Capitalization, for Art’s Sake!

In 2010, Grantmakers in the Arts put capitalization on the national arts agenda by starting a conversation about what funders can do differently to address the chronic financial weakness undermining the vitality of the sector. To advance this dialogue, Nonprofit Finance Fund (NFF) and our consulting partner, TDC, then went on the road with GIA, delivering Conversations on Capitalization and Community, a daylong funder workshop about the financial health and resource needs of arts and culture organizations in local communities. We convened arts grantmakers in thirteen cities around the country from 2012 to 2013.

The partners collaborating on this program define capitalization as the alignment of financial resources to support an organization’s mission for the long term. We collectively advocate for improvements to organizational capitalization because we know that stronger balance sheets enable artistic risk taking and freedom. If society demands and deserves more relevant, accessible, and dynamic art, we emphasize capitalization as the means to that end.

Capitalization has always been a loaded topic in the arts sector and beyond: it raises important questions about who we do and do not fund, exposing uncomfortable realities about equity in grantmaking. Improving capitalization will require either more resources coming into the sector (largely a pipe dream in today’s economic and political context) or making difficult choices about the reallocation of existing resources. We simply can’t capitalize every organization fully, and certainly not if we distribute revenue and capital in the ways we have in the past.

Historically, strengthening the capital structure of cultural institutions has been misinterpreted to mean investing more money in big organizations, for the purpose of building endowments and facilities. While large groups have indeed attracted the lion’s share of the capital, our research shows that they are often capitalized in the wrong ways; their money is trapped in inflexible assets. Many of these organizations have achieved long-term durability, as reflected by the presence of significant fixed assets. But they have done so at the expense of building their own — and the broader field’s — liquidity (having regular access to working capital) and adaptability (having periodic access to capital for resiliency and change).

Improving capitalization in the arts will require all cultural supporters — from board members to wealthy donors to philanthropic institutions — to rethink the kinds and amounts of capital that organizations need in a world where new technologies and models of participation are fundamentally challenging traditional assumptions about what art gets created, where, and how. This implies moving beyond some of the static assumptions about money that interfere with artistic experimentation, organizational risk taking, and managing uncertainty or failure.

Let’s examine some common questions about capitalization in the arts, as a way of supporting grantmakers’ concerted efforts to strengthen the financial health and artistic vitality of the cultural sector.

Does capitalization apply only to the big community anchors? Every nonprofit business — including emerging organizations, organizations serving culturally specific audiences, and small, community-based nonprofits — can set its sights above the break-even mark, manage its expenses in the context of market realities, and contribute to savings. While not every organization needs to build a durable balance sheet, most require access to cash for day-to-day liquidity and periodic risk and adaptation.

There are plenty of examples of how capitalization applies in smaller-budget organizations. Through NFF’s work administering a zero-interest loan fund for performing arts organizations on behalf of The Andrew W. Mellon Foundation, we have seen how many smaller cultural organizations can benefit from having access to financing to generate new revenue sources and to bridge the receipt of delayed funding during times of economic hardship. Our work with single-choreographer modern dance companies in New York City, part of a separate Mellon-funded program, revealed the importance of adequate working capital among groups that often experience extreme but predictable swings in cash flow between alternating years of choreography and performance.

My foundation only gives small, restricted project grants. Does the capitalization conversation even apply? A core principle of grantmaking is first, do no harm. By excluding overhead from project budgets, penalizing surpluses, and placing undue grant management burdens on nonprofits, arts supporters often unintentionally contribute to the erosion of grantees’ financial health. Better practices alone would go a long way toward strengthening capitalization by minimizing financial and human resource constraints.

Although not capital, project funding can also serve a similar purpose to risk capital, the nonprofit sector’s equivalent of R&D money. Risk capital allows organizations to pursue strategic opportunities, such as investing in an important new technology, commissioning a new work with a long lead time, or putting on a risky exhibition without assurance of return on investment. A project grant that covers the full costs of a risky opportunity does no harm. When full-cost funding isn’t an option, grantmakers can play an important role by encouraging grantees to resize their projects to available resources, or to postpone an underfunded project.

If a funder really believes in the artistic vision of an organization’s leadership, he or she might consider seeding a risk reserve as an alternative to project funding. With flexible funds on hand, organizations can afford to be opportunistic about their risk taking, rather than responsive to often unpredictable or lengthy grant cycles. As examples, the Wooster Group and Ping Chong & Company have used foundation funding to establish strategic opportunity reserves to seed future innovation and experimentation.

We give general operating support (GOS). Isn’t that the same thing as capital? General operating support is the rarest but also most valuable form of revenue. A gift of GOS is a gift of trust — trust in the executive and artistic leadership’s knowledge of how and where to apply funds in support of an organization’s mission. But GOS is not capital. It pays for organizations to do what they already do, not to invest in new programs or broader organizational change.

While general operating support alone does not improve an organization’s capitalization, it can indeed cover costs not assigned to specific projects, increasing the likelihood of surpluses, which will be recognized on the balance sheet as capital (in the form of unrestricted net assets).

It is important for grantmakers to be clear about the role their money will play by making the distinction between flexible revenue, which helps keep the lights on, and capital, which supports organizations in changing what they are capable of doing. Funders can do organizations a disservice when they provide general operating support with the expectation that grantees will achieve capital outcomes.

Are arts organizations really committed to doing the hard work around capitalization? NFF’s experience suggests that they are. Most of our nonprofit clients deeply understand the artistic implications of their broken business models and diminished balance sheets. However, many arts leaders live in fear that true openness about their financial state will jeopardize future funding. Organizations that have historically prioritized achieving annual surpluses and savings — those that follow sound business practices — are too commonly penalized for their careful savings. In NFF’s Fifth Annual State of the Sector Survey, only a minority of arts organizations reported any degree of comfort engaging funders about critical needs for working capital, cash reserves, and debt.

As the CEO of an arts organization in Massachusetts told us, “Our balance sheet continues to be one of our toughest challenges. We are continuing to model new strategies to develop appropriate reserves, but we don’t have the right ‘champions’ in the funding community to help us access new resources.” Another arts leader echoed these concerns: “Programmatic funding is getting more plentiful, but funders are not interested in retiring debt, building reserves, or providing unrestricted funds for operations. These areas represent a major concern for our institution. In order to address this, we are seeking to increase earned revenue wherever possible, grow our annual fund, and work closely with long-standing donors on our institutional revenue goals.”

As these examples show, nonprofit managers are not absolved from responsibility for establishing and achieving reasonable capitalization goals. Cultural organizations must own the articulation of their short- and long-term balance sheet needs as part of the strategic planning process. Funders can support integrated planning that helps organizations develop comprehensive, data-driven strategies that are grounded in the context of community priorities and access to resources.

When GIA, TDC and NFF imagined the Conversations on Capitalization and Community series, we hoped the convenings would be just the start of a broader dialogue in the field about the kinds and amounts of resources arts and culture organizations need to survive and thrive. Happily, the dialogue is continuing in cities from Los Angeles to Boston to Atlanta. We hope arts grantmakers will keep asking themselves hard questions and challenging outdated assumptions as they seek to apply universal principles within local contexts. As market shapers and influencers, institutional funders can play an important role in bringing together the many actors — from foundation trustees to individual donors and nonprofit boards — that will collectively determine whether the cultural sector’s financial assets ultimately support or undermine the long-term vitality of the arts.