Social Currency

Great art is often created without lots of money and can be enjoyed for many years. Great arts organizations without the right kinds and amounts of money, however, struggle to see another day.

Mission success for nonprofit arts organizations is reflected in the creation, sharing and appreciation of meaningful work.  Each organization has a different artistic vision and goals, as well as its own strategy for reaching and engaging audiences.  Behind every successful organizational strategy there should be a sound approach to obtaining and stewarding the financial resources required to support mission execution over time. This is a capitalization plan. At its essence, a capitalization plan serves as a roadmap for ensuring an organization has the cash and other assets it needs to manage risk and pursue opportunity.

Strategic plans often lack a rigorous financial foundation. They fail to consider the long-term financial resources needed to support program goals. And when they do include a financial plan, they often conflate regular revenue (ongoing) with capital (periodic), or neglect capital needs altogether.  While financial projections that quantify the future revenue and expenses associated with a strategy are critical components of any strategic plan, they are not enough.  Consideration must also be given to the organization’s long-term balance sheet –or capitalization– needs. 

A capitalization plan is really just an approach to building the right balance sheet. It should consider the kinds and degrees of artistic and organizational risk an organization can and wishes to tolerate, as well as the creative ambitions to which its leaders aspire.  Specifically, a capitalization plan should address an organization’s financial health and goals in the following three areas: liquidity, adaptability and durability.

• Liquidity: having adequate cash to meet ongoing operating needs
• Adaptability: access to flexible funds to adjust to evolving circumstances
• Durability: assets to address a range of future needs

Capitalization planning is not one-size fits all

While the amount of adequate liquidity may differ by organization, cash is king for all nonprofits, regardless of size. Many organizations also need periodic access to flexible capital to pay for adaptation –whether related to growth, restructuring, program revitalization or even downsizing. 

Attendance at the TCG Fall Forum on Governance is comprised of primarily executive directors and board members, with a sprinkling of representation from artists and staff members from the nonprofit theater world.  So, after a day of terrific conversations, it was with great pleasure that I gathered a handful of them together for a panel discussion: “So You Have a Deficit, Now What?”  What followed was a refreshingly frank discussion punctuated with practical lessons applicable to the work of any nonprofit administrator: 

Preliminaries
We began with a few general concepts:

• Talk of deficits demands a consideration of assets, but some valuable assets don’t appear on a balance sheet.   Assets can also include intangibles such as:  audiences, knowledge, staff members, a board of directors, openness to change, technological tools and savvy, diversity of background and age among your staff, board and stakeholders, civic and business partners, your “brand”, organizational self awareness, and, critically, when seeking to overcome deficits, knowing your impact. 
• When considering “health” metrics at NFF, we think in terms of “months of cash” on an Unrestricted Liquid Net Assets (ULNA) basis.  If you strip away all of the buildings, property, equipment, temporarily restricted, and permanently restricted items from your Net Assets, how much cash is left for operations?  It can vary, but a rough starting point for an ideal is a 3 month cash/ULNA reserve.  
• Deficits can be “financed” through a variety of means including: accounts payable, mortgage debt, drawing on reserves, foregone wages, employee furloughs, and over-extended lines of credit.  It can be difficult to ascertain whether an organization is operating at a deficit, and structural operating deficits can be masked by a period of operating at sub-par capacity levels in order to keep expenses in-line. This will not be sustainable.

Managing Costs and Revenue

Tracy E. Long, General Manager of Adirondack Theatre Festival started off the panel by describing an initiative to overcome a $29,000 shortfall on a prior year’s performance, an 8% deficit on the annual budget.  While the scale may seem relatively small, the deficit posed a significant challenge to their cash flow and was an ongoing concern.  Long took on the deficit by addressing both revenue and costs: 

Revenue side

• Increase ticket revenue on the margin by raising ticket prices by $3 each.
• Develop theater projects with partners to share costs but generate new and increased revenue.
• Respond to board member interest in hosting a “Brewfest” with board member spouses and another nonprofit to generate fundraising revenue. 

Cost Side

• Decrease rehearsal periods for plays that could still be produced effectively with shorter advance time,.
• Change the design on printed materials to result in lower printing costs.
• Cut the full-time production manager and move to a “variable” staffing method – hiring as needed for theater tech and sharing the management tasks among the remaining staff.

