A nonprofit is an organization that does not seek to turn invested money into more money for distribution to its owners. The donors have goals that they seek to accomplish through the organization, but those goals do not include profiting directly from the organization's activities. Governments often encourage donations to nonprofits by making those donations tax-exempt. Nonprofits do not necessarily aim to lose money; some try to break even or even accumulate money through sale of products and investment of funds.
Preferential treatment from government
Nonprofits receive preferential treatment by being exempted from income taxes. In the United States, donors can in some cases write off their donations to nonprofits as a deduction on their income tax returns. This encourages the use of the nonprofit form of organization. Murray Rothbard points out that the libertarian solution to this inequity and its harmful consequences is to remove the tax burdens on the proprietary schools.
Competition among nonprofits
As Peter C. Brinckerhoff points out in Mission-Based Management, a nonprofit organization has customers like any other business, the difference being that the customers are paying for products to benefit others. This is not much different than how, say, a for-profit restaurant will gladly accept payment, in accordance with the established schedule of prices, from a customer in exchange for feeding a homeless person whose hunger the customer wishes to alleviate. Both nonprofit and for-profit enterprises attempt to attract customers by offering higher quality or less expensive products than their competitors.
Illusory advantages and real disadvantages of nonprofits
Illusory advantages of nonprofits
All of the perceived advantages of nonprofits are illusory. It might be believed, for example, that a nonprofit will take donors' money and distribute it to shareholders rather than spending it on products for the intended beneficiaries. This can be guarded against through contracts. For example, if the philanthropist were to agree to pay an economics think tank $1,000,000 in exchange for hiring two full-time scholars and three teachers, the think tank would be required to follow through on its contract, whether it were organized as a nonprofit or for-profit entity.
The contractual obligations could be as specific as the philanthropist wished to demand, and the recipient organization were willing to accept. For example, it could specify that a certain number of students should be trained to a certain level of aptitude by classes accredited by an agreed-upon third party. It is not unusual for highly intricate and detailed contracts to be promulgated in the private sector, an example being long-term corporate lease agreements, which go on for dozens of pages, spelling out all the expectations of both parties.
Some donors may believe that a nonprofit organization will have a greater tendency to focus on mission rather than profit. There is not necessarily a great conflict between these two goals. Profits contribute to the organization's financial well-being, helping it to survive and grow. In the case of a for-profit firm, the ability to pay dividends to the shareholders makes company stock valuable and provides an incentive for investors to allocate resources to the company and to closely monitor the company's activities so as to jealously guard the value of their investment.
Furthermore, nonprofits can easily get distracted from their original mission. Foundations are notorious for straying from the goals and values of their original founders. Graft and waste are quite possible in nonprofits and perhaps even more likely to occur than in for-profits because of the lack of incentives for rigorous oversight from the top (i.e. the board of trustees or the delegate body in most nonprofits; the shareholders in for-profits).
It might be asked, In the event that a for-profit fulfils its minimum contractual obligations, what will ensure that it spends the rest of the money on mission-related endeavors rather than on dividends? First, it should be noted that non-profits are not the only organizations that sometimes put charitable endeavors ahead of short-term profitability; for-profit firms also sometimes make donations to charities for the sake of building goodwill and establishing better communities in which to operate. Both for-profit and nonprofit entities also have an incentive to build their own prestige by investing in impressive projects.
E.g., suppose a for-profit libertarian think tank has met its contractual obligations to, say, turn out the minimum number of issues of academic journals required by contract. What will incentivize it to, say, fund an economist's research into public choice problems? The firm could very well be seeking to share in the economist's glory, when he wins the Nobel prize for a new discovery and the firm issues a press release stating how pleased it is at the outcome of the research it funded. Donors will see that the firm is making good use of donations, and be more inclined to donate.
Concerns about dividends to shareholders assume that shareholders will simply loot the firm of its assets rather than reinvesting them in further operations. There is no evidence to suggest that this would necessarily occur. To the extent that dividends do occur, that is the shareholders' payoff for making prudent investment and management decisions concerning the firm. They "deserve" to be paid for this service just like any other worker who provides the benefit of his talent and effort to an organization. It is a necessary incentive.
Disadvantages of nonprofits
There are a number of downsides to the nonprofit method of organization. The lack of profit motive diminish incentives for donors to keep a close eye on the organization's activities' effectiveness and efficiency. Whether the organization accomplishes its goals or not, the donor typically expects to receive no future cash flows from the organization. Perhaps he has already received his reward, e.g. in the form of acclaim for generosity, and therefore feels little desire to continue monitoring the organization's activities.
Also, nonprofits are often organized in such a way that donors have less influence over the organization than, say, corporate stockholders have over their company. Many nonprofits are organized as "board-only" groups, administered by a self-appointed oligarchy. Others are organized as democracies in which each member (whether he donated $25 or $25,000) has one vote. Certain beneficial safeguards against mismanagement and abuse, such as the feedback mechanism offered by corporate stock prices and the potential for hostile takeovers, may be absent.
Some nonprofits are funded by an endowment, while others rely on continuing donations. The former are completely unchecked by any need to serve the organization's intended beneficiaries well; they need only take care not to exhaust the principal balance of the endowment, in order to continue operating. The latter tend to be influenced by whoever is making the donations. In the case of, say, a largely government-funded nonprofit college, the government is in a position to influence the college by offering to increase donations if the government's demands are met, or threatening to decrease donations if they are not met.
Arguably, one of the main problems with contemporary governments is that they are organized as nonprofits. Bureaucratic management is the only alternative available where there is no profit and loss management.