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Are You Capitalizing Comprehensively? Three Strategies for Building and Allocating Assets in a Post-Pandemic Future

Despite dire predictions from many—including me—the cultural sector has emerged from the pandemic with strengthened finances. Federal funds, philanthropic largesse and extensive cost cutting have left many arts organizations with sturdier balance sheets than we have seen in decades. Early data from SMU DataArts for 500 cultural groups shows that the median organization had six months of unrestricted working capital in 2021, compared to two in 2019. Many of RTA’s clients, both large and small, have seen similar or greater increases in their liquidity.

Arts leaders know these gains are temporary and don’t reflect material changes to their core business models, which should reliably bring in earned and contributed revenue to cover costs. In many cases, liquidity gains came at the expense of artists and administrators who were let go temporarily or permanently. In some cases, one-time windfalls from national funders and major donors appeared like manna from heaven.

Pink slips and plum gifts aren’t the stuff that sustainable budgets are made of. As labor costs rise and pandemic funds evaporate, some organizations are already beginning to see the reemergence of earlier operating gaps. These deficits threaten to erode one-time, pandemic-fueled liquidity gains.

But it doesn’t have to be this way.

Newfound assets present a launchpad for comprehensive capitalization: the allocation of liquidity for the pursuit of change, assurance of stability, and management of risk. Cognizant that this flush feeling may be fleeting as the risk of recession rises, many of our clients have been asking how to develop a sound strategy for recently accumulated funds. Some are simultaneously preparing capital campaigns to secure additional assets that they believe will help them navigate the future. Capitalization planning helps organizations with newfound assets and those that seek to raise new funds.

To capitalize on this moment (pun intended), we recommend three ways cultural organizations can secure, deploy and save assets to achieve sustainability goals.

Action 1. Invest in adaptation with Change Capital

During periods of turbulence, many cultural organizations know that they must adapt. They recognize that the moment calls for new or different programs and people to address shifting priorities. RTA clients are deploying change capital for many reasons. Some are investing in advocacy and policy change for social justice. Some are rethinking programming for a more digital world. Some are urgently correcting historical gaps in staff compensation. And others are investing in marketing and fundraising to reach—and inspire—new audiences and donors. What all of these changes have in common are explicit intentions to achieve more reliably profitable business models within several years.

Cultural organizations that secure unrestricted and expendable change capital are in a strong position to respond to evolving community values and needs. Through trial and error, these organizations learn which activities to shed, adapt, preserve or grow. With change capital, they have the breathing room to figure out how to staff and reliably fund what they develop.

Change capital covers operating gaps temporarily, usually over 3–5 years, as organizations identify which strategies are both mission-aligned and financially sustainable. We encourage organizations to prioritize change capital requests both in their fundraising efforts and savings allocation decisions. Change capital draws should be supported by financial plans that show a reasonably conservative return to surplus operations, sized to address anticipated liquidity needs.

Action 2. Prioritize flexibility over permanency

We’ve said it before, but flexible funds—and not endowments—are the key to sustainability. The notion that endowments create sustainability by reducing the need for annual fundraising was debunked decades ago. And yet capital campaigns are still largely structured around the creation of permanently restricted funds “because that’s the way we’ve always done it” or “that’s the type of ask that gets our donors excited.” In our consulting practice, we’ve recently seen many examples of boards locking up newly-acquired pandemic windfalls, investing them aggressively as quasi-endowments that, while unrestricted, serve the same limited purpose as endowments.

In theory, endowments offer perpetual income streams that make an organization more sustainable. But only if three things are true: i) the endowment is big enough to produce a sizable annual draw relative to budget size; ii) the endowment draw is not used to justify otherwise unfunded growth; and iii) the organization already has adequate additional unrestricted and liquid funds available to manage operations and provide a hedge against risk. Data and experience tell us that these three requirements are rarely met, and usually by only the largest of nonprofit institutions.

Consider a mid-sized nonprofit with a budget of $2–3 million. While a $10 million endowment might generate a tidy amount of income each year, the draw on a smaller, $2 million endowment is unlikely to have much of an operational impact. But that same $2 million, used as change capital, can provoke new thinking, spark innovation, and accelerate fund development and audience-building efforts—while still leaving funds for managing risk.

For most organizations, endowment-building should be considered as one capitalization strategy among many—and typically as the last priority. The only way for an organization to be self-sustaining is by managing to regular operating surpluses that generate flexible, accessible liquidity. This liquidity can then be deployed on future rainy days and to make catalytic strategic investments. Boards of directors should consider an organization’s full spectrum of liquidity needs before tying up every asset in long-term investment funds.

Action 3. Secure working capital and operating reserves

A well-capitalized organization has access to two distinct types of liquid resources on its balance sheet: working capital and reserves. Defined in the chart below, these liquid and unrestricted assets should be in place before an endowment, before a facility acquisition, and before a plan for budgetary growth.

Working capital provides a cash-flow smoothing effect. Many nonprofits experience pronounced gaps between when costs are incurred and when subscription revenue, school tuition, government funds, or grant pledges are converted to cash. Working capital ensures organizations pay their everyday costs on time.

Cash reserves, which are overseen by a board-approved policy governing their use and later replenishment, can help soften the blows from revenue shortfalls (or cost overruns) and seed innovations outside of the approved budget. Every arts organization should have some capital on hand to help weather a pullback in contributions or community participation. And every organization can benefit from access to liquidity to experiment with new ideas that have uncertain payoff but promising potential.

Type Purpose Use
Working Capital Manage cash flow cyclicality and seasonality. Handle everyday risk associated with timing of receipts and expenditures Drawn from and repaid at management’s discretion during the normal course of business.
Reserves To address specific needs outside of normal business:
  1. Weather a rainy day
  2. Take risk with programs and business models
  3. Repair, replace, improve fixed assets
Deployed according to purpose in Board-approved policy.

RTA does not recommend standard targets for each of these funds: every organization has a different cash flow cycle and faces a different set of risks and opportunities. We do strongly encourage organizations to set aside several months of existing cash as management-directed working capital, before creating the reserve funds they need most. Reserve funds can be invested for return, but the allocation strategy should follow from the fund’s purpose and time horizon for use.

In our business, we often say, “if you’ve met one funder, you’ve met one funder.” Sure, some donors want to see their name embossed on a plaque or their legacy tied to a permanent asset. But many of our arts clients are surprised by how many of their supporters are receptive to requests for flexible funding when their leadership communicates a compelling artistic strategy and the need for assets that will drive and sustain it.

Fundraising campaigns of the future can draw on some of the same language as capital campaigns of the past—by promoting health, stability and resilience—while securing assets that best suit the times.

How can RTA help?

Are you considering the best use of your existing assets or planning a fundraising campaign to raise additional assets for stabilization and change? Is your organization experiencing more fundamental challenges in the business that supports its programs?

Our consultants can work with your executive leadership and board to develop appropriate capitalization goals, targets, and communications. We can also help you identify options, develop scenarios, and project pathways for improving operating performance and everyday liquidity.

05 May, 2022
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 15 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.

As a former dancer, Rebecca has a particular passion for advising arts and culture nonprofits and grantmakers. She is an advisory board member for SMU DataArts. She formerly served on the boards of DataArts, José Mateo Ballet Theatre and the Rock School for Dance Education.

Rebecca received an MBA from Columbia University's Graduate School of Business and graduated with honors from Yale University with a B.A in French and International Studies.