(Matt Sinclair, PND's editor, interviewed Clara Miller, president and CEO of the New York City-based Nonprofit Finance Fund, in October.)
Philanthropy News Digest: These days, the economic situation looms large in almost every conversation. Most nonprofits raise the majority of their support from individual donors during the final few months of the year, but this year they're going to be challenged by a slowing economy and one of the worst market downturns since 1929. What kind of impact do you think the financial crisis will have on giving?
Clara Miller: Historically, individual giving and foundation giving have not really followed the peaks and valleys of the economy. That said, the financial services industry is to New York what the auto industry is to Detroit, so turmoil in the markets and on Wall Street is going to have a big impact in this city, at least in the short term.
More to your point is the public's perception that credit is freezing up and banks have stopped lending. For organizations where individual giving is the whole ballgame, they probably will feel some pain, but old friends have a way of sticking by organizations like that. The organization in the worst situation is one that finds itself in the midst of or trying to wrap up a big capital campaign for a building or facility and is counting on large pledges from the likes of a Lehman Brothers, Merrill Lynch, Wachovia, Countrywide, or Bear Stearns. Even if that organization is able to complete its campaign and building, it is likely that it will find itself low on working capital. And if an organization depends on admission fees or people walking in the door to pay for services, they're going to have problems, too. Some organizations may even find it difficult to retain staff because they won't have the liquidity or working capital to get through this downturn. Yes, organizations have faced these kinds of challenges before. But a good leader needs to recognize when to retreat so that an organization can rebuild its strength and live to fight another day.
PND: Do you expect to see more nonprofit mergers and consolidations as a result of the crisis?
CM: It's not that simple. The vast majority of nonprofits are tiny organizations with less than $100,000 in revenue. Many of them are fragile as it is and stay afloat by relying on volunteers and small staff. At the other end of the spectrum you have massive institutions, and there I think you might see a couple of high-profile mergers and maybe even a couple of failures. I've got to think that some of the big fixed-cost organizations are going to have trouble. Hospitals, for example, could experience a triple whammy -- that is, increased demand for their services, reduced government support, and reduced philanthropic support. Organizations that serve the people who are most affected by a downturn in the economy are also going to have trouble. But I think most of them will survive. It's the organizations in the middle that are most vulnerable. Typically, they are trying to grow and are already stretched, and a decrease in revenue could really hit them where it hurts.
That said, I don't think mergers are necessarily the answer. Many people believe that if we just consolidated the sector through mergers, everybody would be more efficient and the money would take care of itself. But the economics of scale are subject to the laws of diminishing returns. If we encourage mergers among the guys in the middle, they will only get bigger and what they might save on overhead won't necessarily translate into more funds for services that are really needed. As we all know, mergers are also expensive, time-consuming, and often painful, and they don't necessarily result in a reduction in the amount of money that foundations are asked to provide to the merged entity.
PND: For as long as I can recall, nonprofits have been advised to develop multiple, diverse revenue streams. Is such counsel more or less important during tough economic times?
CM: Actually, I'm skeptical about that advice in any kind of economy, mostly because nonprofits tend to diversify, or think about diversifying, not in terms of revenue but in terms of lines of business instead. And those different businesses almost always are quite complex. For example, NFF used to do a lot of lending to settlement houses, and the bankers would ask us how we figured out the revenue. Now, for home-care operations, there's only one source of revenue -- reimbursements from the government. But 40 percent of settlement house revenue may come from nine or ten different government contracts, all with different regulations and reporting requirements attached to them. Then they might have five foundation grants to juggle and another 20 percent from bingo receipts, dinner-dance events, golf tournaments, or what have you. Throw in a dash of corporate philanthropy and earnings from rentals and you have an accountant's nightmare. Imagine what it costs to hold that kind of organization together administratively!
My point is, if you start diversifying into other lines of business or your board starts brainstorming and decides that now is the time to start an affiliated for-profit enterprise as a way to bolster your revenue stream, just walk away. At the end of the day, it's all about net, not gross, revenue.
