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Jul 24, 2012

What Capital Will Make the Cultural Sector Thrive?

My July column for Columbus Business First was prompted by my thoughts about what the Columbus Financial Review and Advisory Committee is going to publicize as its recommendation for public funding of the arts.  It also was prompted by my thoughts about the transformational change Columbus’ science museum COSI was able to accomplish through a three-year program that focused not on projects but on creating a new and sustainable business model.  In the middle of the last decade, a public-private partnership provided three years’ of change capital to COSI, which enabled it to increase its recurring operating revenues by $2 million per year, a significant return on investment and a key factor in COSI’s perseverance to maintain its change momentum despite the economic downturn.

Columbus has done a lot of thinking about its cultural sector.  It understands how critical the sector is as a recruitment tool to attract and retain talent for its economy.  The 2011 Columbus Arts Market Sustainability Analysis report determined that a vital sector will have “access to sufficient resources to allow the organization to fulfill its mission, reinvest in its future, and maximize its public value by evolving to meet future needs.”  The report advocated more money on all fronts: earned income, public sector funding, private sector support, and endowment.  The Mayor and City Council convened a Financial Review and Advisory Committee which has recommended new revenue sources for the public sector funding called for in the report.

Yet most discussions about sustainability focus on operating revenues and most capital campaigns focus on facilities.  Raising more money begs the question of what is best done with additional money.  My thinking about these issues is echoed by the Nonprofit Finance Fund (NFF), one of the more innovative community development financial institutions in the country.  They have coined the term “mis-capitalization” to describe “uneven, inappropriate, or inadequate funding …[and lack of] flexibility to adjust … in response to changes in the environment and demand for their work.”  They focus on a nonprofit’s balance sheet and its ability to generate recurring operating surpluses.  This focus fits with my notion of sustainability and the Arts Market report’s notion of a “vital” nonprofit.

Often discussions of funding are implicitly focused on operating revenue. I have repeatedly emphasized the need for reserves and a strong balance sheet.  Linking Mission to Money devotes Chapter 16 entirely to the reserves needed for resiliency. And the value of planning and careful financial management takes up the 48 pages of Chapter 3 in More Than Just Money.

NFF insists that equally important is “change capital.”  To test their concerns, they teamed with the Doris Duke Foundation in 2008 to support ten performing arts organizations with a $15 million change capital program called Leading for the Future Initiative.  Its aim is to help nonprofits “adapt their programming, operations, and finances to thrive in a changed and changing economic and cultural landscape.”  Each participant received $75,000 to support a year of planning.  Upon NFF’s approval of the plan, each group received a $1 million change capital grant along with ongoing advice and counsel from NFF in implementing their plan.

Two years into implementation of these plans, here are the principles they have observed to be critical to nonprofit sustainability.

1.    Don’t confuse revenue for operations with capital for liquidity, adaptability, and stability.
2.    Capital is episodic, revenue is forever, so use the former to build the latter.
3.    Change is expensive so don’t underplan or underinvest.
4.    Change takes time so a five year horizon with allowance for trial and error and recalibration is essential.
5.    Temporary deficits are common during transitions, no different than the “burn rate” of a for-profit start-up.
6.    Funders should consider pooling resources in order to ensure the change is adequately supported.
7.    Funders should support planning:  “a smart strategy backed up by a rigorous financial roadmap with artistic, operational, and financial progress indicators is a critical precondition to undertaking change.”
8.    Funders may need to consider first providing recovery capital to rebuild reserves, repay debt, or enhance the nonprofit’s resiliency.
9.    Focus on results, not spending detail, so that spending priorities can shift as the plan evolves and the nonprofit learns which paths are most successful.
10.    Permit deficits during change but insist on recurring surpluses as the outcome of change.
11.    Separate capital in financial reporting so that one does not misread the recurring financial performance of the nonprofit.
12.    If change cannot achieve recurring stability, leadership has a responsibility to consider whether the community values its work and whether a graceful exit is appropriate.

The uniqueness of this approach is reflected by one participant in the program:  “It’s unusual to have a grantmaker that says that the success of the ‘project’ is not what they’re looking for.  This program invests in our whole organization, and gives us the flexibility to experiment and try new things on our way to greater financial and artistic health.”

Change capital can have a powerful effect.  A 3-year change capital investment transformed COSI into the #1 Science Center in the United States.

When you plan a fundraising campaign, is there a strategic plan underlying the campaign that convinces you that you will have operating surpluses after the campaign’s projects are completed?  I have seen too many campaigns that focused on completion of the campaign rather than on completion of a financial restructuring by means of the campaign.  If you have not formulated a strategic plan that lays out a path for sustainability, make sure that is the goal of your next retreat.  If you would like to talk about how I can help you to have a productive retreat, schedule a free consultation at this link.