In this month’s Social Velocity blog interview, we’re talking with Rebecca Thomas. Rebecca Thomas is Vice President of Strategy & Innovation at the Nonprofit Finance Fund, a national leader in nonprofit, philanthropic and social enterprise finance. She has strategic responsibility for national initiatives, funder partnerships and new online and next-generation services that advance the organization’s profitability, visibility and impact. Rebecca serves as a spokesperson and advocate for NFF regionally and nationally, and is the co-author of Case for Change Capital in the Arts and Financial Reporting Done Right, part of a larger publication series on capitalization in the arts.
You can read past interviews in our Social Innovation Interview Series here.
Nell: Your “change capital” project works with 10 arts organizations to help them raise capital to transform their organizations. Why did you decide to focus on arts organizations? What is unique about their need for change capital?
Rebecca: Through the Leading for the Future Initiative, NFF is investing $1 million of change capital in each of ten performing arts organizations that are adapting their programs, operations and finances in ways that contribute to long-term health and vibrancy (click here for the list of participating organizations). The source of this capital is the Doris Duke Charitable Foundation, which partnered with us in 2007 to develop the program as a way of responding to the tectonic shifts taking place in the artistic landscape. These shifts (in demographics, technology, and audience expectations, to name a few) were underway in the arts sector well before the economy went south and jeopardized arts philanthropy and public funding. Because business as usual is no longer an option for this sector, the need for change capital to fund creative re-alignment is particularly pronounced.
Arts sector aside, the majority of nonprofit organizations are mis-capitalized, meaning they lack enough of the right kinds of financial resources to adapt to changes taking place in their external and internal environments. The field often focuses on the lack of capital—certainly a reality for many organizations—but capital is equally often misplaced. Consider the organization with an aging facility and permanently restricted endowment but only two weeks of cash. It may not be undercapitalized but it is certainly mis-capitalized!
The arts sector has, more than many other sectors, suffered from an institutional mindset that equates success with the accumulation of fixed assets, often at the expense of liquidity and flexible capital. The result is that too many organizations are in a starvation cycle, unable to fully pay for their current programs and infrastructure, let alone to invest in meaningful and lasting change.
Nell: Do you have plans to expand to other types of nonprofit organizations with this project?
Rebecca: Our program, which runs through 2013, is limited to the 10 current participants, which were chosen through a multi-phased application and selection process. Given the nature of capital, programs like LFF are expensive and require one or more funders who are willing and able to commit sizable sums of money. The field is fortunate that the Doris Duke Charitable Foundation had the resources and vision to create this program with us. The principles of this program certainly apply to every sector, and we aim to do similar innovative initiatives with funders and nonprofits in other fields (for example, healthcare and charter schools) that we think would benefit from an investment of change capital.
We’ve found that education about the relationship among mission, capacity and financial health is often a precursor to the establishment of a capital initiative of this kind. NFF partners frequently with foundation program staff and nonprofit leaders to introduce the concepts of change capital, reliable revenue and liquid, adaptable balance sheets. From efforts like these have arisen deeper partnerships. For example, we have capital-investment programs with the Kresge and Andrew W Mellon Foundations that, respectively, provide financing for cash reserves and working capital. Change capital is just one of several forms of flexible capital that organizations need, for purposes ranging from risk management to rapid scale to stabilization.
Nell: As part of this project you are demonstrating how nonprofits can adjust their financial reporting to allow for a very necessary distinction between revenue and capital. Do you see nonprofits adopting this fairly significant change? What will it take to change accounting standards to recognize this distinction across the sector?
Rebecca: One of the things we learned early on in this work is that changing the financial reporting—to separate capital flows from recurring revenue—would not be an easy sell, for understandable reasons. Executive directors are reluctant to take a chance presenting new formats to donors who don’t understand the technique, and many board members aren’t inclined to re-learn nonprofit accounting principles. Moreover, NFF’s suggested methodology is not required by the Financial Accounting Standards Board, and auditors don’t always feel comfortable suggesting novel formats, even when they provide heightened clarity.