Accumulated vs. Structural Deficits
Michael Gennaro, Executive Director, Trinity Repertory Company, began by making two important points:

• Even well managed companies are beginning to fail.
• Accumulated deficits and structural deficits are different and managing them requires different strategies. 

Michael drew from his experience with the Pennsylvania Ballet as his first example.  When he went there he found an accumulated deficit of $2 million on a $6 million operating budget.  In that instance Michael suggests the first step is to analyze what makes up the debt you are inheriting and evaluate any creative strategies you can employ to get rid of it.  At the Pennsylvania Ballet, the debt was almost completely financed through accounts payable, so Michael negotiated a “work-out” with the vendors to pay a percentage on the dollar of outstanding bills and thus retire the deficit.

In his current tenure as the Executive Director at Trinity Rep, he inherited a more challenging scenario:  Three separate lines of credit were maxed out or frozen, and the building required an expensive update to meet fire code standards.  Together, they amounted to more than $3 million dollars of accumulated deficit with the cost of deferred upgrades to the building generating a structural deficit.  In this instance he took the following steps:

Twenty-five percent of annual operating expenses. That’s what the National Center for Charitable Statistics recommended in it's Operating Reserve Policy Toolkit for Nonprofit Organizations, published in September 2010 in partnership with the Center on Nonprofits and Philanthropy at the Urban Institute and United Way Worldwide.  Grantmakers in the Arts, in January 2010, launched their National Capitalization Project and at their October meeting in Chicago released a summary document which stressed the importance of well capitalized organizations and added, “…we repeatedly came back to the fact that the most common source of capital is accumulated surpluses. We agreed that getting organizations to achieve a surplus would require encouraging a significant shift in nonprofit practice and culture, a challenge we thought well worth undertaking.”

Nonprofit Finance Fund has long been a proponent of healthy balance sheets, but as the reports and recommendations mount, it’s clear that NFF is not alone in suggesting a course of action that considers the creation of reserves.  While reserves alone do not comprise total capital structure, they are an indicator of the degree to which an organization is prepared for the day to day and long term challenges they may face.   Capital structure is the nature, composition and magnitude of the assets, liabilities and net assets comprising the balance sheet – or in other words the financial and physical platform from which the organization’s mission is accomplished.

The provocative question is, how will nonprofits develop healthier balance sheets?  And perhaps more pointedly, how patient are we willing to be?  While generating operating surpluses may be ideal, it will take time and patience to realize a well capitalized sector utilizing this approach.  Our third annual national survey of over 1900 nonprofit leaders (funded by Bank of America) is telling on this point: 

So, is capitalization via accumulation of operating surpluses the answer?  In simple terms, if we are waiting for the sector to build (or re-build) balance sheets independent of new philanthropic dollars, it will take a minimum of five years for those functioning at the 5% surplus level to generate even the equivalent of three months of additional cash reserves.

At NFF our recently released paper, The Case for Change Capital in the Arts, sets out a series of definitions, strategies, and sample cases from our work with Leading for the Future (funded by the Doris Duke Charitable Foundation) that can inform the conversation about capitalization.  In today’s economic environment, in the midst of the conversations and changing dynamics in the field about capitalization for nonprofits, the time for an equity ethic, an embrace of philanthropic equity if you will has arrived.   While we have many tools to teach nonprofits how to create new strategies for operating that generate surpluses, the sector has been struggling for a long time with inadequate capitalization.   Asking nonprofit leaders to generate operating surpluses to build healthy balance sheets will also require asking ourselves if we are providing the proper support for that expectation to be realized.

Last week, we published a series of documents stemming from the early results of our Leading For the Future initiative, funded by Doris Duke Charitable Foundation.  You can download the Case for Change Capital in the Arts here and the companion document, Financial Reporting Done Right, right here.  Together they showcase the lessons of the work done so far and provide a road map for foundations and their grantees who might like to put some of the lessons into practice themselves.  The Case for Change Capital in the Arts made Nell Edgington's 10 Great Social Innovation Reads for May and got a thorough airing on Andrew Taylor's Artful Manager blog as well.   

In late April, we gathered the participants in the initiative together in New York City to talk about how their capitalization experiments are going.  We had a chance to interview two of the organizations in greater depth.  Earlier this week, we posted Rebecca Thomas' interview with Charles Dillingham of Center Theatre Group.   Below, you'll find Rodney Christopher's interview with Polly Carl and Martha Lavey of Steppenwolf Theatre Company who share how they've invested their change capital over the last two years.