Fractured Atlas’ Adam Huttler posted about the disincentives inherent to the traditional non-profit model partially in relation to the fall of so many financial institutions over the last few weeks.

I’ve often argued that the traditional non-profit model discourages necessary risk-taking. It does this for a few reasons:

1) Employees can’t own stock, so they don’t benefit from financial success. Yet they’re still vulnerable to financial failures (i.e. they can lose their jobs or suffer career setbacks). To a lesser extent, the same is true for non-profit Board members. When someone’s got no stake in the upside but is still exposed on the downside, the rational response is extreme conservatism.

2) The culture of the non-profit sector is such that managers go to absurd, herculean efforts to avoid admitting failure, mostly in an effort not to embarrass themselves in front of funders.

3) Non-profit organizations are chronically under-capitalized. By failing to build reserves or hoard surpluses, we end up in a situation where each budget is a tightrope. A single serious misstep is enough to pose an existential threat to the organization.

He goes on to talk about how free market enterprise incentivizes excessive risk taking in the for-profit industry and lists the form this takes. Huttler notes that while regulation can help keep the activities of for-profits from becoming too risky, you can’t make for profits engage in riskier behavior. However, he feels that if the relationship with funders could be changed, risk aversion can be mitigated to a degree.

His observations paint behavior of for and not-for profits as two sides of the same coin. For profits have a short term view because they are trying to burnish their quarterly reports for the sake of enhancing earnings. Not for profits take a short term view because their funding only covers a limited period. Given the necessity to continue to seek funding, the organization has to frequently reinvent parts of itself to conform with grant opportunities.

What Huttler suggest as a solution seems very close to what the Independent Sector proposed a few years ago. The Independent Sector suggested that foundations engage in long term core support of organizations rather than program support. They also suggested foundations develop a uniform application and reporting procedure so that organizations weren’t devoting so much time and energy on applications and reporting. (The entry I link to is one I am particularly proud of so take a look! Not to mention that the issue is more complicated than I have presented here.)

Huttler notes that it is difficult to provide performance incentives on par with the for profit world given IRS rules preventing revenue sharing. He mentions that Fractured Atlas provides performance based group bonuses which are apparently legal and I am sure sound like a good idea to most non-profit employees.

One of my initial thoughts upon reading Huttler’s first point about how non-profit employees face all the risk and none of the profit-sharing reward that for profit employees do, was that this group was motivated by factors other than financial. I am glad he acknowledged that near the end of the entry though I assumed he understood this even if he never mentioned it. But as I read the entry I reached the same conclusion he did–it can be tough to translate this non-monetary motivation into risk taking.

One of the first things that popped into my mind was that attempting this could actually lead to the pursuit of grants that didn’t really align with the organizational mission. A person is enthusiastic about serving X community and comes to the leadership with a grant supporting that very thing. But is it really in the organization’s best interest? Do they really want to continue the program past the grant period? Will there be anyone to continue it after the person leaves? It is easy to get caught up in the enthusiasm of a person for a clearly worthy cause when your organization is fueled more by coffee and enthusiasm than money. Engaging an employee’s interests can reward them for all their hard work when there isn’t much else with which to reward them. But you have to weight that against the long term interests of the company.

Yet it is easy to dismiss the suggestion of a really risky venture that would be in the long term best interest of the organization based on the risk alone. A fantastic failure as a result of risk taking won’t be in the interests of the company if it closes or most everyone gets laid off. Engaging an employee’s passion when there is money readily available from a foundation looks like the sane choice even if the program it funds probably won’t exist in 3 years–at least the organization itself will.

Not all risks are directly related to finances, of course. Just as every passion doesn’t necessarily require grant funding. An employee might be interested in cultivating an online community on behalf of the organization employing software that is available for free. All you have to do is allow them a couple hours a week to work on it. But if an incident arises that causes your organization to become an object of derision online and spills over to the local print and broadcast media, that can be a huge problem for you. But if your employee manages to tap into the interests of a bunch of influential 20 or 30somethings, the effort could be rewarding for you, your employee and your new supporters. (Though this win-win-win situation could be detrimental if the established supporters feel the organizational character has changed for the worse. That is the risk you have hopefully anticipated and prepared for.)

Ultimately though this whole issue leaves me wondering if there isn’t a better way than the non-profit model. Is there someway that allows employees to share in the success of the organization and have their non-monetary motivations engaged as well? Given the complex financial instruments constructed by the investment firms that got the country into its current financial crisis, I guarantee the brain power to design a way to finance such an organization exists (both constructively and legally, of course). There is simply has been no motivation for them to turn their minds to constructing such an opportunity. Perhaps the non-profit world at large should push to have these people prosecuted for criminal malfeasance and negligence and then advocate that they be sentenced to community service creating a proposal for such a funding scheme.