Notwithstanding these challenges, nonprofits that periodically raise and deploy capital—whether for investing in fixed assets, building a reserve, or implementing a change strategy—should take the straightforward step of separating capital from ongoing operating revenue and expenses, at least in managerial reporting. Financial Reporting Done Right explains in greater detail how this is done, but suffice it to say that when capital and revenue are conflated, an organization’s reports do not present a realistic view of operating performance. Unintentionally misleading information can lead to poor planning and decision making by nonprofit leaders, boards and funders.
Longer term, it will take aggressive education and advocacy efforts to convince nonprofit executives, board members and funders of the value of producing transparent financial reports and audits that reveal business model economics separate from capital infusions. Nonprofits will need to be convinced that they won’t be penalized for producing statements that may, at times, show temporary weakness in operating results during a change or growth period.
Nell: What can and should funders do to make change capital a reality for more nonprofit organizations?
Rebecca: Funders can start by encouraging their grantees’ efforts to adapt in the face of shifting environmental and internal realities. Nonprofits need to know that their supporters view these efforts as important, recognize the risks involved in attempting change, and are willing to provide flexible funding without judgment.
Also, funders can provide support for the development of a rigorous strategy and financial roadmap for change, both of which should be in place before a sizable investment of change capital is made. This planning should include the preparation of financial projections for the period of change and program and financial metrics (identified by the grantee!) to measure progress and guide course corrections. Because change takes time and can be costly, funders should consider aggregating their resources to support a grantees’ change strategy – and any funder “pool” should embrace one standard of reporting.
I want to stress that not every organization is a good candidate for change capital. Many are too financially fragile to invest in transformative efforts and first need capital to recover from previous setbacks. Some characteristics of “change capital-ready” organizations include: an enterprise perspective that sees the organization as more than the sum of its programs; a strong, stable and collaborative management team and board; a commitment to strategic planning, self-reflection, and continued learning; a culture of risk-taking and adaptation in the face of obstacles and new information; a track record of surplus performance and adequate liquidity; and a continuous focus on results and the use of data to inform decision making.
Nell: How open do you think philanthropists are to the idea of building versus buying services? Is the idea catching on for funders? What will it take to make the idea widespread?
Rebecca: The importance of role clarity can’t be understated. Both individual donors and institutional funders need to be clearer about whether they are investors in nonprofit enterprise health (“builders”), annual supporters of nonprofit services (“buyers”), or both. Among venture philanthropists and their ilk, this concept has gained much momentum in recent years. NFF Capital Partners collaborates with such investors in their efforts to scale high-performing nonprofit organizations. Through NFF’s grantmaker training programs, which reach a broader audience, we are also seeing a deeper understanding of this concept, although its application remains uneven. Ben Cameron, Program Director of the Arts at the Doris Duke Charitable Foundation also deserves a lot of credit for understanding and embracing this concept, and then stepping forward to be the learning example for an entire sector.
Time, education, and openness to change will be required for field-wide change. More stories about how nonprofits are successfully (and not so successfully) deploying capital to scale, change or restructure their operations would also help.
But let’s remember that not every philanthropist can or should be a builder. The field would benefit greatly from more buyers who provide (or partner with others to provide) unrestricted support that covers the full costs of program delivery, rather than limited program support or expansion at the margins.
Nell: What challenges are your change capital clients finding during this journey? Are they successfully raising change capital across the board, or are some faring better than others? Why?
Rebecca: Several of our clients have sought to raise change capital outside of this program as they seek to fully realize ambitions that carry a price tag larger than $1 million. A few have raised funds that serve a similar purpose without calling these dollars “change capital.” What we’ve heard from many of our clients is that foundations and boards either don’t have the resources to provide capital at this scale or don’t fully understand the concept. While grantmakers are increasingly embracing other improvements in practice –such as supporting reserve-building efforts, encouraging surplus management, and providing general operating support – few are yet providing flexible capital to be invested in implementing and sustaining enterprise-level change.
I want to make one last point. We set up the Leading for the Future program to enable our 10 participants to embrace innovation and experimentation as they adapt their business models in response to new challenges and opportunities. But programs like this one are not about change for change’s sake. Change capital is not the same as an “innovation grant.” The capital is meant to be deployed in ways that lead to more reliable net revenue (read: surpluses) to sustain each change strategy once the capital is fully spent.
And, at the end of the day, it’s worth remembering that financial stability is only a means to the end of greater nonprofit effectiveness and impact.