A new blog at the Chronicle of Philanthropy site launched this week that I’m pretty excited about. Written by Clara Miller and others at the Nonprofit Finance Fund, the Money and Mission blog will help nonprofits “understand and skillfully wield money as a tool.” What a revolutionary idea.
As Clara writes in the inaugural post:
Great ideas, deep caring for those in need, creativity, resourcefulness, a service ethic, and an expansive vision for the future are abundant in the nonprofit world. But we lack the financial capacity to meet these ideals, and our financial habits undermine efforts to build it. We need to think of finance as more than a muddle of fund raising, budget monitoring, and compliance with overhead rules. The current, tough economic environment is spurring needed change. Now, understanding money concepts like risk, leverage, and accounting, seems to be a moral imperative.
Indeed, the nonprofit sector has for too long been burdened by a lack of financial literacy and thus an inability to use money effectively. Sure there isn’t enough money in the sector, but if nonprofit leaders better understood the financial tools available to them and how to use them to their advantage, the results could be revolutionary. This is the argument in our Financing not Fundraising series.
Capital campaigns provide a great example of this. Nonprofits have used capital campaigns for years to raise money for a new building or, less often, an endowment. Capital campaign money is raised and used in a very different way from how general operating money is raised and used. A capital campaigns USES money raised to buy a building. An annual fundraising campaign USES money raised to buy additional services that the nonprofit provides (food for a food bank, mentors for kids). An annual fundraising campaign often RAISES money by cobbling together various activities (events, grant writing, some direct mail appeals) hoping that the sum will equal the expenses needed for the year. A capital campaign, however, RAISES money by conducting a feasibility study to determine how much they can likely raise, then creates a plan, budget, and case for support. Then potential donors are cultivated and solicited in a systematic way. This is a deliberate, strategic way to bring capital campaign investors in the door.
However, capital campaigns are often misguided attempts to grow the impact of an organization. A nonprofit thinks that in order to be taken seriously in the community and attract larger donors they need to build a new building. Enormous amounts of time, energy and money are spent to create a building they don’t need, burn out their development staff, and eventually shoulder new building maintenance fees for years to come.
What if nonprofits could pour those same desires–to do more, to make a bigger impact, to attract more resources, to build deeper networks–and that same time, effort and resources into a campaign that will actually help them build a more effective, more sustainable organization that delivers more impact? What if the methods of a capital campaign were instead employed to raise growth or capacity capital that allows the organization to provide more, better services to the community? That would be huge. Enormous.
The Nonprofit Finance Fund turned capital campaigns on their head with their SEGUE (Sustainable Enhancement Grant) program. It is essentially a capital campaign, but instead of buying a building, the nonprofit raises growth capital to scale the organization for greater social impact. NFF takes a concept nonprofits understand and are comfortable with, a capital campaign, and transforms it into a way to raise organization building money, a completely new idea. I’d love to see more nonprofits using financial tools already available to them to accelerate their ability to create social impact.
Like it or not, money is an incredible tool. If nonprofit leaders could better understand it, stop fearing it, and learn how to wield it effectively, the results could be transformative.
Photo Credit: piermario
Last month we kicked off a new, monthly Social Velocity blog interview series where I interview leading thinkers and doers in the social innovation space. Our inaugural interview was with Kevin Jones co-founder of both Good Capital, one of the first venture capital funds that invests in social enterprises, and the Social Capital Markets Conference (SoCap) which marks its third year with the upcoming October event.
This month’s Social Velocity interview is with Clara Miller, President, CEO and founder of the Nonprofit Finance Fund, a national leader in nonprofit, philanthropic and social enterprise finance. Directly and with others, NFF has leveraged $1 billion of capital investment into nonprofits, and provided over $200 million in direct loans. Clara Miller was named among The NonProfit Times “Power and Influence Top 50″ four years in a row and is a board member of GuideStar and Grantmakers for Effective Organizations.
Nell: You and the Nonprofit Finance Fund have initiated this idea of equity capital for nonprofits, or money to “build” organizations rather than the tradition funding to “buy” services. Do you think the idea of equity capital for nonprofits is catching on?
Clara: First of all, I should say that many people have contributed to the idea of a nonprofit version of equity over the years. My NFF colleague George Overholser has been a field leader. He focuses almost exclusively on the version we call “growth” capital, which is used to rapidly build organizations, changing what they do through major investment undertaken around a single set of metrics, business plan, and ideally, with all funders acting in concert.
And yes, I do think the broader notion of “equity”—and for that matter, the importance of the balance sheet in its entirety—is catching on, especially among major foundations, capital campaign veterans and those familiar with these concepts in the for-profit world. The broader concepts of “building” organizations and “buying” services, and how financial roles differ, are resonating strongly with both organizations and funders. We have a foundation partner that has simply put the question, “is this a “buy” grant or a “build” grant?” on the program officers’ intake checklist.
Nell: How do traditional nonprofit capital campaigns, which are predominantly focused on raising money for new buildings, fit into all of this?
