Properly Capitalizing Nonprofits: A Key to Long-Term Impact

Many in the nonprofit and philanthropic sectors have heard the cautionary tale of New York City-based mega-nonprofit Federation Employment & Guidance Service (“FEGS”), which shut its doors suddenly and surprisingly in 2014. Bankruptcy filings blame, among other reasons, “inadequate financial systems and revenue cycle management… a failure to adequately reserve and plan for the repayment of significant regulatory and governmental advances and contract termination costs… [and] numerous unprofitable agreements.”

How does this happen at a nonprofit so large, with a $250 million annual budget, an 80-year history and thousands of clients depending on it for housing, employment, health, childhood and disability-related services? For the same reason (among others) that too many important nonprofits have gone out of business, or struggle to obtain and retain the resources they need to achieve meaningful outcomes on a long-term basis: poor capitalization.

Without the right resources at the right times, no organization, whether for-profit or non-profit, is able to maintain or improve operations year after year sustainably. Proper capitalization depends in part on financial management that clearly differentiates between capital and revenue in the nonprofit context: revenue is the ongoing income that pays for a nonprofit to offer its goods and services, and capital is the start-up or periodic money that is invested into building or changing the enterprise itself. Capital is what allows an enterprise to exist where none existed before, or to grow or change so that it operates differently—with intended results such as more reliable revenue and greater impact.

Nonprofit capitalization is either misunderstood or ignored at the peril of long-term impact by nonprofits. It could have made a difference for FEGS, and certainly can make a difference for all nonprofits today. With the required adoption in 2018/2019 of new FASB guidelines for reporting information in nonprofit audited financial statements, now might be an especially good moment to consider proper capitalization.

Therefore, Heron’s Rodney Christopher in a series of videos talks about the road to healthy capitalization for nonprofit organizations. Spoiler Alert: The key to achieving proper capitalization for all—and a stronger, more impactful nonprofit sector—is making it the norm for nonprofits to achieve surpluses and have reserves, rather than an anomaly that must be defended to suspicious funders (or, more often, media outlets or other stakeholders).

Spoiler Alert: The key to achieving proper capitalization for all—and a stronger, more impactful nonprofit sector—is making it the norm for nonprofits to achieve surpluses and have reserves, rather than an anomaly that must be defended.

In this first installment, “Why Capitalization Matters for Nonprofits,” Rodney makes the point that the purpose of capital is to help make sure the enterprise is safe and healthy and able to deliver on the outcomes we all want it to achieve.

Having the right kinds of money at the right times allows an organization to be flexible when changes are needed—and even to experiment such as with a new approach or program, to learn what kinds of changes might be most impactful. Capital also allows an enterprise to be resilient to blows from outside (whether the loss of a single major donor, or a global financial crisis and sudden influx of clients). And capital allows enterprises to have facilities that are durable and useful year after year: maintained on an ongoing basis; renovated or repaired when the organization needs it (or the results of a major weather event demand it). The right money at the right times can mean reserves allocated for building maintenance, surpluses from previous years to cover that unexpected funding shortfall, or a bank line of credit allowing the organization to take on a new government contract that won’t be funded until after the work is completed.

Funders sometimes push back on nonprofits with reserves: “If you already have money, why are we funding you?” Unfortunately, this approach can lead well-meaning funders to contribute to an environment that keeps excellent organizations always a few missteps or one external shock away from catastrophe, rather than thinking big and preparing for a future of even greater impact. (To be clear, we also do not encourage funders to punish or avoid nonprofits that are not currently well-capitalized!)

Likewise, those of us who see impact as the most important focus may protest: “It sounds like you want organizations to have surpluses and reserves whether they’re doing good work or not.” We at Heron do not believe this to be an either/or choice. Rather, we see that lack of capitalization is sometimes the cause of insufficient impact, or worse.

Capitalization is not a destination. It’s always going to be a journey.

Capitalization is not a destination. It’s always going to be a journey. Ultimately, there is no quick path or “perfect” capitalization, but having the right goals and approaches in mind puts a nonprofit (and its funders) on the road to more strength and better impact over the long haul.