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Getting Beyond Breakeven a Review of Capitalization Needs and Challenges of Philadelphia-Area Arts and Culture Organizations

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Getting Beyond Breakeven a Review of Capitalization Needs and Challenges of Philadelphia-Area Arts and Culture Organizations Getting Beyond Breakeven A Review of Capitalization Needs and Challenges of Philadelphia-Area Arts and Culture Organizations Commissioned by The Pew Charitable Trusts and the William Penn Foundation Author Susan Nelson, Principal, TDC Contributors Allison Crump, Senior Associate, TDC Juliana Koo, Senior Associate, TDC This report was made possible by The Pew Charitable Trusts and the William Penn Foundation. It may be downloaded at www.tdcorp.org/pubs. The Pew Charitable Trusts is driven by the power of knowledge to solve today’s most challenging problems. Pew applies a rigorous, analytical approach to improve public policy, inform the public, and stimulate civic life. We partner with a diverse range of donors, public and private organizations, and concerned citizens who share our commitment to fact-based solutions and goal-driven investments to improve society. Learn more about Pew at www.pewtrusts.org. The William Penn Foundation, founded in 1945 by Otto and Phoebe Haas, is dedicated to improving the quality of life in the Greater Philadelphia region through efforts that foster rich cultural expression, strengthen children’s futures, and deepen connections to nature and community. In partnership with others, the Foundation works to advance a vital, just, and caring community. Learn more about the Foundation online at www.williampennfoundation.org. TDC is one of the nation’s oldest and largest providers of management consulting services to the nonprofit sector. For over 40 years, TDC has worked exclusively with nonprofit, governmental, educational and philanthropic organizations, providing them with the business and management tools critical to carrying out their missions effectively. Learn more about TDC at www.tdcorp.org. Copyright © 2009 by TDC, Inc. Introduction This document reports the key findings from the “Review of Even more importantly, undercapitalization can chill artistic Capitalization Needs and Challenges of Philadelphia-area Arts risk-taking. An organization one failure away from closing and Culture Organizations,” a study commissioned by The has a strong incentive to choose the tried and true over Pew Charitable Trusts and the William Penn Foundation and the experimental. Even before the radical downturn in the conducted by TDC, a nonprofit research and consulting firm environment, the arts sector was at an inflection point, where based in Boston. The objectives of the study were to review the rapidly changing consumer tastes and habits were challenging capitalization status, needs, and challenges faced by nonprofit the traditional business models of arts organizations. Without arts and culture organizations in the five-county Philadelphia adequate capitalization, cultural organizations are hard put region; clarify how well these organizations understand these to pursue innovative strategies to address the changes in needs; and develop recommendations for how organizations’ the marketplace. financial health and capitalization could be improved.1 Finally, undercapitalization puts organizations at risk of failure, This study was commissioned and conducted in late 2007 and of course, organizations cannot meet their missions if and early 2008, before the severe economic downturn in the they don’t exist. The squeeze of straitened resources and fall of 2008. In this context, the first question we address is a narrowing options resulting from the economic downturn simple one: Why talk about capitalization, especially now when has placed the risks of undercapitalization into sharp relief. so many organizations are struggling just to survive? This is a Those organizations with solid capital structures have the fair question, especially in the nonprofit context. In the for-profit capacity to last through the rainy day. Those that don’t world, capitalization – embodied in an organization’s equity – are already pressed. The purpose of having a discussion is everything. For nonprofits, however, financial performance about capitalization now is not only to grasp the teachable is not the sine qua non of exemplary overall performance, moment. Rather, the forward-thinking intent is to help viable and balance sheet analysis cannot measure social impact organizations to create realistic plans as they adjust their or artistic excellence. strategic goals to fit a new, uncertain landscape of funding and audience engagement. So why should nonprofit arts organizations care about capitalization? TDC posits that financial health and This discussion of capitalization falls into a field primed mission impact are linked for a number of reasons. First, both in theory and practice. TDC recognizes that there are undercapitalization is distracting and debilitating, making it long-time players in the sector who have been talking about challenging to maintain the focus and energy necessary to capitalization for many years, including the Nonprofit Finance conceive and produce the highest quality artistic programs. The Fund and National Arts Strategies. This study has built on this stress and distractions can take many forms: listening to angry invaluable thinking. (For further reading, we have included a list phone messages from creditors, patching up systems in poorly of resources we found helpful on page 9.) In our conversations maintained buildings, wondering how the next debt payment or with Philadelphia organization managers, service providers, payroll will be covered, scrambling to find replacement funding and funders, TDC was heartened to find a culture that values when a grant doesn’t come through or when the last show and supports capacity building and strategic planning. We hope wasn’t a success. that the insights gained through this project will help to move that agenda forward. 1TDC interpreted “arts and culture” broadly to include a multitude of disciplines, reaching beyond the traditional fine arts. We sorted organizations into 10 discipline groups: art museums, arts education organizations, arts service organizations, dance organizations, historical museums and societies, humanities organizations, music organizations, natural history and other museums, theaters, and visual arts organizations. 1 What is Capitalization? Before delving any further, let’s step back and define the Not all organizations require all of these funds. The nonprofit subject at hand. What is capitalization? sector is plagued with misconceptions about the different types of capital funds and their use. For example, while endowments Capitalization is the accumulation and application of resources are an essential piece of the capitalization mix for organizations in support of the achievement of an organization’s mission and that have significant long-term obligations, they may not be a goals over time. The province of capitalization is the balance helpful use of funds for those that live primarily in the current sheet, which encapsulates the record of an organization’s day. In fact, by restricting capital, endowments may actually be financial performance as net assets and measures the counterproductive for some organizations that could be better magnitude of its assets and liabilities. A strong balance served with board-restricted reserve funds. The proper scope sheet evidences an organization’s ability to access the cash and scale of capital structure can only be determined after an necessary to cover its short- and long-term obligations, to examination of an organization’s time horizon, core business weather downturns in the external operating environment, and model drivers, and lifecycle stage. to take advantage of opportunities to innovate. Conversely, an undercapitalized organization often falls short of these capabilities. Unpacking the balance sheet. By building their net assets through years of surplus operations, organizations develop the capacity to plan for the future, react quickly to new opportunities, and support missions that require major fixed assets and a long-term view. There are six distinct types of capital funds, described in the table below, that managers can use to maintain organizational health. Each of these funds addresses a distinct need. Fund Description of use Time Horizon Operating funds The money that organizations use to pay for their reasonable, Current: Planned operational need planned day to day expenses during the year to run their programs as stated in their current strategy. Working capital Working capital funds are meant to smooth cash flow bumps that Current: Planned cyclical need arise from predictable business cycles. Operating reserve Unlike working capital, operating reserves are held in order to protect Current: Unpredictable, one-time risk against unexpected downturns, i.e. the “rainy day.” Capital replacement A cash fund organizations with facilities maintain to realize long-term Long-term: Planned capital replacement reserve facilities replacement plans. Endowment Endowments are meant to ensure the longevity of organizations with Long-term: Planned operational need long-term time horizons through investment earnings dedicated to ongoing costs, such as maintenance of a collection or historic building. In general, the endowment corpus is legally restricted, although boards can create quasi-endowments not restricted by donor intent. Risk capital Risk capital is meant to give organizations the freedom to try out Long-term: Strategic risk new ideas, such as product extensions, new marketing campaigns to broaden audience, earned income ventures, major growth, or a new strategic direction. Risk capital should be
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