Clara: We think these “growth capital” and “equity” principles comprise an ideal way to think about (and operate) a successful capital campaign. Our early work in the 1980s (when we were Nonprofit Facilities Fund, and exclusively financed “community facilities” with loans) revealed that a rash of problems would almost invariably follow capital campaigns for facilities: cash crises, burnout, funder fatigue, “night of the living dead” program operations, the need to lease excess space at below-cost rent…you get the idea. It was a real eye opener. We learned a lot about the need for truly unrestricted “growth capital,” in addition to funds focused (and often restricted) to build and fit out the facility. Among the NFF-documented lessons: that facilities projects typically need 3 to 4 times the bricks and mortar cost for working capital to cover program and administrative growth needs; that the building frequently changed the business model radically, but planning never covered the whole enterprise; and that putting large amounts of cash into an illiquid asset while expanding operations was problematic on a number of levels. Also, many of these building projects came with opportunity costs: organizations weren’t investing in new technology, upgrading skill sets, or replenishing cash reserves.
Beyond facilities projects, capital campaigns frequently focus on other (typically illiquid) parts of the balance sheet: building an endowment, or on the acquisition of, for example, a program asset (such as a painting or piece of medical equipment). Thinking holistically about improving or acquiring illiquid assets, via a campaign for growth capital, can better the situation.
Nell: The for-profit sector currently enjoys a broader and deeper array of financial vehicles than does the nonprofit sector (seed funding, angel investors, growth capital, stacked deals, etc.) do you anticipate that the capital market for nonprofit organizations will become more robust and what will it take for that to happen?
Clara: I’ll push back a little and say that the vast majority of both nonprofits and for-profits (that are small, with less than $200K in revenue) have approximately the same level of access to similar financing vehicles: sweat equity, seed/angel funders/investors (friends and family, the first foundation grants, etc.), credit card debt, bank loans, retained earnings, etc. Then there is “growth capital” or “capital grants,” which a very small proportion can access in either sector. And while large for-profits are much, much larger than large nonprofits, large nonprofits have reliable access to some highly sophisticated funding and financing vehicles that for-profits don’t (and vice versa). Some very large nonprofits have access to for-profit subsidiary ventures and investments—and some are highly sophisticated (universities investing in development of intellectual property and associated products, CDFIs with venture funds, public media with development and sales of program assets, and others). And on the debt side, much of nonprofits’ “capital market” is for-profit-run (bank debt, investments, tax-exempt bonds, etc.)
The most important barrier to enterprise scale (for either sector) is not so much lack of access to capital as it is a scalable, focused business model with reliable net revenue. Once you have those—or evidence that they are possible—capital will flow.
But that said, we’re talking about a couple of “market wide” dysfunctions. The first is that despite highly resourceful managers, sophisticated board members and billions of dollars of revenue and capital funds, there is no tradition of “enterprise finance” in the sector. “Pretty bad ‘best practices’” designed to make nonprofits more efficient and fiscally prudent cost the sector dearly. Confusion about the direct funding of programs (it’s not possible, most of the time you need to fund an enterprise to deliver programs) means capital is mixed up with revenue, growth with regular operations, and “build” grants with “buy” grants (and a variety of hybrids!). This wreaks financial havoc in growing organizations. Missions—along with the public—suffer.
The second problem is that there’s no really reliable signaling mechanism for organizations to fold their tents, pass their programs to another organization, and go out of business. In the for-profit world, that would be financial failure; in our world, that’s not so straightforward: so we hang in there, meaning resources that might go to a stronger program remain tied up. It also means that the biggest and richest players have (and, largely, keep) the vast lion’s share of resources (even more pronounced than in the for-profit world).
Finally, there is a problem with access to charitable revenue. Promising, mid-sized organizations—especially those serving low-income people (and therefore lacking access to the traditional source of capital in the sector, individual donors) have a difficult time building the operation they need to grow. Foundations are the logical path here, and having foundations embrace “enterprise friendly” practices—including growth capital and build-buy understanding—can go a long way toward changing that dynamic. Establishing a field-wide understanding of basic enterprise finance principles will help insure that growth capital campaigns become true innovation with long-term staying power, rather than a short-term novelty.
Nell: Growth capital for nonprofits is mostly only available to larger nonprofits that have the capacity to prove the results of their model. Do you think growth capital will increasingly become available to the bottom 80% of nonprofits (those with a budget less than $1 million), and how and when do you see that happening?
Clara: Our goal is not that all organizations of every size and business model have access to growth capital and pursue aggressive growth goals ASAP. That’s neither possible nor desirable in either the for-profit or the nonprofit worlds. In both sectors, some business models may not be scalable, and that’s ok—in fact, it’s good. Nobody wants their favorite neighborhood clam shack or Italian restaurant to go public or become a Pizza Hut. Diversity is good; and most people like things about both large and small enterprises. This is true in any sector, where economies of scale and preservation of quality are frequently subject to the laws of diminishing returns. Growth capital is not for everyone, and it is only one tool in the enterprise tool box.
