Nonprofits Are Not Like a Business

Nonprofits should not be run like a business. There are many misconceptions about the nonprofit field. One of the most pervasive is that nonprofit leaders are inexperienced and lack the management savvy of the private sector. However, the non-profit sector is replete with counterintuitive and contradictory constraints. Thus, only the most talented managers and executives are able to build robust, healthy, and sustainable nonprofits.  

In fact, it is common to hear people tell nonprofits that they need to function “more like a business”. This ill-advised recommendation is steeped in a deep misunderstanding about the nonprofit field. In reality, nonprofits need funding that allows them to: 1) strengthen their systems, 2) their organizational infrastructure, and 3) build the capacity needed to match their objectives. 

This is why when people from the business field make the leap into working with nonprofits, they are surprised by the sophistication they encounter, particularly in larger organizations. They also come upon a series of unexpected obstacles nonprofits need to overcome that businesses are not encumbered by.

This is Part I of a two part series.

What Makes Nonprofits Unique

Countless mistaken beliefs about the nonprofit sector lead funders, the general public, and policymakers to create accountability and funding mechanisms that are misaligned with the nonprofit corporate structure. This is partially attributable to the fact that nonprofits share structural characteristics with both governments and the private sector. Thus, nonprofit hybrid corporate entities require funding, organizational systems, and accountability mechanisms that are consistent with the needs of the industry. 

Nonprofit Hybrid Corporate Structure

Running a nonprofit like a business does not adequately prepare organizations to navigate the funding and regulatory landscapes. The Third Sector shares countless features with the private and public sectors. Like the government, nonprofit missions are driven by the need to provide a public benefit. Whereas the private sector is driven by a desire to generate profit and to obtain a private benefit. However, much like publicly traded companies, nonprofit missions are defined by the board of directors whose governance responsibilities include fiscal oversight.  

Similar to the government, legislative, legal, and regulatory mandates determine the fiscal requirements in nonprofits. Simultaneously, like the private sector, nonprofits also must follow Generally Accepted Accounting Practices and IRS guidelines. 

The fact that nonprofits do not experience the linear exchange between the business and the “client” that takes place in the for-profit sector makes nonprofits incompatible with a for-profit management system. Unlike the business sector, where individual companies control the parameters of their operations, funders set the rates or place limitations on the design of cost distribution for nonprofit organizations.

With respect to profit distribution, only the private sector is profit driven. The profits can be held either privately or publicly traded. This is not the case for nonprofits. Like the government, nonprofits have a non-distribution constraint in the treatment of financial and other surpluses. Thus, when they generate revenue from entrepreneurial ventures and fees, the revenue must be re-invested into the nonprofit and advance the mission.

In a nonprofit, no one person owns shares of the corporation or interests in its property. The income must be distributed to the corporation’s public benefit mission and activities. However, like the business sector, if a revenue source comes from an unrestricted source and does not have any program or performance requirements, the funding can be used in any way the organization would like. This is not the case in government where the money often has to be returned to the legislature’s coffers.

Unrestricted funding for nonprofits, though, is very difficult to obtain. The reality of the funding landscape is that funders place numerous constraints on how organizations spend their dollars. Government, in particular, has the most restrictive funding controls.

These hybrid corporate features make running a nonprofit like a business almost impossible. Instead, nonprofits need systems that adapt to the uncertainties of being expected to generate revenue, while at the same time working in a market that expects nonprofits to function as a government and as a business at the same time. Funders, should likewise, adjust their funding parameters to cover all of the administrative costs build capacity, and administrative systems.

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Next time, we will cover “Incompatible Funding and Accountability Approaches for the Nonprofit Hybrid Corporate Structure".