position. The study’s authors conclude that “if this is a job that most people do only once, then the possibility of hiring experienced people is greatly limited, and it raises a question about whether something is wrong with the way nonprofits typically construct the job and their boards’ relationship to the job.”
The job contains an often-fatal contradiction, a situation referred to by economists as the “principal-agent problem.” The principal of a business is (are) the owner(s). You’re the principal of your lemonade stand; the principals of Xerox are the shareholders, represented by a Board of Directors. The principals of Xerox, however, have little interest in or acuity for running the company, and deputize agents to run it for them—agents like the CEO and the rest of the management. The “problem” exists when the interests of the principals diverge from the interests of the agents. The situation’s been compared to the divergence of interests between renters and landlords, between short-timers and lifers.
Corporate America attempted to bring these two divergent interests more in line with one another through stock options to executives and other equity-building measures in the 1990’s. But in Nonprofit America, there is no equity to offer. Compounding the problem in the nonprofit sector is the fact that the “principals” are short-time renters themselves—a nonprofit’s Board of Directors (themselves a group of volunteers) has no equity, and has no long-term stake in the organization (board membership averages about four years at most nonprofits).
James Surowiecki writes in The New Yorker, “The problem is that in any principal-agent relationship one person knows more than the other, so that the principal is at the agent’s mercy.” The staff of a nonprofit knows more about the nonprofit than the board does. It’s simply the way the organization is set up. But the staff doesn’t have ultimate control, and this psychotic split within the organization, between control and understanding, is tearing many nonprofits apart.
“The ‘tyranny’ of a Board of Directors is at the crux of the problem of whether the nonprofit structure works for an organization,” continues consultant Claudia Bach. “Where it’s most successful is where the need is well defined on both sides.”
Who is the Crispin Spaeth Dance Group if not artistic director Crispin Spaeth? Who is the Mark Morris Company if not Mr. Morris? Who is Livestrong if not Lance Armstrong? Technically, if the board of directors decides it’s “time for a change,” these companies could be yours.
“I am always aware,” says the director of a major east coast arts festival, “that I could be kicked out, regardless of public outcry, because the mood of the board has shifted. It’s a very real issue, and I think another reason (the first being money) that less and less [sic] people like me are willing to take the risk of being an Executive Director.”
As the makeup of nonprofit Boards of Directors shifts more and more to those with corporate, legal, and institutional backgrounds, we see groups that, less and less, represent their organization’s constituency - its community.
How is it that our initial group of Golden Rule Followers, those who choose to live life as if humanity and the planet depended on it, now work for those who chose the other way? When did the Mother Teresa’s of the world agree to work for the Gordon Gekko’s? Who put these people in control?
Forget the disappearing funding, dwindling market share, non-commensurate compensation, and any other external pressures. Nonprofits are destroying themselves from within.
The sidewalks of Seattle are littered with stories of runaway boards firing respected, popular directors at the height of their organizations’ success. Regina Hackett, writing in the Seattle Post-Intelligencer this past March, argues “Seattle’s getting a reputation as a bungling board hot spot.” Look at Mark Murphy of On the Boards, or Fidelma McGinn of 911 Media Arts, or Simon Siegl and Damian Murphy of Pratt Fine Arts, or Don Hudgins of CoCA. All were fired by boards of directors who were subsequently either ousted (in the case of 911), or ultimately took the director back after weeks of public outcry (On the Boards), or left the organization leaderless (CoCA). Ellen King Torrey was not so lucky:
Ella King Torrey was the director of the San Francisco Art Institute, and under her leadership the school launched a respected residency program, launched and completed a successful capital campaign for new studio spaces, tripled their endowment, and increased annual giving by over 500 percent. Torrey is credited with raising the profile of the school to the international level. The school’s debt ratio also grew under her tenure, a situation for which she was “not to blame” according to sources close to the situation quoted in Art in America and a situation of which the Board of Directors was “well apprised.” On April 1, 2002, after seven years of leadership, her board of directors asked for her resignation when news that the debt level had grown became public. On April 2, 2003, the day following the first anniversary of her resignation, she was found dead in her home at the age of 45.
Anne Gardon writes in the Journal of Nonprofit Management, “There are many situations in which nonprofit executives and members express a high degree of frustration with their boards.”
Walks Like a Duck, Talks Like a Duck
Writing about the differences between the nonprofit sector and the for-profit sector in arts and culture, former director of the National Endowment for the Arts Bill Ivey commented, “Well, there just isn’t much difference.”
In 1999, nonprofits as a sector (if you remove church nonprofits) earned 75 percent of their total income, according to the New Nonprofit Almanac. This is up 145 percent since 1980. In arts and culture organizations, the earned income growth was 280 percent since 1980. The whole US economy has only grown 81 percent since 1980. In fact, as a measure of relative income, only earned income has risen for nonprofits in the past 30 years.
