“Not for Profit” Is Not “For Profit”

 

 Nonprofit

“Begin with the end in mind.”

The second of Stephen Covey’s famous “7 Habits of Highly Effective People” carries cartloads of implications for anyone planning pretty much anything. Knowing what is ultimately to be achieved guides every decision at every point along the way, and, most importantly, allows clear statements to be made as to whether the work has succeeded or failed, and to what degree. In this sense, an evaluator’s most critical work is done at the beginning of a project, when the end is determined, not at the end.

With this in mind, it should become immediately apparent that a key disparity exists in what we have named these two sectors. On the one hand, intending to exist and work “for profit” is a positive, measureable outcome. The end is profit; that means having greater financial assets at the end of the work than at the beginning. It exists or it doesn’t. On the other hand, intending to exist and work “not for profit” is a negative, saying simply what will not happen, and nothing about what will. The implications of this are significant in a variety of ways, none of which are discussed with any frequency.

We believe we all know what we mean by “profit,” which is the central term here, but I suggest that we don’t, or that the term has not been fully defined for each sector. In a business setting, “profit” means a maximized excess of revenue over expense that is distributed to individual shareholders for their financial benefit. Shareholders demand a financial gain, regardless of the enterprise. They are in it to make money, period. At times, some share of profit is distributed to benefit a community in the form of “charitable giving,” but this is neither required nor adhered to if overall profits decline. And charitable giving is generally done as a method of public relations—convincing customers or clients that the company is “contributing” and is therefore worthy of continued patronage. Otherwise, the shareholder is the primary financial beneficiary, in all cases.

But what is glossed or ignored is that because this definition of “profit” is assumed to be the same as in “not for profit,” the not-for-profit sector has been crippled in attempting to reach the end it has in mind. Because the funds are “charitable,” nonprofits must labor to assure funders and the IRS that no individual is benefiting financially. This burden of proof has led to a perversion of the definition in the nonprofit sector to mean that there can be no excess of revenue over expense at all. “We are not for profit,” says the sector.

The major problem with this, of course, is that no organization can survive, let alone thrive, if there is no excess of revenue over expense to fund operational health and improvements. The notion of maximized profit became conflated to mean any excess revenue, even though whether or how much revenue existed was never the issue in the first place. The issue was whether or not any individual benefitted financially from said revenue – truly, the definition of “profit.”

Which leads to the core of the issue: If a not-for-profit is not “for profit,” then what is it for? Broadly, most people would agree that it is for the social, physical, mental, and quality of life benefits of the community it serves – all things that generally cannot be done at a maximized profit because they cannot be easily or cheaply commoditized and sold. Thus, they are most accurately “for community benefit,” as opposed to “for shareholder benefit.” In this construct, excess of revenue over expense becomes a divergent consideration, not a primary focus. Both sectors now have a clear “end” in mind with which they can begin, and in each case, “excess of revenue over expense” has a completely different application and purpose. For the nonprofit, the excess can be rightly called a “margin” instead of a profit – the funds it needs to operate well as an organization.

So why are the implications so significant? Because virtually nothing about the means to the ends of the two sectors are the same, even though we persist in thinking they are, or continue to view the one as merely the flip side of the other. It is not. In seeking the greatest possible financial benefit for shareholders, a company’s focus is entirely financial. Since profit, as defined above, is the primary goal, all decisions are focused on cash in and cash out. Customers or clients are sources of revenue, labor is a commodity, spending must be minimized.

In the community benefit environment, none of this is true, or shouldn’t be. Customers or clients are generally not the source of revenue; many third parties are—and that fact alone and all its implications on cash flow are enormously significant, forcing constant adjustments and adaptations. But the end in mind here is to improve the lives of people; thus, deep interactions with them are required. Over and over and over again, “best practice” in dealing with people in need has been shown definitively to be based on personal interaction and trust building, guiding people over time. Health, mental health, job training, social service, even arts all now concede that personal contact over time is what works. If profit is the endgame, this is hugely inefficient, costly, human-based work. There is very little “labor” in community benefit work. There is only people interacting with other people. That’s the work. Period.

This raises the interesting challenge of the nonprofit as “investment vehicle” that has taken place over the past several years. Beyond the fact that I am mystified by the concept of seeking market-rate profits from investments in nonprofit organizations, there is the fact that the margins (profits) of a nonprofit should NOT be available for distribution as dividends. I understand fully the thinking behind the creation of “nonprofit investment,” particularly the desire to push the nonprofit toward better business skills and management. I’ve followed the excellent work of the F.B. Heron Foundation closely. But this diversion from mission-related work toward profit-making work is exactly what’s wrong. Managing an organization for a margin (vs. a profit) is certainly a welcome thing, and needs much more attention. But to then treat the margin as a profit and distribute it as dividends to investors is to fundamentally change the core value of the organization and the sector. It is not for profit. Its work needs support, not investment.

Finally, what of the emergence of the “for-benefit” corporation? First, I would say this is the most welcome development in the evolution of capitalism that I have seen in my life. Second, I see this hybrid as branching in two directions. One branch is the for-benefit corporation that is like any other for-profit business (an office supply company, for example) with the exception being a definition of profit modified to mean a “net profit after required social expenses” instead of a “maximized profit.” The for-benefit corporation, in its founding charter, requires itself to assume selected costs that most other for-profits would see as optional at best. These might include environmental maintenance costs, living wages, and the like. These cannot be forgone.

The second branch is the “social enterprise”: the corporation that has direct social benefit as its primary goal, and considers itself to be “mission-driven.” These might include enterprises that focus on recycling, or affordable housing, or renewable energy, or sports-as-therapy programs. In some cases, job-training programs are part of the work, or other community engagement activities. And certainly, these can draw investments from individuals who expect a return. But because of the nature of the enterprise, any investor must recognize that their return will be less than market, since the primary function of the enterprise is not intended to be profit. Forcing such an enterprise to deliver a market rate return completely misunderstands the nature of the investment, and, as with any investment, the investor should have read the prospectus.

There are many ways of doing this work effectively and efficiently, measurably, and well. There are also many ways of doing it badly and wastefully. But using the approaches of the for-profit sector ultimately leads the community benefit sector astray, and cajoles it into thinking that its primary concern should be financial. The financial health of the community benefit sector is of great concern and must be attended to. And if this thinking makes sense, then funders, individual donors, and the IRS must stop thinking that any excess of revenue over expense is “profit,” which is forbidden to the for-benefit sector, and recognize it as the organization’s operating margin. Funders should allow—insist on, even—such revenues to be present, and to be reinvested back into the organization for the benefit of the community. We must all stop thinking that community benefit work (or, now, social enterprise work) is simply a different kind of financial transaction. In the end, working with money and working with people are nothing like the same thing, and we must free the not-for-profit sector from the constraints strapped onto it by imposing an inappropriate system.

 


 

Paul T. Hogan is the vice president of the John R. Oishei Foundation.