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Nonprofit Finances on the Brink

Posted: 8/3/2020

Click here to read on the Chronicle of Philanthropy

by Ben Gose

For years, Playworks was a high-growth darling, with a randomized, controlled study demonstrating effectiveness and $26 million in expansion capital to propel the charity toward its goal of reaching 3.5 million kids and 7,000 schools this year.

Covid-19 brought that ambition to a crashing halt. The 24-year-old charity, which provides coordinated activities and recess coaches for elementary schools, gamely tried to carry on last spring using Facebook, but recess is one activity that's hard to move online.

Schools pay for about half the program, and donors pay for most of the remainder. (Playworks also receives support from AmeriCorps.) But it's unclear exactly how much either group will commit for the 2020-21 school year, when school itself remains a question mark.

In the abrupt shift from growth to survival, Elizabeth Cushing, president of Playworks, didn't flinch. The organization spent all its reserves, laid off 96 employees — about 20 percent of its work force — and furloughed an additional 95 workers for the month of July. Some of the charity's existing supporters came through with emergency grants.

Playworks hopes to bring the furloughed employees back in August, but it has decided to work with fewer than 1,100 schools this year — half as many as last year. That will allow Playworks to enter the school year with 90 percent of its budget secured — and an odds-on shot at making it to the other side of the pandemic.

"Instead of looking at the past, and saying 'oh boohoo, we're not as big as we were,' we're going to see what the new version of Playworks looks like," Cushing says. "It's not all doom and gloom, and it's not all rosy. We're not sitting around waiting for philanthropy to rescue us."

The financial pressure on nonprofits is already intense, and experts say it may worsen as the pandemic persists and federal assistance, such as the Paycheck Protection Program, begins to phase out. Many charities entered this downturn with shaky finances. For years, studies have shown that only about half of nonprofits have enough reserves to cover their budget for three months, and research this year by the Kautz-Uible Economics Institute at the University of Cincinnati found that 12 percent of the charities substantial enough to file a tax return had only enough reserves to get by for two weeks.

The Johns Hopkins University recently estimated that 13 percent of nonprofit employees had lost their jobs, and a survey by La Piana Consulting found that 25 percent of social-service nonprofits were concerned enough about the future to consider a merger as a way out.

That the nonprofit world will shrink is inevitable. What remains unclear is how many charities will fail. A new report from the Candid research center estimates that 7 percent more nonprofits will close their doors in the next 36 months than normally would. But it also says that if the economy really sours, that could lead to 38 percent more closures. Lack of reserves, coupled with anticipated cuts in state-government spending and social-distancing rules that make it difficult for charities to generate revenue, could lead to a slow hollowing of the field that stretches over years.

Michael Jones, executive director of the Kautz-Uible institute, says many groups may turn into "zombie" nonprofits that limp along with volunteers but no building or staff.

"Nonprofits don't die like small businesses do," Jones says. "It's going to take a lot longer time — a several-year period — to see a lot of them exit."

Brand-name charities are also suffering. The American Cancer Society, Habitat for Humanity, and Minnesota Public Radio are slashing budgets and laying off workers. Several arts organizations, including the New York City Ballet, the Lyric Opera of Chicago, and the Los Angeles Philharmonic, are tapping their endowments in unusual ways to make it through.

Midsize nonprofits face the biggest risks. They aren't as nimble as smaller charities and don't have the reserves bigger ones do.

Midsize charities with budgets between $5 million and $30 million face the greatest risks, says Kate Barr, president of Propel Nonprofits, an organization that helps charities with financial management and governance. Small organizations are remarkably nimble, with an ability to expand and contract, while the bigger charities tend to have ample reserves and endowments. Midsize nonprofits have many fixed expenses — including real estate and staffing — but fewer resources to fall back on, she says.

Shena Ashley, director of the Center on Nonprofits and Philanthropy at the Urban Institute, says large charities also have the philanthropic connections to nudge out midsize groups for resources during desperate times, a scenario that played out in the Great Recession.

"This would completely wipe out midsize groups, as they shrink to become small ones," Ashley says.

Existential Crisis

In good times, charity CEOs tend to talk about putting their clients and employees first. Now the talk has turned to organizational survival.

The Japan America Society of Greater Philadelphia, which operates a Japanese garden, holds an annual festival, and provides educational programming, counts on sales of tickets and other items for about half of its revenue in a typical year, but it didn't earn anything in the three months after Covid-19 struck. (The outdoor garden reopened in June.) Kim Andrews, the charity's executive director, sliced her annual budget by nearly two-thirds, to $1 million, and worked with two key foundation supporters — the William Penn Foundation and the Pew Center for Arts & Heritage — to move up or ease the terms on grants totaling $370,000. She also laid off one senior staff member and cut the center's seasonal employees by more than half.

