August 07, 2016

Vulnerability: A Deeper Dive Into the Nonprofit Funding Challenge

Sustainability is understood generally as a measure of the ability of an organization to create mission impact without depleting its human and financial resources. As noted by Masaoka and her colleagues, sustainability is not a destination, but an orientation. In other words, there is no finish line in the journey toward financial viability. To appreciate the significance of sustainability orientation, we need to acknowledge some of the inherent challenges to sustainable nonprofit funding.

First, if serving the homeless or feeding the hungry were profitable ventures, there would be entrepreneurs launching business for these purposes. As Thomas McLaughlin points out, nonprofits typically figure out how to deliver services, while the entrepreneurs come in and figure out how to make the delivery of those service profitable. Look no further than the disabilities and hospice industries for evidence of the entry of for-profit providers into what traditionally has been the domain of the nonprofit. These providers are not a threat because they are for-profit. Rather, they threaten the status quo by raising the expectations for cost effectiveness in the delivery of service.

But the fact remains that most nonprofit work is not profitable on its own. Rather than relying on a seller and a buyer, the nonprofit economy requires a provider (the homeless shelter), client (the homeless), and a funder (individuals, corporations, and philanthropic organization). In simple terms, the nonprofit economy depends on the presence of entities willing to pay for services that they themselves will not receive.

There are exceptions, of course. Some nonprofits are profitable on their own because of the micro-environment within which they operate. Hospice services, for example, can be profitable because of the ability to charge market rates for service directly to the consumers of that service. Whether the family pays out-of-pocket or relies on an insurance policy is beside the point: it is a closed system of buyer and seller.

Second, when it comes to competition for market share between a nonprofit and a for-profit, it is not a fair fight. The key determinant in succeeding in a competitive environment is access to capital. For a for-profit, this means seeking additional investors who can infuse cash into the organization on short notice. For a nonprofit, this often means launching a multi-year capital campaign. Who will get there quicker?

And third, let’s acknowledge the dilemma created when foundations play hot potato with nonprofits in order to prevent dependence. It is reasonable for a foundation to want nonprofits to diversify funding so as to not be over-reliant on its own foundation grants. However, foundations need to recognize that they are part of the sustainability formula for nonprofits. Passing grantees off to other funders – whether individuals or organizations – only relocates the problem for the nonprofit.

From Sustainability to Vulnerability

To be sure, concerns about long-term sustainability are a legitimate obsession in the nonprofit sector. But I believe there is more to it than this. To illustrate, consider an organization that provides adult literacy instruction. A typical funding mix for such an organization might look like this:

  • 60% from a government contract
  • 20% from a local foundation
  • 15% from the local United Way
  • 5% from charitable giving and events

We know from the work of the NCNE (National Center for Nonprofit Enterprise) that the ideal funding mix consists of one major revenue stream with three to four supporting streams. We also know from the NCNE that over time, charitable gifts are the most reliable and government funding is the least reliable.

Given its funding mix, can we say with any degree of confidence whether the organization in the example above is sustainable? On the one hand, we can be confident in the fact that the organization has a diversified funding mix – one major source with three supporting sources. On the other hand, its major revenue source historically is the least reliable. The most reliable source – charitable giving – makes up only five percent of the organization’s annual revenue.

To repeat the question, then, is this organization sustainable? In reality, the best we can say is, “yes, as long as…”

  • As long as the government doesn’t shift its focus.
  • As long as the foundation doesn’t reshuffle its priorities.
  • As long as the United Way meets its campaign goal.
  • As long as we continue to identity new donors.
  • As long as our signature fundraiser is successful.

And let’s not forget this one: “as long as we are able to attract and retain quality staff who are willing to work for less pay than they are likely to earn elsewhere.”

The vulnerability assessment I am suggesting builds on the macro analysis of sustainable funding provided by NCNE but offers a finer grained analysis that focuses on the specific circumstances of the individual nonprofit. So, for example, even though government funding as a category is the least reliable funding source overall, it may be the most reliable source for your organization if you are the exclusive provider of mental health services in your community.

The vulnerability assessment is built around the following three questions:

  1. Where are you the most vulnerable to changing conditions?
  • What is your current revenue mix?
  • What is your single largest revenue source?
  • What has been your most reliable source over the years? The least reliable?
  • How has the overall mix shifted over time?
  • How difficult is it to capture the revenue from each source?
  • What percentage of your overall revenue is unrestricted?
  1. What steps have you taken to reduce your vulnerability to those changes?
  • Do you have an active donor development program?
  • Do you have ongoing contact with your foundation funders?
  • Do you have an annual board giving campaign?
  • Do you include a provision for operating reserves in your annual budget?
  1. What is your emergency funding plan?
  • Do you maintain a list of your “go to” donors – individuals and corporations – to whom you can turn for emergency fundraising?
  • Do you maintain a line of credit?
  • How quickly could you liquidate your assets?

Indeed, sustainability assessments are vital to the ability of a nonprofit to generate the greatest mission impact in the most financially responsible manner. I have found that tools such as the MacMillan Matrix and its derivatives are especially useful for helping organizations make mission-driven financial decision in times of decreasing revenues and increasing demands for service. To borrow a sports phrase, these tools help nonprofits keep their eye on the ball during difficult times.

While valuable, these processes tend to be in response to events that have already happened (e.g., loss of a funder or program). What nonprofits need is a deeper dive into their funding mix on the front end so that they can be more intentional in guarding against changes that could threaten the ability of their organization to sustain its most important work. Recognizing these threats is a big step forward in the never ending journey toward sustainability.

Need Additional Assistance?

If you are interested in going deeper into your nonprofit strategy or if you wish to review your organizational strategy more broadly, click the link below to schedule a 30-minute phone or zoom consultation with Mike Stone.

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