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. You can spend that $10 on candy, or CDs, or strippers—whatever you like. You could also choose to reinvest the $10 in the stand, buying a lemon juicer to increase profit. In 10 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.

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 30 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, such as 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 there exists 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 on 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 to make the world a better place (i.e., doing the government's job). That's "charitable deductibility," and it's what allows nonprofits to do the work they do.

Nonprofit America is serious business: There are currently over 1.3 million nonprofit corporations in America, employing 11 million people with 5.7 million more working as volunteers. One in 10 working Americans works for a nonprofit. Nonprofits account for roughly 10 percent of the GNP, with over 100 universities and colleges offering nonprofit-management degrees and certificates—University of Washington, Seattle University, and Seattle Central Community College to name a few locally.

However, the size of the nonprofit sector is no indication of its health. In fact, nonprofits are in trouble. The federal government is talking about how the system is 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.

This is important because the nonprofit structure is the structure we've got for doing the type of work they do—nonprofits clothe the naked and feed the hungry, they heal the sick and protect the planet, they drive contemporary culture and preserve the past. Trouble for nonprofits directly equals trouble for the constituencies they serve. And if you believe that there should be organizations in the world doing this work and driven to do it by mission, not margin, then yes, this is important.

In an article in the Wall Street Journal, editor and Seattleite Douglas McLennan argues 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?"


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. Interestingly, Seattle isn't among the search results. This is interesting because there's one nonprofit to every 90 people in Seattle—the highest nonprofit-per-capita ratio of the United States' 100 largest cities.

Why wouldn't Seattle want to tout this superlative? Perhaps we're not so proud of how a density of nonprofits has affected (or perhaps failed to affect) our fair city. Seattle ranks toward the bottom of the curve in almost any area in which nonprofits work: 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). 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 10 worst cities in America for number of homeless women and children (according to the U.S. Department of Housing and Urban Development). 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?

Washington State is also one of only 15 states in the union who are what I will call net exporters of grant money, according to numbers provided by the Foundation Center. This means that grant makers in Washington awarded more money (collectively) than grant seekers 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. 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."

Why are so many of our nonprofits failing? 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 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 University 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, and over 7 percent of all nonprofits declared insolvency and died. This compares to a corporate insolvency rate for the same period of about 2 percent.

So what's killing our nonprofits?


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 1990s 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).

However, for individual nonprofits, there is less money coming in. Primarily, this is because there are now more nonprofits looking for a slice of the pie than ever before. "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.

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 1960s through 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 of Arts & 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."

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.

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 of the core of nonprofit structure. In academic accounting circles, "social accounting" or "environmental accounting" has been taught and advocated for 30 years as a way to allow qualitative program-based accomplishments to appear on balance sheets and cash-flow statements. 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

Nonprofits are losing market share to for-profits not only in obviously commercial areas such as entertainment, but in traditionally charitable areas such as child care, health care, social services, and education. Nonprofit child-care jobs declined 14 percent against corporate competition in the 1990s. Forty percent more health-care workers work at for-profits than did in 1990. Even corporate giant Lockheed Martin has entered into the social-services realm. 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."

"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.

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. 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 him as $200 in a month. Your nonprofit lemonade stand has the same opportunity, but you're not allowed 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.

4. Nonprofits vs. the Public

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. Regina Herzlinger argues in the Harvard Business Review that neither nonprofits nor government are to be trusted. She writes that "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," said CoCA's former board president John Gascon in 2005. "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...


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 one-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 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 the owner. 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, are neither qualified to, nor interested in, running the company, and so they deputize agents to run it for them—agents such as the CEO and the rest of the management. The "problem" exists when the interests of the company's owners diverge from the interests of their agents.

Corporate America attempted to bring these two divergent interests more in line with one another by granting stock options to executives in the 1990s. In for-profit America, rising stock prices benefited both the owners and their agents. But in nonprofit America, there is no stock or 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. But the staff doesn't have ultimate control, and this psychotic split within the organization, between control and understanding, is tearing many nonprofits apart.

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 nonprofit companies could fire their founders and hire, say, you instead. Or anyone.

"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.

"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 fewer and fewer 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.

Forget the disappearing funding, dwindling market share, noncommensurate 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 organization's success. Regina Hackett, writing in the Seattle Post-Intelligencer this past March, argues that "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 themselves (in the case of 911), or ultimately took the director back after weeks of community outcry (On the Boards), or left the organization leaderless (CoCA). Ella King Torrey was not so lucky.

Torrey was the director of the San Francisco Art Institute, and under her leadership the school started 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."



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 U.S. 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 "nonrelated income"—things such as 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.

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."

More and more, nonprofits are walking like, and 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. 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."

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.'"

In 1819, Daniel Webster argued in front of the U.S. 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 (America's oldest nonprofit) 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 pleaded 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 effecting 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 makeup 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 colonial legislatures to 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 let's pretend: 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—this one line item in your budget—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 nonprofit 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 DJs spin records, bartenders pour drinks and hawk T-shirts, and a cover price for dance nights. 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.

However, 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 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.

Last example: You're 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 can 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 do traditionally "charitable" work—a new type of socially responsible corporation that takes the best that the for-profit world and the nonprofit 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.

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. This structure would also remove the profit incentive from companies such as Lockheed Martin, Fidelity Mutual, and Merrill Lynch, all of whom are currently engaged in active competition in traditionally charitable areas of business.

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 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. Smith's invisible hand, meet nonprofit America. Nonprofit America, meet the invisible hand.

Matthew Richter is a former performance editor for this newspaper. 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.

This piece is excerpted from a larger work entitled Utopia Aflame.