These are the difficult truths about risk management and nonprofits

SeaChange Capital Partners exists to help nonprofits get transactions done. We generally eschew research so it’s ironic that we’ve become known for a series of risk-related research reports coming out of the 2014 bankruptcy of FEGS. As this writing odyssey comes to an end, SeaChange and Oliver Wyman are pleased to reflect on what we’ve learned, since nonprofits currently face an environment where risk management really matters.

Following the FEGS debacle, board members from other nonprofits started calling SeaChange because they were unclear about how risky their situation was (“Is it normal to have four weeks of cash on hand?”) and uncertain about how to approach risk management (“We don’t want to be the next FEGS.”) To our surprise there weren’t many pre-existing resources to steer them to so we decided to develop something ourselves together with GuideStar, the largest source of information on nonprofits.

The first report – Risk Management for Nonprofits – gave board members some rough-and-ready tables to put their nonprofit into context. It also showed that many organizations have such a small margin for error that risk management is vital. Lastly, the report argued that nonprofits fail in predictable ways and recommended practices that we felt could make a real difference.

The report was released at an opportune moment. The nonprofit community in New York was making a concerted effort, in part through the Nonprofit Resiliency Committee, to better connect with a De Blasio Administration that was sympathetic in principle but not always in practice. Our report was also complimentary with a broader call to action published by the Human Services Council at around the same time.

In the wake of the first report we spoke with dozens of organizations that ultimately decided to adopt some or all of the recommended practices. We also got a lot of questions about overhead and released a related addendum in response. Some critics thought we had fetishized risk, but the overall reaction was positive.

The New York report led to an invitation to do a similar report for the Philadelphia area. Shortly after that, we produced a national report based on the full IRS Form 990 dataset. The culmination of this work was an analysis of the Human Services sector – A National Imperative: Joining Forces to Strengthen Human Services in America – commissioned by the Alliance for Strong Families and Communities and the American Public Human Services Association.

So, what did we learn while doing this work and what trends have we observed?

“Nonprofit sector” is a largely meaningless concept

Other than their tax-exempt status and a desire to work for the public good, many nonprofits have little to do with one another. Thinking of them collectively as a “sector” is usually nonsense. The largest – the 2 percent that provide 80 percent of the services – have little in common with the smallest ones – the 66 percent that provide 2 percent of the services. High philanthropy fields like animal welfare, some arts and culture have very different dynamics than those that act as financial extensions of government such as human services. While state and federal policy plays a role, most of the action for nonprofits is at the local level.

The sector is undercapitalized

Most nonprofits are profoundly undercapitalized with few resources available for long-term investments or to cushion unexpected bumps in the road. This makes risk management paramount. It should be a call to action for board members to be more aggressive about fundraising. It should also encourage funders to provide more general operating support.  An under-capitalized sector is unlikely to be able to fulfill its economic and moral potential as a partner of government.

Nonprofits fail in predictable ways

Those that fail tend to start off fragile and struggle to recruit and retain strong financial staff members. They are often surprised when they hit a bump in the road. They then take a while to figure out what is going on, take too long to decide what to do, and then delay doing it.

A handful of risk management practices can help

These include assigning a  board-committee to be responsible for risk management and crafting a risk appetite statement. In addition consider scenario planning, benchmarking against peers and others, and setting explicit financial stability targets.

Failure to acknowledge some inconvenient truths

These truths include: Size matters. Philanthropy is largely fixed. Many organizations will always be extensions of government from a financial standpoint. There would be more collaboration between nonprofits if ego and self-interest didn’t get in the way.

Risk management is a team sport

Organizations are hamstrung since so few have much internal analytical capacity. Good risk management requires the cooperation of leaders, line-staff and board members. The role of the board is often underestimated. Consider this: half of nonprofits have more board members than staff. Many boards operate in an information vacuum. Most people lose the “warm glow” that drives service when they think too hard about risk.

Nonprofits offer a great return on investment

While the money given to nonprofits is viewed as "charity", investments in high quality services provided by nonprofits such as safe housing, nutritional counseling, childcare solutions, job training and the like, more than pay for themselves through reduction of downstream costs in the larger healthcare and criminal justice systems. However, high quality services require financially stable organizations to deliver them.

Conclusion

Looking back, we hope our reports have played a role in helping to establish “risk management” as a discipline alongside “strategic planning” and “program evaluation.” We’re optimistic this will happen given that leading technical assistance providers are now incorporating risk management into their work. We also believe that a dose of dour risk management can help improve the state of strategic planning in the sector. Strategic planning is too often not taken seriously because it seems divorced from the past, short on contingencies, and long on magical thinking.

There are certainly a lot of risks out there. The recent stock market wobble won’t help giving. The new tax law has put pressure on state and local budgets yet demand for the traditional work of nonprofits seems likely to grow given the opioid epidemic, continuing inequality, the aging of the population and much needed reforms in criminal justice. In certain areas such as higher education and those parts of human services moving toward value-based payment, we expect a lot of consolidation, restructuring and even failures.  

On the other hand, nonprofits committed to outcomes have increasingly inexpensive ways to measure their results. And these data will show what we already know: well-run nonprofits are better able than government or the private sector to deliver the goods. 

John MacIntosh is a partner at SeaChange Capital Partners, which helps nonprofits complete transactions including mergers, acquisitions, joint-ventures, financings, divestments and dissolutions. Dylan Roberts is a partner at Oliver Wyman, a global management consulting firm with more than 4,000 consultants.