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Getting Capital Right: Six myths and Realities for Grantmakers Part 1

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March 9th, 2015
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Poor capitalization remains the norm in the nonprofit sector, despite the now common wisdom that long-term financial health is a means to mission fulfillment. Most nonprofits, regardless of sector, subsist on one to two months of working capital. Their leaders and supporters have become accustomed to this hand-to-mouth existence.

This reality persists even as capital fundraising proliferates. A recent Boston Globe article reported that capital campaigns in the region are becoming run-of-the-mill. They are growing in ambition, lasting longer and occurring with greater frequency. The article noted that smaller organizations too are jumping on the capital campaign bandwagon, motivated by a recovering economy, competitive pressure, and the unremitting demand for resources.

So, what gives?

My belief is that the sector often raises and deploys capital in inefficient ways, despite good intentions. In my philanthropic and nonprofit consulting practice, I see that nonprofits and grantmakers alike hold on tight to a number of myths that buck practices supportive of organizational health. It’s time to let go of these myths.

Given the power that grantmakers have to influence nonprofit missions and finances, it's crucial to "get capital right." In this two-part series for AGM’s InPhilanthropy, I highlight six false ideas about money that I often hear and offer some suggestions for how grantmakers can improve how they communicate with and support the sector. While strengthening the sector’s financial health will certainly require some heavy lifting by nonprofits themselves, funders are in the driver’s seat, so change starts with you.

Myth #1: Facilities and endowments provide security

Truth: With assets like these, who needs liabilities?

Historically, in the nonprofit sector, we’ve equated healthy capitalization with the proliferation of shiny new facilities and hulking endowments. Indeed the edifice complex remains alive and well in New England, and across the country. While bricks-and-mortar and long-term investment funds are indeed elements of capitalization for many organizations – particularly the larger ones – capitalization is actually about having access to cash. Well-capitalized organizations have enough cash to pay their bills, innovate and experiment, navigate tough times, take care of facilities they already have, and adapt to changes in their environment. The sad reality is that many organizations have built up significant fixed assets and endowments at the expense of securing adequate working capital and savings. Few are attracting flexible kinds of capital, such as operating or risk reserves, or change capital, although some promising examples are out there.

Recommended funder practice: Encourage comprehensive capitalization planning.

When making a capital investment of any kind – whether for a fixed asset or more flexible cash reserve – ask yourself whether your contribution aligns with the organization’s strategy and financial plan. Funders can support financial training for executives and boards who aren’t well versed in the nuances of planning comprehensively for long-term health. Then, they can invest in comprehensive planning efforts that match organizational strategy to: 1) a business plan that tests the financial and operational viability of the strategy and 2) a capitalization plan that sets (and quantifies) comprehensive goals for savings and investment. As a general rule, a facility or endowment should never be the first capitalization priority. Most organizations need liquidity first.

Myth #2: Capitalization only applies to big nonprofits  

Truth: Every organization can and should save. Surpluses and reserves are a sign of good management.

Whether an organization is large or small, mature or emerging, institutional or community-based, it can and should manage its expenses in line with revenue realities, set its sights above the breakeven mark, and make contributions to savings. In my experience, most nonprofit leaders – even of small-budget institutions – understand that surpluses, which contribute to savings, provide them with breathing room to take and manage program and business risk.

Recommended funder practice: Reward surpluses and promote savings for organizations of all sizes.

Small organizations present an attractive opportunity for capital investment because their needs tend to be relatively straightforward. These organizations require working capital to manage the day to day and possibly, a modest amount of additional savings for unanticipated risks or opportunities. By encouraging organizations of all sizes to budget and mange to surpluses – and set aside surpluses as savings – nonprofit supporters can help their grantees take steps to strengthen capital health. Don’t turn away a prospective grantee for running its business well. Strong financial stewardship and program leadership typically go hand in hand.

Myth #3: Capitalization is too expensive for smaller funders

Truth: Financial strengthening need not break the bank.

We often hear from nonprofit organizations and their supporters that capitalization is the purview of national funders who have the capacity to make sizeable, multi-year investments. In fact, nothing could be further from the truth. While large community anchors may have complex infrastructure to maintain, the majority of nonprofit organizations have low fixed costs and modest savings needs. Helping these organizations strengthen their balance sheets with working capital and reserves doesn’t need to be expensive, particularly if multiple funders come to the table to share the cost.

Recommended funder practice: Consider seeding a cash reserve, alone or with others.  

If you are in a position to make a capital grant, consider seeding a cash reserve that can be designated by your grantee’s board of directors for any number of purposes such as a rainy day, care of fixed assets, or pursuit of special opportunities. Can’t afford the full amount? Think about who else shares your values and priorities that might be rallied to the cause.

In my next post for InPhilanthropy, I will share three additional misconceptions about capitalization, offering recommendations for how grantmakers can invest and communicate in ways that strengthen the long-term health of organizations they support.

Rebecca Thomas is the founder and managing director of Rebecca Thomas & Associates. She was previously a Vice President at Nonprofit Finance Fund.

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