PND: Given most nonprofit organizations' lack of equity capital, you have likened the 21st century nonprofit business model to something more suited to the 15th century. How can the nonprofit sector develop its own version of equity capital and an equity-based approach to how it goes about its business?
CM: First, let's remember that, by law, a nonprofit can’t be "owned." That said, what is important about equity in any healthy enterprise is that it helps to build the enterprise's capacity to attract revenue. Now, several things make it hard for nonprofits to attract that kind of equity. One is a lack of an "equity ethic," an understanding that you have to protect the enterprise from over-exploitation. By that I mean you have to guard against other people who overexploit it by trying to get it to do too much for too little revenue. A board member's job in this regard is to put her hand out and say no to a government contract that pays thirty cents on the dollar, despite the pleas of the well-intentioned social worker who says, "But I don’t want to turn this kid away!" No matter how sincere and well-intentioned that social worker, that is overexploitation of the enterprise.
Second, foundations and high-net-worth individuals have to understand their role as equity investors in an organization, and that is to build the enterprise. It's different from saying, "We want to do this program and we're going to pay you for it." The minute you ask a nonprofit to do something different, you're putting demands on its equity. It doesn't matter if the organization plans to grow, wants to conduct impact assessments on a regular basis, or is changing it accounting system; you have to build the enterprise platform first in order to do those things.
Lastly, the battle cry of the nonprofit sector should be, "Accounting is destiny." The for-profit sector understands that, but you don't have the same kind of visibility into the enterprise in the nonprofit sector because all monies in the nonprofit world are booked as ordinary revenue. Even when it's an equity investment or a capital investment, it has to be included in the income statement. In the for-profit sector, on the other hand, capital just goes onto the balance sheet and is counted as an asset. But when a nonprofit gets a capital grant or an equity grant, it all flows through the income statement. As a result, you can't tell whether you're making progress toward sustainability by building the platform. What an equity analysis does is to ask questions like: What do you want to build? How many people do you need in your development department to actually support the fact that you lose $300 every time a kid walks through the door of your daycare center? And if you need to get more of your support revenue from individuals, what will that actually require?
Improving the financial health of an organization doesn't just require announcing to the associate executive director, "Now hear this, Mrs. Bigheart will be approached and asked for money. It's your job to do it this afternoon." It may require building an entirely new business, one that is likely to take at least three years to show net revenue. The for-profit sector understands that; unfortunately, the nonprofit sector doesn’t. We just see money coming in from Mrs. Bigheart along with the rest of the revenue, including revenue from contracts or annual donors. Equity analysis and the visibility it gives "equity stakeholders" -- like the board of directors -- reveals what is regular, reliable income, and what is equity-like capital. Stakeholders then have a better understanding of how to deploy equity to support operations and whether the organization is financially sound or weak. The idea is to develop an ethic that values seeing and protecting the enterprise so it can serve the public in the long run.
PND: What kinds of tools can help people in the sector understand this better?
CM: At NFF, we have a division called Nonprofit Finance Fund Capital Partners, which is similar to a venture capital firm. It combines our experience in the field investing money in nonprofits with our understanding that you lose a dollar on every "widget" in the sector, and you can't make it up in volume. Unlike a for-profit business that would shut its doors under those conditions, nonprofits stay in business because it's what our mission tells us to do. NFF Capital Partners analyzes an organization and its deficits, and documents what needs to be put in place to make it whole and put it on the road to sustainability. For anybody who wants to invest toward the goal of building an organization's ability to attract revenue, it also has developed an accounting treatment that is designed to reveal progress along the way. On the funder side of the equation, we need to help foundations see that none of them has enough capital on their own to boost a nonprofit up the curve of sustainability. If, on the other hand, they collaborate with other funders, they can actually accomplish their goals and, with a well-thought-out exit strategy, move on to other things.
-- Matt Sinclair