Can non-profit organizations meet all the needs for-profit businesses currently meet?
June 29th, 2009 | Published in Economics idea | 16 Comments
Could non-profit organizations do the same type of work that for-profit businesses do today? For example, could a non-profit organization manufacture and sell toothbrushes?
I spent a little time looking around on the web to see if there were any barriers that would prevent non-profit organizations from doing things that the for-profit sector usually does. I didn’t find anything. There is no reason that I could find that they need to limit their work to charitable or social goals.
Non-profit organizations have very similar structures to for-profit businesses. They have directors that are responsible for the organization. They can do almost anything that a for-profit company can. The only restriction on non-profit organizations is that they can’t distribute profits to shareholders or members.
The regulation of non-profit organizations is done by state or provincial governments in the United States and Canada. The result is that the specifics of the laws governing non-profit organizations vary. Different types of non-profit organizations have different rules depending on their objectives. If a non-profit organization wanted to produce toothbrushes, there is no reason in principle that it couldn’t.
The only barrier I see that prevents non-profit organizations doing more of what for-profit businesses do is start-up funding. People won’t donate money to a non-profit toothbrush manufacturer. Governments would be reluctant to provide them with grants. Banks wouldn’t loan them start-up money. Without access to start-up money, a non-profit toothbrush manufacturer wouldn’t be able to start production.
The problem comes down to managing risk. The risk of failure of for-profit businesses is borne by investors. The advantage of having start-up money provided by investors is that they presumably will be careful with their investments and will invest their money where it can be most productive. Self-interest ensures that the risks inherent in any new business are carefully managed.
My belief is that there are other ways to manage business risk that could be just as effective, or even more so. I will write more about them in coming posts. If non-profit organizations could get access to start-up money, there really is no limit to the type of work they could do.
June 29th, 2009 at 2:45 pm (#)
Stephen,
If we got past the start-up difficulties you mention, how would you see a non-profit toothbrush manufacturer handling profits and losses year to year? That is, if it had large profits in a given year, would it hold the money in a bank account or re-invest it? What if it had built up more money than it needed? Conversely, if it had a loss in a given year and didn’t have a “cushion” bank account, what would it do?
Eric
June 29th, 2009 at 9:24 pm (#)
Stephen,
I believe you have nailed the obstacle. What thinking person would provide the capitalization for a not-for-profit manufacturer? I’ve been a board member of a N-F-P corporation and the atmosphere is totally alien to one that is needed to achieve the efficiency necessary for a manufacturing operation.
Eric,
NO PROFIT, remember? Losses are a definite probability, but profit is a no-no, by definition.
June 29th, 2009 at 11:35 pm (#)
Clyde,
Yup – I got the no profit thing. What I mean to say is, what do they do if they happen to take in more money one year than they spend? It can be tricky to line up all your expenses so that you spend the last dollar on December 31 and then start again. Or else they might have made a mistake and sold too many toothbrushes.
Eric
June 30th, 2009 at 7:47 am (#)
Eric
Non-profit organizations are currently allowed to have endowment funds. I can’t see any reason why they shouldn’t be allowed to build up a cushion of funding in good times to tide them over in rough times. There would have to be limits on how much a non-profit company could save to prevent abuse. Perhaps a limit for a producer could be set as a multiple of sales or the value of its physical capital.
If they burn through their cushion, they really only have three options: get emergency funding from somewhere, borrow against their assets, or stop producing. The same options private sector companies have.
ClydeB
I’m not surprised that the atmosphere of a not-for-profit organization would be totally different than a for-profit business. The things not-for-profits do today are very different from what for-profit businesses do.
If a non-profit organization was doing something similar to what businesses do, I would expect their boards to function in similar ways. Their task is defined by the type of work the organization does, not the ownership structure of the organization.
June 30th, 2009 at 1:20 pm (#)
In the original post you say that there “is no reason that I could find that they need to limit their work to charitable or social goals.” Well, actually, there is… In the U.S., at least, nonprofits receive their tax-exempt status – 501(c)(3) – from the IRS. The application requires a statement of the organization’s charitable, educational, or social goals or mission. Presumably, the IRS reviews that before approving the application… presumably…
But, that doesn’t mean that a nonprofit couldn’t manufacture toothbrushes. If, somehow, the production of toiletries were related to the charitable purpose. For example, I’m aware of a catering company that is a tax-exempt nonprofit. The nonprofit’s mission is to train at-risk populations in how to work in the food industry. New cooks enter the program, are trained, work real catering gigs, and then graduate to make room for the next group of new cooks.
To the clients hiring them for parties, they’re just like any other caterer, but to the IRS it’s a legitimate social enterprise providing educational assistance. I don’t know how to translate that story to making toothbrushes, but you get the point.
A nonprofit can also run a for-profit business. A typical example would be a thrift shop set up to support a social cause. In this case, the IRS sees the profit from that enterprise as “Unrelated Business Income.” The nonprofit does pay taxes on that portion of their income, but as long as it doesn’t become their primary activity, it doesn’t endanger their tax-exempt status for the charitable work.
In one of the comments, Clyde writes, “… Losses are a definite probability, but profit is a no-no, by definition.” You’d think so, but “nonprofit” is really a misnomer. Nonprofits can (and, in good years, should) earn more than they spend in order to build reserves for lean years (such as we’re now experiencing). What nonprofits are barred from doing is distributing that profit to the Board or principals as dividends. Profit is wonderful, as long as it is re-invested into the charitable mission.
Anyway, thanks for this post – It’s an interesting conversation.
July 2nd, 2009 at 10:53 am (#)
Ken G
Thank you for the detailed response. I took a quick peek at your blog and you are clearly an expert on non-profits. I’ll also take a look at the comments on your post of your comment on your site.