Nonprofits are earning more money, but they’re not doing it through their programming. Programming income stayed relatively steady (adjusted for inflation) over the past two decades, while the explosive growth has been in what the IRS calls “non-related income”—things like gift shops, bars, facility rentals, and corporate partnerships for “cause-related marketing” efforts. Non-program-related income doubled in the past decade across the sector. (It should be noted, too, that nonprofits are notoriously good at hiding non-related income within their exempt income, and that the IRS is notoriously bad about caring, so any increase in these reported numbers almost certainly represents an even larger increase in reality.)
McLennan, writing in the Wall Street Journal, says “Many nonprofits are already playing with a for-profit mentality, coyly stepping up to the line separating it from nonprofit practice—sometimes even stepping over it while hoping nobody notices. Major museums mount fashion exhibitions that are sponsored by industry players. Public TV and radio run promo spots that they call ‘underwriting’ rather than the ‘ads’ that they are. Boston’s Museum of Fine Arts rents out its collection to a Las Vegas casino.”
More and more, nonprofits are walking like, are talking like, for-profits. Anne Gardon says, “Activities previously barred under the trust standard - including self-dealing, insider-decision-making and conflicts of interest - are now legally permitted if certain conditions are met.” The door is opening wider for nonprofits to behave like for-profits.
Nonprofits are now often indistinguishable from for-profits, until you really get under the hood. So… why are they still nonprofits?
“We’re always going to champion the nonprofit form,” says Killoren from the Mayor’s office. “But,” he acknowledges, “nonprofits face some enormous challenges, and there are also other models that are worth looking at. These alternatives might be flashes in the pan or they might be sustainable, and sustainability is the real issue here. We don’t want to be myopic about our focus on the nonprofit structure. Look, government funding is about the purchase of services for the community—regardless of what model can provide that public benefit most efficiently and with the greatest sustainability.”
Anne Focke, Director of Grantmakers in the Arts, says, “Lots of my members [her members range from the Rockefeller Foundation to the Paul G. Allen Foundations] are concerned and interested in ways to fund other structures. Some are talking about figuring out how to fund for-profit structures, individual artists acting as for-profit independent contractors, etc.”
Bill Ivey, former NEA director, says of the nonprofit model, “Now we’re bumping up against the outer limits of the model… To paraphrase the tune from Oklahoma, ‘We’ve gone about as far as we can go.’”
Now, after 150 years of exploring the limits of the original nonprofit structure, it’s time to reinvent not only how a business can survive within the confines of that structure. It’s time once again to reinvent the structure.
There are a few alternatives being played with around the country. Most are best described as a sort of shell game played by holding companies with both for-profit and not-for-profit subsidiaries. Minnesota Public Radio created a for-profit subsidiary to handle the excessive success of A Prairie Home Companion. The Nature Conservancy is a holding company with five for-profit and four nonprofit organizations within its structure. Locally, there’s the Pacific Jazz Institute—which shares an address, a phone line, a fax number, and a website with Dimitriou’s Jazz Alley. John Dimitriou is the president of the board of the Pacific Jazz Institute. The Institute is a nonprofit conjoined twin of the for-profit club, seeking and receiving grants for the programming at Jazz Alley.
But what I propose here is a whole new structure, not simply a shell game exploiting loopholes in current law and code.
In 1819, Daniel Webster argued in front of the Supreme Court that eleemosynary organizations (early nonprofits) had to be emancipated from the state in order to effectively get their work done. Remember that at this time the Board of Directors of Harvard consisted of the members of the Massachusetts state legislature. Webster’s argument, and the court’s subsequent ruling for him, was an indispensable step in the development of the modern nonprofit sector.
“It will be a dangerous,” he plead to the court, “a most dangerous experiment, to hold these institutions subject to the rise and fall of popular parties and the fluctuations of political opinions… Benefactors will have no certainty of affecting the object of their bounty; literary men will be deterred from devoting themselves to the service of such institutions, from the precarious title of their offices. Colleges and halls will be deserted by all better spirits, and become a theater for the contention of politics… These consequences are neither remote nor possible only. They are certain and immediate.”
Nonprofits, Webster was arguing, couldn’t operate effectively under the constant fear of interference from a group whose make-up rotated every two years, who were removed from the operations and mission of the nonprofit, whose whims could destroy what years of work had created. In describing the legislatures of the 18th century he was describing the Boards of Directors of today, and the “most dangerous” effects he feared for nonprofits—loss of staff, loss of funding, loss of relevance—have come to pass. It’s time to emancipate nonprofits again. This time from themselves.
Ownership of these organizations has been passed from the Queen of England to the colonial legislatures to the boards of directors. What I propose here is simply the next step in the evolution of organizational ownership. I propose that these organizations belong to their owners.
