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Risk Capital in the Age of Austerity

Battered by the news headlines, conversations in many cultural nonprofit boardrooms have turned to questions of “what if?” Over the past month, I’ve participated in several discussions that went something like this:

  • “What if our major donors shift their funding to social justice, women’s rights and legal advocacy organizations?”

  • “We just heard from a national funder that their longtime support of our organization may be in jeopardy. How will we meet this year’s budget if they reduce the size of their annual gift?”

  • “What if the NEA goes away? How will potential ensuing cuts in government funding at the state and local levels affect us?”

In this environment, organizations can be tempted to pull inward and pray for preservation of the status quo in 2017 and beyond. And indeed, it would be irresponsible for cultural organizations not to look closely at their business models and ask themselves which less profitable activities might be consolidated or cut back with minimal harm to mission – and which money-making programs or functions have the potential to attract additional earned or philanthropic income.

And yet, the sector has a lot of critical work to do in response to shifting political winds. Many cultural organizations are already raising their voices, whether by creating or presenting new works that expose audiences to competing ideas, pledging to support international and immigrant artists, advocating for state and local governments to hold the line on arts funding, or investing in community-organizing strategies.

This work calls for a special kind of capital that remains all too rare in the nonprofit sector: risk capital.

Risk capital is unrestricted, board-designated money that allows organizations to take business risk or pursue artistic opportunities. It can seed program experimentation or pay for upfront investments in new infrastructure. It can support testing new ways of reaching constituents or different strategies for attracting and engaging donors. For example:

  • A theatre client used risk capital to commission a major international production where box office returns were uncertain but the opportunity for an elevated global profile was high.

  • Two arts service organizations we’ve worked with set up strategic risk reserves as a source of startup or enhancement capital to invest in programs that are mission aligned and sensible financially.

While these funds were set up during times of greater political certainty, it’s not a stretch to see how similar reserves might be useful in today’s volatile environment for efforts in field-building, arts advocacy, or the development of creative works that embrace diverse people and perspectives.

Risk-capital initiatives can pay off down the road by seeding new earned or contributed revenue streams. But some may never make money, even if they are essential for advancing the health and cause of the arts. Such is the nature of risk. Failure is not only possible but should be seen as acceptable, particularly if it teaches the risk-taker how to work differently — and more inclusively — in the future.

Risk Capital is not Project Support

While risk capital can function similarly to a project or innovation grant, it is structurally different. Risk capital sits on the balance sheet, as a form of savings in reserve. Its purpose and use are governed, not by funders, but by the nonprofit’s board of directors.

Is this a distinction without a difference? Not at all. Opportunity doesn’t always come knocking on a grantmaker’s schedule. When organizations have cash in the bank, they can take risk proactively, when the moment is right. Furthermore, risk reserves are unrestricted and flexible, while project grants tend to be restricted and limited in their coverage of overhead costs. Risk reserves can therefore be tapped to pay for critical administrative costs that support an initiative’s success.

Of course, risk capital doesn’t give organizations permission to spend money on every exciting experimental activity. Organizations lucky enough to possess these funds must spend them strategically and periodically, and always with an eye toward replenishing with operating surpluses or special fundraising. Otherwise, risk-taking can quickly give way to unsustainable growth — and a later liquidity crisis.

Risk Management Comes First

For many organizations, acting boldly to confront inequity, tackle fear, and invite debate is not a choice, but a necessity. But securing capital for risk-taking shouldn’t be the first priority for institutions that run chronic deficits or lack basic liquidity.

An organization’s ability to rise to today’s challenges depends at least in part on its financial foundation. Reserves for risk-taking placed on top of a regularly money-losing business will not be used productively; they will quickly be absorbed into operations, diverted to fund payroll or tapped to maintain facilities.

For financially frail institutions, the first priority must be to assess costs in light of earned and contributed revenue potential; then, to decide how to return the operation to surplus. Surpluses are the primary source of liquidity for managing cash flow. They are instrumental for weathering the many risks inherent in running an arts organization, such as absorbing losses at the box office, navigating the unexpected exits of funders, or enduring economic downtowns. Capital for risk-taking can augment — but not substitute for — working capital and reserves for risk management.

Nonetheless, capital for risk-taking plays an essential role as part of a comprehensive capitalization plan, which examines all priorities for cash and evaluates their importance in the context of financial, strategic and community imperatives.

Risk capital has been missing for too long from too many organizations’ capital toolboxes. It’s time to make risk capital a fundraising and investment priority.

02 February, 2017
posted in arts, capitalization, risk

About The Author

Rebecca Thomas
Rebecca Thomas

Rebecca Thomas is the Managing Director of Rebecca Thomas & Associates. She has over 10 years experience advising nonprofits and foundations.

Prior to founding RTA, Rebecca was the Vice President of Innovation at Nonprofit Finance Fund, with overall strategic responsibility for national initiatives, funder partnerships, and online services. She served as a spokesperson and advocate for NFF regionally and nationally, speaking and writing on issues of nonprofit capitalization. Before entering the nonprofit sector, Ms. Thomas served as Senior Economics Correspondent for Smartmoney.com, where she covered economic developments and financial markets, and appeared as a commentator on CNNfn, MSNBC, and Fox.

Rebecca leads Finance and Development committees as a board member of the Rock School for Dance Education and Jose Mateo Ballet Theatre, and participates on the Finance Committee of the Lark Play Development Center. She received an MBA from Columbia University's Graduate School of Business and graduated from Yale University with a B.A in French and International Studies.