change capital

Note: This post originally appeared on NFF's blog at the Chronicle of Philanthropy. 

In an annual ritual marking the change of seasons, pitchers and catchers just reported to Florida for spring training.  Professional baseball sends a powerful lesson to those of us who work to solve social problems: Despite nearly 150 years of entrenched traditions, the sport has shown itself to be open to change.  And that change is transforming how the game is played.

How does baseball point a path forward for those of us struggling to support a just and vibrant society in our troubled times?

The answer lies in the story of Billy Beane, manager of the Oakland Athletics, who demonstrated how radical innovation can allow anyone to  achieve positive transformation even against seemingly impossible constraints.

Mr. Beane, immortalized in print and film by Moneyball, watched his baseball team lose the 2001 playoffs to the much wealthier New York Yankees. He approached the Athletics owner for more money to spend on salaries and was turned down—the money just wasn’t available. Yet Mr. Beane refused to take that as defeat. He still wanted his team to achieve greatness.

Mr. Beane’s staff members offered to work harder and put in longer hours to help the team win. However, he sensed that even an improved version of business-as-usual would lead to failure. He did not have access to the funding others had used to solve similar problems. He needed to radically reinvent how he ran the team to have any chance of success.

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. 

Today, with the help of a particular kind of money--Change Capital--Alvin Ailey American Dance Foundation is attracting new revenue by building a technology platform and internal capabilities that maximize opportunities for patron and audience engagement.  Merce Cunningham Dance Foundation is raising money upfront to wind down its operations in a graceful way and leave a meaningful legacy. 

These are success stories.  But, when grantmakers and grantseekers fail to make the distinction between different kinds of revenue and capital, the consequences can be dire: desired outcomes aren’t met, organizational infrastructure is hollowed out, and communities go underserved.  Given these risks, the nonprofit field and funder community need greater clarity about the role of each type of money and what they can separately and collectively achieve. 

First, some definitions:

General Operating Support

GOS is unrestricted revenue, meaning it can be spent at the organization’s discretion – on anything. It might be used to fund programming, to offset administrative salaries or to pay the rent.  In a universe where many grants are tied exclusively to specific programs or projects—often without paying for an appropriate share of the infrastructure required to deliver them—GOS is a rare form of flexible revenue that can pay for mission-critical expenses that few (sadly) are yet willing to support. As such, annual GOS is an essential element of a healthy revenue mix for any organization. It is typically raised from select foundations as well as individuals and corporations, often through special events.

Capacity Building Revenue

Grants for capacity building, whether formally restricted or not, are revenue typically earmarked for building new organizational knowledge, staff and infrastructure. Board development, expansion of the marketing department and the purchase of new technology would all qualify as capacity building expenses.  GOS is often but not always used to pay for capacity-building activities. In that sense, the two can overlap. The difference is that capacity building dollars usually have a specific non-programmatic intention.  They are typically raised from foundations.

Change Capital

Change capital is a concept we developed at NFF to describe a flexible form of capital, distinct from revenue.

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.  

Last week, we announced a new series of publications laying out an approach to providing and accounting for influxes of capital in nonprofit organizations, with a particular focus on arts organizations.  The publications stem from early results we're seeing from a five-year initiative called Leading For the Future, which we've undertaken with support from the Doris Duke Charitable Foundation. (Read more about it and download those publications here!)  In April, we held a gathering of the arts organizations participating in the initiative, and we had a chance to talk to two of the groups, Steppenwolf Theatre Company and Center Theatre Group.  Below is the interview our Rebecca Thomas did with Charles Dillingham of Center Theatre Group:  

Nonprofits need capital to plan for and invest in strategies that will help them prepare for future growth and make changes to the way they operate. They also need reliable and recurring revenue to sustain themselves year in and year out after the change has happened.

Through our Leading for the Future Initiative, Nonprofit Finance Fund is directing more than $10 million of a specific kind of capital -- change capital -- to ten performing arts organizations* that are adapting their programming, operations and finances to ensure long-term health and vibrancy.

With funding from the Doris Duke Charitable Foundation, these ten nonprofits are working with NFF over five years to develop and implement plans for achieving this transformation. The goal is to provide these organizations with the flexibility to test new ideas, explore new business approaches, resist distraction, and even risk failure. While each participant is investing its capital differently, all seek to reaffirm the value of their art, while increasing reliable net revenue and building more liquid and adaptable capital structures.

NFF is excited to share with our readers and clients a series of new publications on the need for and uses of capital in the arts. The written and video materials convey stories and lessons learned from the Initiative thus far. Nearly three years into the program, we now have much to share with the field, both funders and nonprofits alike.

Please check out our new publications:

1. The Case for Change Capital in the Arts shares the philosophy governing the Leading for the Future Initiative and discusses the need for and application of change capital in the arts. It also outlines core principles and practices that can improve capitalization in the sector but that will require changes in behavior by both nonprofits and funders alike. The piece tells how each of the participating organizations is applying change capital to undertake meaningful artistic, organizational and financial change.

2. Financial Reporting Done Right introduces a new way of financial reporting that improves transparency around how organizations manage their capital resources. While conventional accounting and reporting treat capital and revenue in the same way, NFF recommends that nonprofits make straightforward adjustments for capital that better reveal their true operating performance and progress.

3. Change Capital in Action: Hear how three organizations are applying change capital to realize their artistic and organizational ambitions! Center Theatre Group, National Black Arts Festival and Steppenwolf Theatre Company share their stories in these short videos.

NFF has long advocated for greater access to capital for nonprofits, particularly as they invest in growth or change. We’re excited to share these real-life examples of change capital in action in the arts. To learn more about the Initiative, please check out our other recent writings:

Envisioning Success: How Funders and Nonprofits Can Lead for the Future

Chronicle of Philanthropy: Four-part Interview Series with Ben Cameron, Program Director for the Arts at Doris Duke Charitable Foundation

* Participants in the LFF Initiative include :

Alvin Ailey Dance Foundation, New York, NY
Center Theatre Group, Los Angeles, CA
Cunningham Dance Foundation, New York, NY 
Jacob's Pillow Dance, Becket, MA 
Misnomer Dance Theater, New York, NY 
National Black Arts Festival, Atlanta, GA
Ping Chong & Company, New York, NY
SITI Company, New York, NY 
Steppenwolf Theatre Company, Chicago, IL 
The Wooster Group, New York, NY