Imagine a third lemonade stand. Under current law and code, this lemonade stand can’t exist. But imagine it with me. This lemonade stand is a for-profit, wholly owned and controlled by you, selling lemonade at a large margin and supporting your stripper and candy habits. But you’re a socially conscious person, and recognize the need in your community for education about lemonade’s heritage. So you start a program where once a week you bring in at-risk minority youth, offer them free lemonade, and invite guest lecturers to speak on lemonade’s pertinence to at-risk minority youth. You apply to the IRS to have this one program within your business granted a tax exemption under section 501(c)3. So while the lemonade stand as a whole continues to operate like a for-profit, the education program you’re running can operate as a nonprofit (this is the part that doesn’t exist yet). You can convince your lemon suppliers to donate goods, knowing they’ll be tax-deductible. You can write grants to support the program. You can mail cards for the program at non-profit rates. You can convince patrons in the area to support the program with donations. Because there’s the danger of you personally profiting from this program, you hire an accountant to conduct an extra audit at the end of each year, proving that none of the donated monies, and none of the monies generated by the program, ended up in your pocket—they’ll need to go right back into supporting the program. But the key is that for this one program within your for-profit organization, you maintain a classification as a tax-deductible charitable purpose—the golden ring of charitable deductibility.
Let’s work with a few real-world examples. You’re Re-bar, the Seattle dance-club that for years has endeavored to produce and present world-premiere theater and performance art, in addition to having DJ’s spin records, bartenders pour drinks, hawk t-shirts and cigarettes, charge a cover price for dance nights, and serve food from your bar menu. You have no Board of Directors, you and your partners are in control and you are all personally liable should things turn sour. You are a for-profit corporation. And this is as it should be—donors, corporations, foundations and taxpayers shouldn’t be expected to subsidize bars.
But the theater program you’re running, seen in a vacuum from the booze and t-shirts, should qualify as a “charitable purpose” under section 501(c)3. Under our new structure, you could support this work the same way the Seattle Repertory Theatre does. Re-bar simply sells more booze (but, ironically, fewer t-shirts) than the Rep does.
Second example: you’re VAIN, the successful hair salon and accoutrements store in downtown Seattle. In the two floors of tiny rooms above the store, you’re running an artists-in-residence program, and showing artists’ work with monthly openings and showings. Again, you would, under our new structure, be able to support this program the same way the Henry Art Gallery supports its residence program. You simply sell (ironically) more color than the Henry does.
Last example: you’re Amazon.com. You have the means and the connections to get powerful literature into the hands of underprivileged readers around the world. You start a program within Amazon to ship free books to those who fill out a simple application online. You can see where we’re headed with this. Using the benefits of charitable deductibility for this one charitable program within a for-profit structure, you work your publishing and shipping connections, you work with the Ford Foundation and the Pulitzer family, and you do the right thing without having to invent a new and separate nonprofit corporation to get it done.
What’s needed in this country is a new hybrid model for organizations that want to support the Golden Rule—a new type of socially responsible corporation that takes the best that the for-profit world and the non-profit world can offer. A new structure that allows its owners equity in what they’ve built while maintaining the charitable rating that allows it to fund charitable-purpose programs.
The idea here, the key to this, is convincing the IRS to separate out an organizational “charitable purpose” and an organization’s “charitable programs.” The former currently gets you the golden ring of charitable deductibility (accepting grants and donations). The latter currently gets you bupkis. Right now, an organization’s entire mission and at least 51 percent of its cash flow must meet the IRS’s 501(c)3 requirements in order to qualify for exempt status. In our new model, organizations wouldn’t need to “coyly step up to [and over] the line” separating them from for-profits. That line has already been thoroughly fuzzed over in the past two decades. Like the batters’ box in the eighth inning, it’s tough to tell any more what side of it a player’s on. Let’s redraw the line. Let’s at least acknowledge that it’s already been moved.
Would donors give to this new hybrid structure? “Once foundations get beyond the old model,” says former NEA chairman Ivey, “they will see a horizon of new possibilities. Some may choose to fund for-profits… We must take up the challenge again and shape a new model for supporting the arts [and, this author would add, other nonprofit missions] in the next half-century.”
An organizational structure that could combine owner’s equity with charitable deductibility would incentivize social entrepreneurship in this country like nothing has been able to in two and a half centuries. Entrepreneurs would be encouraged, rewarded, and driven to form the exact same kinds of companies that already exist in the nonprofit sector—largely earned-income driven organizations that also conduct charitable, mission-driven business. But in the new model they would be incentivized to stay there, to build from there, to commit to both the business and the mission. They would be incentivized to remain solvent out of personal liability. They would be incentivized to do good, to follow the Rule, by the benefits of deductibility. And they would be incentivized to thrive by the potential for personal gain (strippers and candy).
Adam Smith, one of the fathers of modern capitalism, said “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.” This is part of the “invisible hand” that guides a marketplace and, in Smith’s model, finds an equilibrium somewhere short of monopoly. Adam Smith’s invisible hand, meet nonprofit America. Nonprofit America, meet the invisible hand.
Matthew Richter is a former Performance Editor for this paper. He has founded four successful nonprofit organizations, including Consolidated Works, the contemporary arts center in Seattle. He is the recipient of the Safeco Rudy Award (for the nonprofit director of the year), the Mayor’s Arts Award, and was recently described by Art in America as “an arts visionary.” He is currently designing and building custom furniture under the moniker xom.