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Risky business in nonprofit sector

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Question:

What are the first steps nonprofit organizations should take in the area of risk management?

Answer:

What it means to manage risk in a nonprofit falls into two different areas. The first, protecting against catastrophic risk, is commonly thought about and addressed by nonprofits.

Very few organizations, however, consider the second, crucial side of risk management, which is making strategic decisions under risk.

* Protecting against catastrophic risk

In this category, I think nonprofits are generally fairly well-versed.

Most have insurance for the various types of liabilities their organizations could face — directors and officers insurance, property insurance, and so on.

A related protection strategy is diversification.  Here many nonprofits pay attention to diversifying their investment portfolios of financial securities, as any prudent investor does, but they would do well to apply diversification to other areas of their operation as well.

For example, where is your income coming from? Are you depending too much on certain sources? If you just have earned income, should you balance that with donations, investments, government income?

Similarly, what programs do you offer?  If one does poorly, are there others that could compensate?

Diversification offers protection since changes in multiple income streams or programs are unlikely to happen all at the same time so that greater overall stability can be achieved.

* Strategic decision-making

This second, often neglected side of nonprofit risk management consists of making important, discrete decisions where risks are necessarily involved.

In these decisions, an organization is often in the position of having to find the right combination of risk and reward so that it can achieve its goals while tolerating a comfortable level of risk.

Decisions involving significant risk range from hiring a new staff member or deciding whether to start a new program to cutting back a program that’s not going so well. Do you enter a partnership with a corporation or another nonprofit? Or should you make that singular investment like undertaking a commercial venture?

In all these decisions, there are risks involved and also different levels of reward associated with different choices.

In hiring a new executive director, for example, there may be certain candidates who are a pretty clearly low risk, meaning there are known quantities, but the candidates perhaps may be limited in upside performance potential. And there may be other candidates whom you don’t know as well and who are therefore higher risk but potentially better performers as well.

You can eliminate some risk by due diligence in assembling such information as the candidates’ past performance records but you can’t entirely eliminate the risk.

You have to balance this risk by comparing the probabilities and gains and losses of a good or bad outcome for each option that you have.  This requires some analysis and reasoning, even if it’s more qualitative than quantitative.

Such strategic decision-making around risk is not easy and this is a new area of research in nonprofit management that is very much in the beginning stages, but it’s very important.

While catastrophic risk management and strategic decision-making under risk apply to all organizations, there are certain aspects of it that are unique to nonprofits.

For example, nonprofits are unusual in having so many different kinds of income and programs around which to diversify. Nonprofits can also be part of umbrella associations or federations that can help them share risks with other nonprofits.

Nonprofits may have a more difficult time measuring the value of potential outcomes and rewards because they cannot always be measured in financial terms.

And nonprofits must consider some special factors in formulating their policies towards risk, balancing their roles as responsible trustees of charitable resources with their obligations to try new approaches to achieve greater social impacts.

There are, however, a growing number of resources for nonprofit professionals interested in getting started in this emerging area of risk management and strategic decision making for nonprofit organizations.

— Compiled by Elizabeth Floyd.


Dennis Young is founding CEO of the National Center on Nonprofit Enterprise in Alexandria, Va., and Bernard B. and Eugenia A. Ramsey Professor of Private Enterprise at the Andrew Young School of Policy Studies at Georgia State University.

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