"When you have few reserves, you have to take prompt action. Waiting can kill you."

Thanks in part to a recent merger, the charity now has 10 employees, up from two when Andrews started a decade ago. She says she could go back to two and still provide basic functions, if necessary. As part of her contingency planning, she maintains a list of employees and the order in which they would have to go.

"As of this moment, I don't anticipate doing that, but I have to make sure the organization can survive," Andrews says. "I can't be very softhearted about it."

The experiences of Playworks and the Japanese museum highlight one of the cruel realities of the pandemic: Diverse sources of revenue, which are helpful during good times, have compounded the suffering during the downturn. Admission fees, facilities rentals, ticket sales, gift-shop proceeds, and other revenue have vanished for many museums, performing-arts organizations, education providers, and other charities that have had to shut down programs or facilities. Social-services nonprofits in a number of states are already dealing with late payments on government contracts, and their leaders fear cuts when those contracts are set to renew.

"This pandemic has shown us that a certain combination of diverse revenues can put an organization in a difficult situation," says Hilda Polanco, CEO of Fiscal Management Associates, a consulting company.

Fortune Society, a New York City nonprofit with a $40 million budget that helps former prisoners re-enter society, is used to late payments under city and state contracts, but the pandemic has raised concerns about whether the group will be paid at all. JoAnne Page, the charity's CEO, says it still has $2 million worth of unpaid reimbursements that were outstanding in March, when it had to move to virtual counseling. She also wonders whether the size of new contracts will be cut and how much of the $3.8 million Paycheck Protection Program loan the charity took out will be forgiven.

"It's a constellation of issues coming together at once," Page says. "We're a solid nonprofit, but we're all fragile. I worry that some of the organizations that are more fragile than we are might not be here when the dust settles."

Charities should envision three scenarios: a baseline expectation, a more positive outcome, and a dire one.

One rare bright spot: The uprising following George Floyd's death brought more visibility to the charity's work with people of color and led to a doubling of online donations. "If you care about racial equity, the criminal-justice system is the motherlode of injustice," Page says.

That kind of support heartens Ashley, at the Urban Institute, and makes her more optimistic than she was a few months ago. The growing interest in racial equity among foundations and corporations is leading to more unrestricted gifts to small and midsize organizations that are led by or serve people of color, she says.

"That gives me a little more hope that this will not be as bad as we thought it would be," Ashley says.

'Waiting Can Kill You'

For now, the most stable nonprofits are those that can rely on longstanding supporters for revenue. The stock market is not far off its historic highs, many big foundations are paying out a higher proportion of their assets than ever, and individual donors are seeing needs and stepping up.

Hillel, a Jewish student organization that serves 550 college campuses, is suffering from some of the same programmatic challenges that other education providers are facing. With campus events and international travel shut down — Hillel is a big organizer of Birthright Israel trips — the charity laid off 10 percent of its national staff in April and furloughed an additional 10 percent.

The college shutdown didn't jolt revenue directly because students pay nothing to participate. And while fundraising is proving challenging, some of the charity's biggest supporters allowed Hillel to accelerate spending on multiyear grants to meet near-term needs. As a result, Hillel expects it will replenish its reserves — which typically cover nearly a year of the charity's $185 million budget — by the end of this year.

"We chose to make adjustments early and make them at a level that we believe will be sufficient," says Adam Lehman, Hillel's chief executive.

Hillel's quick response should be instructive for charities with fewer resources. The worst decision, experts say, is to limp along without a plan.

"When you have few reserves, you have to take prompt action," says John MacIntosh, managing partner of SeaChange, which helps nonprofits facing complex financial challenges. "Waiting can kill you."

Plan for the Best — and Worst

Michael Anderson, a nonprofit consultant in Minnesota who serves on seven nonprofit boards, says he was encouraged to see charities respond quickly after much of the country shut down in mid-March. At board meetings in the first two weeks of the shutdown, he says, chief financial officers showed up with contingency plans for surviving whatever Covid-19 would bring.

"Folks right now are really challenged to figure out how to make the next six, 12, and 18 months work," Anderson says. "They're trying to connect the short-term strategy to the long term."