I find your examples of thrift shops and cook training encouraging because it shows that non-profit organizations can do things that are similar to for-profit businesses.
I’m not an accountant and don’t know much about the tax laws for non-profits. You are probably right that a non-profit toothbrush manufacturer would run afoul of current tax rules and regulations. The worst case scenario is the non-profit manufacturer operates under the tax rules for for-profit businesses.
July 2nd, 2009 at 3:38 pm (#)
Stephen,
Most of the discussion so far has been about the “social mission” of non-profits. I don’t think this is applicable for what you’re talking about. And since you’re not targeting special tax treatment, is there any reason that the structure of current businesses can’t work?
In Ken’s blog, you raised the idea of the “rich nut” who wanted to start a non-profit brewery. I don’t see any barriers to him doing that on his own as a sole proprietorship with the intention to not take any money out of it. Profits could be set aside in a reserve fund or else re-invested. And he could tweak the prices up and down to target a net break-even.
Similarly, other business structures could be set up with charters that require the same sort of thing.
The trick then, as you noted, is finding the initial investment money.
Eric
July 2nd, 2009 at 4:01 pm (#)
Eric.
I think you and I have reached the same conclusion. It’s possible to set up a non-profit manufacturer. The question is where to find the startup money.
July 2nd, 2009 at 4:20 pm (#)
Stephen,
It seems like the answer has to be “from government”, but that’s not really an answer since the government isn’t really a thing in itself. Really, we would need everyone in society to chip in, either directly or through taxes, with no expectation of return for their money. Long-term, they may benefit from cheaper goods & services if they are customers of the non-profit manufacturer.
Eric
July 2nd, 2009 at 7:18 pm (#)
This entire discussion ltterally begs the question “Why”. It is diffcult enough to form, develop, start and sustain a legitimate for-profit business with pristine goals. Why on earth would anyone go through all that with no hope of a rewarding success as the desired outcome.
Certainly some not-for-profit organizations are successful, the Red Cross is an example. Most struggle for survival and depend on going hat-in-hand to benefactors on a regular basis for sustenance.
Do you have the notion that profit is undesirable?
July 3rd, 2009 at 8:44 am (#)
ClydeB
I am interested in non-profit producers for two reasons.
First, from the consumer’s perspective, profits increase the cost of a good. The money paid to shareholders comes straight out of the customer’s pocket. It’s a cost. All else being equal, if a company wasn’t trying to earn a profit, it could lower its prices. If there was a way to get producers to work efficiently without bribing business owners, we would be better off.
Second, in my grand design for a better economy, I need to connect the cost of goods and services to the labor and raw materials used to produce them. If businesses are allowed to maximize profits, this connection is difficult to make. It would simplify my story if the for-profit sector could be dispensed with. I can work around this problem, it just takes more fancy footwork.
July 8th, 2009 at 10:52 am (#)
I think the conversation only comes down to whether enough people would see a value in funding “X” Non-P versus purchasing from “Y” For-P. So the organization’s operation is to produce/manufacture toothbrushes for all the needy children of the world, yadah, yadah, yadah… meets the IRS codes, yahdah, yahdah, yahdah… and sells toothbrushes to a market in direct competition with all the other toothbrush manufacturers. Can it operate efficiently and effectively to produce a product and service perceived to be of enough value to stay in business? So long as the government isn’t running it and creating a monopoly, then this concept is already a reality, i.e. charitable hospitals, private religious schools, even insurance companies like the Knights of Columbus.
July 8th, 2009 at 11:01 am (#)
So long as there is a “free” market, you will not be able to do away with the For-profit sector. You could do away with the Non-profit sector, but the Non-profit sector necessarily depends on there being a For-profit sector. Imagine trying to start a Non-profit with the mission to deliver luxury “X” for all the people or animals in “Y”. The supply of funds just would not be able to support the demand.
July 9th, 2009 at 8:43 am (#)
Dave
Interesting points. I agree that non-profits are able to effectively do many things. Your examples in health, education, and insurance are good.
I don’t understand why you think a For-profit sector is necessary. I don’t see any particular reason a non-profit couldn’t deliver luxury goods. The people wanting the luxury goods would just have to pay the cost of producing them.
Non-profit doesn’t mean non-revenue generating. It just means no profits being distributed to owners or shareholders.
August 27th, 2009 at 7:14 pm (#)
HELLO STEPHEN
I’m Not sure it can be done.
Please consider this for us your insight and assistance is vital.
Tiles for Smiles is a nonprofit organization dedicated to the advancement of Children with Cerebral Palsy. Our purpose is to provide schools, religious and other charitable organizations a resource to expand their fund raising activities by producing engraved tile, stone and any other product that can assist their efforts and financial growth. Through the production and sale of specialty craft items, and participation in local craft events, we will raise support, awareness and funding. Our intention is to grow to enable a greater level of financial assistance for local and national therapeutic centers along with organizations that support Children with Cerebral Palsy.
We are currently in our final stages with the IRS in consideration of our 501 tax exempt status and question 13 goes just like this –
Please explain how granting exemption to would not provide an unfair advantage by operating as an exempt organization, over for-profit competitors. Competition with commercial firms is strong evidence of the predominance of nonexempt commercial purpose for determining weather an organization can be classified as tax exempt. And if the conduct of a business with apparently commercial character is a taxpayer’s sole activity the fact weighs heavily against exemption.
All officers are non-compensated (volunteers) as we are a volunteer organization.
Any opinions on this would be very much appreciated.
THANK YOU
Peace
Tom P.
August 28th, 2009 at 8:41 am (#)
Tom P.
My background is in economics. I don’t have expertise on specific tax issues. In this post, I am asking high level questions about the plausibility of having non-profit organizations do the work that for-profit organizations normally do.
I’m sorry I don’t have any specific advice to offer.