Social Currency

During a recent consulting engagement, I worked with the program and administrative staff of a mid-sized cultural institution to incorporate outcome measurement into its planning and management.  I posed the following question to the team: What is the business model and capital structure your organization needs to achieve its program and organizational goals?

A pause ensued before my clients asked me what I meant by “business model” and “capital structure.” The ensuing discussion reminded me how often consultants and sometimes funders take for granted that nonprofit staff and managers understand and agree what financial terms like these mean.

I returned to the office just in time, by coincidence, for a scheduled discussion on a related topic. NFF’s consulting staff had come together to discuss the following questions:

1. How do we define business model?  
2. What makes a healthy business model?

The dialogue was a lively one, and many of us ultimately opted for the simple and straightforward definition: a business model represents how an organization makes and spends money, in the service of its mission.

Because nonprofits do not exist to make a profit (although their existence very much depends on it), the linkage to mission was key. Ultimately, the revenue and expenses associated with a given nonprofit business model should depend on the creation and delivery of value for clients and communities.

The answer to the second question –how to define business model “health” – is far more complex. Often times, board members, funders or nonprofit consultants try to boil down health to a simple formula. For example, they equate healthy business models with fixed percentages of revenue or expenses (advocating for such pretty bad best practices as: 60% of revenue should represent earned income or fundraising expenses should be limited to 10%).  Or, they tend to forget that any combination of earned and contributed revenue should cover, with some reliability, not only total annual expenses but also regular balance sheet investments, including the building of liquid assets, maintenance of fixed assets and reduction of liabilities.

Further, business model health is often described as a static state (or held to some absolute standard) when in fact, organizations periodically need to invest in activities that change the way they make and spend their money. A healthy business model is an adaptable one, and adaptation requires periodic and sizeable infusions of capital (which is different from revenue) to fund changes in how an organization operates and creates and delivers impact.

Since an organization’s business model directly influences and is affected by its capital structure, NFF rarely has a conversation about one without the other. Capital structure, as we’ve long defined it, represents the composition and magnitude of financial resources –assets, liabilities and net assets– that comprise the balance sheet. A healthy, right-sized business model contributes to a healthy, right-sized capital structure that enables an organization to pursue its mission effectively by taking risk, innovating, and pursuing new opportunities.

To illustrate the dynamic between business model, capital and capital structure, consider the case of the Cunningham Dance Foundation, which recently announced the acquisition of 150 props, costumes backdrops and other pieces by prominent 20th century artists to the Walker Arts Center in Minneapolis. These fixed assets have become liquid capital, which will cover the Foundation’s expenses as it seeks to secure and preserve the legacy of Merce Cunningham’s work and guarantee its public access. The business model is transforming, in essence, as the organization moves from supporting the choreography and performance of modern dance to the establishment of a Trust that licenses the digital archives and rights of Merce’s work. It is a great example of how one organization plans to apply capital to change how it delivers value via a new business model.

To summarize then, achieving a healthy business model requires nonprofit leadership and their supporters to ensure that:

• Earned and contributed revenue together reasonably and reliably cover full costs, including necessary balance sheet investments
• Expenses are periodically evaluated and adjusted to be in line with revenue realities
• Capital resources are periodically raised and invested in ways that enhance the organization’s capacity to generate reliable revenue and achieve an appropriately liquid capital structure
• The eye is kept on the prize: whether the organization is making progress toward its stated mission goals and indicators of success.

How do you define your organization's business model and assess its health? NFF would welcome your additions to our continuing conversation.