Since the financial crisis more than a decade ago, consultants have urged nonprofits to develop contingency or scenario plans. Charities should envision three scenarios: a baseline expectation, a more positive outcome, and a dire one, says Barr of Propel Nonprofits. All the senior executives and board members should be involved, she says.

Scenarios to consider include: If we cut a program, would we stay in the same facility? If donations drop, would we tap reserves? How can our reserves buy time to bridge the charity to new possibilities?

Contingency plans were an immediate need for arts groups, arguably the area of the nonprofit world hardest hit by the pandemic.

The Tenement Museum in New York City, which focuses on urban-immigrant history, gets 75 percent of its revenue from ticket sales, gift-shop proceeds, and tours — all of which were shut down by the pandemic. The charity laid off 13 people and furloughed 70 tour leaders. It has cut its budget in half, but still must roughly double its fundraising to meet even that lower level of spending.

Fundraising consultants typically frown on desperation appeals, but a link on the museum's website that reads "Help the Tenement Museum Survive" has worked well so far, bringing in 3,000 new donors.

Morris Vogel, the museum's president, says he thinks it can survive at least a year with the smaller budget, the new gifts, and tapping reserves. But he has drawn up plans for deeper cuts if necessary.

"We have a number of scenarios," he says, declining to share specifics. "You write them up in case you need them. You don't go out and put them up in Times Square."

The museum also has a $2.7 million endowment, but withdrawing aggressively from the endowment would trigger penalties on bonds the charity issued to buy its building, Vogel says.

Experts on nonprofit endowments say charity boards and executives should proceed cautiously before tapping into endowments to survive the crisis. Ann Novacheck, an attorney specializing in nonprofit law, says board members can be held personally liable if they break laws set up to protect the principal of restricted endowments. The best course of action for a charity that desperate is to approach a living donor, she says.

"Hopefully, you have a great relationship with that donor," Novacheck says. "If they release the restrictions, it becomes an unendowed fund, and then you're free to spend it."

Calls for Collaboration

For decades, some foundation leaders and other observers have complained that the United States has too many charities, but calls for more mergers have generally gone unheeded. Will this time be different?

Some think it might. For one thing, there's more foundation support targeted at collaboration than in the last recession. The Sustained Collaboration Network, now working in six locations, is backed by $20 million from foundations and is supporting everything from shared staffing to mergers.

"There's a lot of replication and duplication in the nonprofit sector," says Steven Seleznow, chief executive of the Arizona Community Foundation, which supports a member of the network called Arizona Together for Impact. "They're not guided by the kind of business models and access to capital that drive for-profit businesses. They're in a weaker position to sustain themselves in this kind of environment."

Seleznow says the community foundation also stands ready to help charities that need low or zero-percent interest loans through its Community Impact Loan Fund. Such funds may buy groups enough time to restructure for the new realities of the pandemic.

"We all have to be more flexible and creative," Seleznow says. "The nonprofits will tell us what their capital needs are, and we need to be in a position to respond to them."

Some lenders are learning that bridge loans are not enough. The Open Road Alliance, which provides short-term loans to charities experiencing unexpected roadblocks, has distributed $3.5 million in loans through its Impact Fund since the pandemic started. One loan product it pitched — an "event loan" that might assist a charity that had expected to raise, say, $50,000 through a gala but had to punt the fundraiser to the fall — never caught on.

Maya Winkelstein, Open Road's CEO, says early concerns about canceled galas were overshadowed by broader problems as charities saw multiple revenue streams fall apart and expenses rise to cover costs such as purchasing protective equipment for workers.

"That combination of revenues down and expenses up made something as specific as an event loan ultimately inefficient," Winkelstein says. "They needed more than that."

TAKEAWAYS

  • Experts say the nonprofit world is likely to contract as a result of the pandemic and the recession it touched off. Some charities will go under, while others will shrink in size.
  • Midsize charities face the greatest risks. Their higher fixed costs, like real estate and employees, make it hard for them to be as nimble as small groups, and they often don't have the healthy reserves and endowments many larger nonprofits enjoy.
  • The most stable charities are the ones that depend on foundations and individuals for the bulk of their revenue. Organizations that rely on ticket sales and other earned income have been hit hard, and nonprofits with extensive government contracts worry about late payments and looming cuts.
  • To weather the financial storm, nonprofits should develop several contingency plans and think through different scenarios, such as what would happen if it cut a program or donations fell sharply. Both senior executives and board members should take part in the planning.

(The Chronicle of Higher Education, the organization that publishes the Chronicle of Philanthropy, has received a loan under the Paycheck Protection Program.)

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