The more important revolution is to make broadly accessible the tools and principles of enterprise finance—with a clear understanding of the realities of the commercial proposition of the sector (i.e., there’s a reason we have a nonprofit sector). There are well-managed and poorly managed (and capitalized) enterprises of all sizes and tax statuses, and there are scalable and non-scalable ones as well. Most critical on the scaling front is that our sector embraces and deploys the broad set of principles that make enterprises of any size or shape effective in reliably achieving great results. Trouble arises when a specific social benefit or innovation is so compelling that we all want the maximum number of people to benefit from it: Our failure to use the principles of growth capital and proper scaling techniques to assure results while growth proceeds is (and has been) tragic for the social sector, and a change in practice can help.
Nell: How do you think the Social Innovation Fund will change the capital landscape for nonprofits?
Clara: I think the SIF already has raised the profile of the ideas around growth capital and scaling discussed here. And it certainly has the attention of a group of large foundations, a significant number of whom are applying as intermediaries. I think it took courage for them to apply, and courage for the SIF to get developed. At the beginning there will be some fits and starts, and government procurement can be dicey (especially when it’s trying to be capital rather than revenue), and foundations are trying to make it work in this way for the first time. That said, it’s very exciting for us to see “growth capital,” which is the core concept, being given a whirl by both the White House and the Foundation world.
Nell: Venture philanthropy funds (that provide growth capital to nonprofits) and social venture capital funds (that provide capital to double bottom-line businesses) currently don’t interact very much in the marketplace. Do you see an opportunity for greater integration of nonprofit and for profit social investing? And if so, what will it take to get there?
Clara: I think there is increasingly frequent interaction between for-profit and non-profit business models (and entrepreneurs) on the conceptual level, and that’s being translated into some compelling platform-agnostic enterprise structures to accomplish social ends in many sectors—health care, research, arts and culture, media, housing—are all examples. And interactions may not be best between two enterprises that are both at the “venture” or “start up” stage. A start-up nonprofit may want to partner with a fully-scaled for-profits (and this is common), while a fully-scaled nonprofit may want to create (or house) a venture for-profit to help reach certain social goals.
On the “deal” level, I think there’s a reason to maintain a bright line between the nonprofit and for-profit tax status. I favor crisply defined hybrids (of which there are a variety) over mushiness (we’re a for-profit but we are good people doing socially beneficial work) because they are more likely to stand the test of time and skepticism, and since ownership and tax structures have bright-line legal and moral duties attached to them.
One benefit of the recession for nonprofit organizations is that they can no longer deny the critical importance of finance in what they do. No executive director would say that fundraising isn’t critical to what they do, but I bet a majority would admit that they don’t have an overall financial strategy for the organization. And in a recession that hole becomes ever more apparent.
In flush times it is a bit easier to refrain from analyzing the financial statements every month, predicting cash flow, making hard decisions about whether to end financially draining programs, creating bold (and potentially risky) revenue streams, and so on. The financial strategy of a nonprofit organization often takes a back seat to program strategy. But the recession makes that stance nearly impossible. Because if you turn away from financial reality for too long, you could be out of business.
Clara Miller of the Nonprofit Finance Fund, has some great insights into how the nonprofit sector should be responding to the recession in terms of better financial management. Among her list of things nonprofit leaders should do to be good financial managers are:
- Create a cash flow forecast for at least a year into the future, conservatively estimating what will happen with each revenue source over time and update it regularly
- Conduct a program profitability analysis, which compares the distinct funding sources to the direct expenses of every program a nonprofit operates. When coupled with mission effectiveness this helps inform decisions about what programs to cut or to increase fundraising efforts for
- Understand the relationship between reliable revenue and fixed costs. If your reliable revenue, or revenue that you are reasonably certain will come in on a consistent basis, is lower than your fixed costs, you’ve got a serious problem.
- Focus every conversation at board and staff meetings on strategic choices that face the organization and the financial implications of those
- Be conservatively realistic about all of your numbers
But nonprofits need much more than just good financial management. They need a financial strategy for delivering social impact. They need to understand and analyze how program decisions and strategy affect the financial viability of the organization and vice versa. The two are inextricably linked. It does no good to make program or operating decisions without really understanding the financial implications. And it is not sustainable to create a strategic program plan without a corresponding and equally strategic financial plan.
Finance has for too long taken a back seat in the nonprofit sector. Fundraising staffs have been separate (physically and strategically) from program staffs. Strategic decisions for the organization (program expansion, new buildings, etc) have been made without a clear understanding of the current or future financial implications of those decisions. Program goals have been made without knowing what it will truly cost to implement those goals and where that funding will come from.
Nonprofit leaders need to take a bigger view of how their organizations and missions are financed. It’s not enough to manage money wisely. Nonprofit leaders need to create a comprehensive, fully integrated financial strategy for the social impact they want to achieve and then execute on it.
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