NPQ's The Ethicist

Dear Nonprofit Ethicist,

For nonprofit organizations and those affiliated with them, has anyone seen or developed principles, general guidelines, or “filter questions” that would help define an appropriate relationship between doing good and doing well? With the rapid growth of social entrepreneurship, the issue seems increasingly relevant.

Rarin’ to Go

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Dear Rarin’ to Go,

Congratulations: your question is a stumper. For the first time since this column began, the Ethicist put out a call to his colleagues in the academic and practitioner communities. Although Tom Pollak at the National Center for Charitable Statistics and Pam Leland at the Leland Leadership Group had good insight, no one knew of a “decision template” for social entrepreneurship. Therefore, the Ethicist offers a few simple rules of his own devising:

The social in a social-entrepreneurship project comes first. Ask whether a money-making project advances the charitable mission—in some way—regardless of the amount of money it raises. Numerous scholarly articles caution that doing well may distract senior management from its real job of doing good.

The pecuniary benefits from the entrepreneurship in a social-entrepreneurship project should go primarily to the charitable class of persons for whose benefit the project is purportedly undertaken.

Entrepreneurs—not the charitable class—should bear any outsize risk associated with social-entrepreneurship projects. Part of entrepreneurs’ charitable contribution is bearing risk.

If a taxable organization undertakes a social-entrepreneurship project, it should voluntarily follow the rules applicable to tax-exempt organizations regarding conflicts of interest and private inurement.

The last point deserves elaboration. While there are no federal rules and regulations regarding conflicts of interest, Appendix A to IRS Form 1023 has a model conflict-of-interest policy for tax-exempt entities. On the other hand, existing rules and regulations do limit private inurement: persons capable of exerting substantial influence on a tax-exempt organization’s business decisions are entitled to no more than reasonable compensation.

But regulations do not address return on an owner’s equity as a special form of inurement, because tax-exempt entities do not have private owners. When taxable entities undertake social-entrepreneurship projects, the policy against private inurement must be extended. The Ethicist suggests that the risk-adjusted rate of return on an entrepreneur’s equity should not exceed the most favorable rate at which the taxable entity can borrow.

These restrictions may prompt entrepreneurs to ask, “What is the economic incentive to undertake social projects?” True, there is no special incentive, but these rules are no disincentive either. The object of social entrepreneurship is not to do well but to do well enough. Doing good should be its own reward.

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