In my last piece for In Philanthrophy, I offered three recommendations for how grantmakers can overcome commonly held misconceptions about the role of money in strengthening nonprofit effectiveness. I encouraged funders to: support comprehensive capitalization planning, reward financial management practices that promote surpluses and savings, and consider seeding cash reserves as a source of funds for handling and taking risk.
Here, I share three additional myths that get in the way of healthy nonprofit finances and suggest funder practices that, in my experience, create an environment more supportive of organizational success.
Myth #4: Grantmakers who only fund projects don’t need to worry about capitalization
Truth: Well-structured project funding supports healthy capitalization
Many funders believe they can have the greatest impact by restricting their grants to fund projects or programs that align with their priorities. These grants are a form of revenue, and nonprofits need revenue that covers their full costs to survive and thrive. By structuring contributions to cover both the direct and indirect costs of projects and programs – or by making gifts with no strings attached at all – funders help organizations achieve the net revenue, or surpluses, that contribute to capital health. When project grants do not cover their full costs, organizations divert flexible funds from other places to cover the shortfall, thereby undermining financial health.
Recommended funder practice: Provide reliable, full-cost funding
If you make program or project grants, invite prospective grantees to discuss the full costs of these endeavors, including reasonable overhead. Be open to funding the full amount, or work with the organization to re-scope the project given available resources. If you are able to provide unrestricted grants, remember that a gift of general operating support shows the ultimate trust in nonprofit leadership.
Myth #5: Growth leads to sustainability
Truth: Small can be beautiful. Growth is not for every organization.
I hear often in my practice: “If we could only get to scale, our financial problems would be solved.” In fact, growth can be quite destabilizing, and studies show that small organizations tend to have the healthiest capital structures. They typically rely heavily on volunteers, ask staff to wear multiple hats, and operate from free or low cost space. With fewer fixed costs, they can scale up or down as circumstances demand. When organizations embark on growth, they often expand their cost base before they’ve tested the demand in their community – from both clients and donors – to pay for it all.
Recommended funder practice: Invest cautiously in growth (and transformational change). Ask yourself: Who will sustain the growth you catalyze?
As reported in the Globe and elsewhere, nonprofits are increasingly experimenting with untraditional capital campaigns to support the implementation of plans for growth. I’ve had the privilege to be a part of a funding initiative in the performing arts sector that put large amounts of multi-year capital into organizational transformation that, for some grantees, led to budget expansion. Capitalization efforts like these can be highly effective as long as they are structured to cover both the one-time costs of growth, and the temporary deficits incurred during a period of revenue ramp up. As funders, if you invest in programs, capacities or infrastructure that contribute to organizational growth, make sure you understand what combination of earned and contributed revenue will be there at the other end to support the organization in its larger, changed state.
Myth #6: nonprofits don’t understand capitalization
Truth: The majority of organizations knows their capitalization situation and needs, but hesitates to engage grantmakers in candid conversation.
Nonprofits live in constant fear that true openness about their financial condition and needs will jeopardize future funding. If they are doing well financially, they often go to great lengths to hide it. If they are in crisis, they rarely share the true extent of the turnaround required. Because nonprofits think their funders want to hear about program innovation and expansion, they start there. While leading with mission and program is always a good idea, these discussions need to be grounded in financial reality.
Recommended funder practice: Invite honest dialogue about money realities.
Encourage organizations to be frank about both the progress they make and the obstacles they encounter en route to healthier capitalization. To build trust, nonprofits need to see their interactions with you not as exercises in compliance but as opportunities for exploration and shared learning. Give grantees permission to make difficult choices that build health over time, even if that means tempering program ambitions in the short term in order to achieve greater impact over the long term.
As a final thought, remember that capitalization is a long-term proposition. You can’t capitalize an organization, declare victory and go home. An organization’s capital needs are constantly evolving – and the kinds and amounts of resources it needs today will change in the future. As you consider capitalization as one investment strategy, ask yourself: what is the appropriate next step on your grantee’s path to financial health? Then, consider joining that organization on its long but worthwhile journey.
Rebecca Thomas is the founder and managing director of Rebecca Thomas & Associates. She was previously a Vice President at Nonprofit Finance Fund.