I’ve been preparing materials for a session this week at Allied for Action conference, the joint annual conference of Minnesota Council of Nonprofits and Minnesota Council on Foundations. The session is on a topic that I love to discuss: “Reserves Aren’t Enough: Understanding and Planning Nonprofit Capitalization”. The idea that nonprofits need different kinds of financial capital, in the form of cash, investments, or facilities, has gained traction in the last few years (especially in the arts thanks to great leadership from Grantmakers in the Arts). Understanding the concepts and terminology is a good first step. The term “capital” includes a number of types of reserves designated for operating needs, for opportunities and risk-taking, and for facility repairs and upgrades. Some nonprofits also need capital for long-term needs such as building and endowments. Capital structure should reflect the organization’s mission goals and strategies. Building a capital structure is a commitment that requires some changes in the underlying assumptions and “best practices” that nonprofits have believed for decades.
What’s the biggest barrier to strong capital structures for nonprofits? Break-even budgeting.
While there are occasional opportunities for nonprofits to receive a special grant or unexpected windfall to create a reserve or opportunity fund in one fell swoop, the most realistic path to capitalization is to accumulate annual surpluses from operating activities. In plain terms: income that exceeds expenses. At nonprofits. On purpose.
Why is this such an obstacle? Because of this conviction: “Nonprofits aren’t businesses, we aren’t supposed to make a profit.” If you believe that “making a profit” is unnecessary for nonprofits, maybe even a little unseemly, then your organization is unlikely to have adequate capital reserves for operating contingencies, opportunities, expansion, or to test out innovative ideas. The problems caused by accepting breakeven as the financial “standard” is documented in the report Getting Beyond Breakeven by TDC.
There are many incentives in the system that encourage organizations to break even. We heard repeatedly how running a deficit was frowned on by boards and funders. Organizations have responded well to that message and work hard not to run a deficit. This same discipline, however, has not occurred with larger capitalization issues. While breakeven is an essential goal for achieving adequate capitalization, it is not enough. When the goal is breakeven, there is no avenue through which to build up net assets and capital funds, which can only be accumulated through regular and significant surpluses.
A related issue is caused by what Elizabeth Keating calls the “current services trap”. By using all available resources to meet urgent, short-term needs – current services – nonprofit organizations undermine their long-term stability and viability. When faced with increasing community need and demand for more services, nonprofits that are committed to generating an operating surplus are forced to make hard choices that may sacrifice current services for long-term financial stability and strength.
I promise there’s also an upbeat discussion of capitalization when we talk about the opportunities afforded by strong capital structure – stability, risk taking, expansion, and innovation. If you’re interested in learning more and talking with others about understanding and planning capitalization for a stronger nonprofit, come to my Allied for Action session on November 2 at 11:00. I hope to see you there.