Nonprofits poorly treated by restrictions on funding

Published in the February 10, 2006 edition of Columbus Business First.

Too many nonprofits are grasshoppers. We need to let them be ants.

Everyone is familiar with the tale of the grasshopper and the ant. The grasshoppers focused on the day while the ants toiled to put away food for the coming winter. When winter came, the grasshoppers were starving while the ants were distributing food from the stores they had collected over the summer.

The moral of the story, of course, is that one should prepare for days of necessity. Nonprofits prepare for days of necessity by building flexibility and liquidity usually through accumulation of large, unrestricted cash reserves. 

Unfortunately, we make it very hard for nonprofits to become ants all the while we are critical of their grasshopper-like vulnerability.

A common viewpoint is that nonprofits should manage themselves more like for-profit companies. I have always felt uneasy that this view ignored something very fundamental.

Recently, I came upon a paper by Clara Miller in the NonProfit Quarterly that clarified my unease. The nub of her argument is the observation that when we invest in for-profit companies we give them our money for any purpose they choose.

Yet when we invest in nonprofits we tend to give the money with many restrictions on how and when the money can be spent, thereby limiting the value of the investment. The result is that restricted gifts make building flexibility and liquidity more expensive for a nonprofit, forcing many to remain grasshoppers, using far too many resources in the summer and leaving themselves stretched thin and vulnerable during the winter.

Unforeseen burdens

Restricted gifts have limited flexibility or liquidity and, in some circumstances, they can harm existing flexibility and liquidity.

For example, a nonprofit manager who receives a $50,000 gift restricted to a new exhibit cannot use this investment to boost attendance, increase working capital, upgrade computer systems, respond to unanticipated events or add fundraising staff. Typically, the expanded program from that exhibit will also increase illiquid receivables, raise payables, probably add more illiquid assets requiring maintenance and expand operating expenses. 

To stay financially healthy with these changes, the nonprofit will need more unrestricted income and higher cash reserves than it did before accepting the restricted gift and adding the exhibit. Similarly, a restricted challenge grant requires fundraising staff to be diverted to raising funds for the restricted grant rather than for current operations. 

Donors need to understand that restricted gifts have hidden costs – financial and nonfinancial. Some government and foundation programs acknowledge this by adding an extra payment for some of these extra costs, but generally corporate and individual donors do not compensate for the burden of their restrictions. 

A nonprofit that wants to be an ant that is prepared for the winter needs to take one or more of the following five actions:

• Have strong seasonal ups and downs? Form an adequate working capital fund.
• Dependent on developing new programs? Form a reserve for program development.
• Have volatile revenue? Form a stabilization reserve.
• Are service demands unpredictable? Create an emergency service reserve.
• Have facilities or equipment that are essential to your operations? Create a maintenance and replacement reserve.

Paradox with dollar sign

This list is not a luxury, rather  it is an essential element for flexible and efficient management.

Yet it is difficult to fund because all these categories require unrestricted, liquid assets. Endowments, sponsorships, scholarship funds, matching gifts and other restricted gifts will generally make it more difficult to meet this need.

Therein lies the paradox of nonprofit fundraising: As donors we want the biggest bang for the buck, yet we put restrictions on our investments in nonprofits that may wind up creating the need for bigger bucks for that same bang.

How can we expect nonprofits to achieve the flexibility and liquidity needed to prepare for difficult times when we routinely confront them with the hidden costs of restrictions we place on how they can use our gifts? As long as donors feel the need for restrictions, nonprofits will have one hand tied behind their  backs and they will need increasing philanthropy in order to survive. 

We trust for-profits to use our investments wisely; let’s treat our nonprofits the same way and give unrestricted cash that they can use to build the reserves they need to sustain their current operations and become ants that are prepared for the winter. 

Allen J. Proctor was chief financial officer of Harvard University and is the author of “Linking Mission to Money, Finance for Nonprofit Board Members.” Reach him at  www.proctorconsulting.org.

Copyright 2006. Reprinted with permission, Business First of Columbus Inc.