The challenge (and opportunity) of nonprofit debt

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The for-profit world used to complain that the nonprofit world (especially in the arts) needed to behave more like businesses. Now that nonprofits are suffering the same wrenching impacts as every other industry, the complaint is that we were behaving too much like businesses. The current such complaint relates to nonprofit use of debt.

One of the things for-profit businesses do is use debt to advance their profits. If it's cheaper to get capital by borrowing the money, they borrow. If it's cheaper to get capital by buying, they buy. Over the past decades, major nonprofits discovered this new terrain, and started using it to leverage their resources (instead of spending those donations, let's use them as collateral against low-interest bonds, and we can pay the interest with the investment returns).

When the financial markets collapsed this last time around, a whole bunch of folks holding debt and collateral against debt saw their financial position turn upside-down (homeowners, for example, found themselves with mortgage debt greater than the value of their homes). It's easy to blame the individuals stuck with the bag (who might have known better), and slightly more productive to blame the system (which didn't help them know better). But it would be a mistake to shun the tool we used to get here -- in this case, debt.

No doubt, many businesses on the commercial and nonprofit side underestimated their risk in using debt, as this New York Times article suggests about nonprofits. And I'm not about to step to the general defense of nonprofits that over-extended themselves on the prospect of ever-increasing investment returns. However, in the thoughtful pursuit of mission, a nonprofit is charged with exploring any resource it can bring to bear -- ever balanced against the risk of using that resource. And tax-exempt debt is one of those resources.

A circular saw is a potentially deadly device, but it's an essential tool for building big things. We can't stop using the saw. But we can certainly learn to use it with more humility, focus, and intent.

September 30, 2009 8:17 AM | Permalink | Comments (3) |

3 Comments

By Ellis Carter on October 7, 2009 2:28 AM

Nonprofits can't win this fight. For the last decade, the chorus chiding nonprofits to act like businesses was almost deafening. If they act too much like a for-profit business, they risk loss of tax-exempt status. If they don't exercise enough self-interest, they risk failure.

Agree that board members need to stop treating non-profit resources like other people's money.

With respect to Tim's comment, invading endowments usually illegal. Dumb is just dumb whether you are running a for-profit or a non-profit.

By Drew McManus on October 4, 2009 9:32 AM

Great piece Andrew and I especially like the woodworking reference. One of the messages that needs to be reinforced during a time of counter-productive financial planning among nonprofits is debt is something to assume with purpose and to be managed.

It isn't some sort of universal evil nor is it a harmless tool to carry from one year to the next without consequence. What's missing here is some reasonable guidelines for when to assume debt and to manage it regardless if it is planned or unexpected.

It is certainly just coincidence, but it is amusing that the captcha phrase for this comment is "whatever overdose."

By Tim on October 1, 2009 8:33 AM

In view of the number of solid NFPs that have grossly invaded their endowments, often with disastrous results, I question whether debt is the morally-neutral tool you describe. Many of the places I worked had one comptroller who was also the chief HR officer and the payroll department. They were often borderline alcoholics due to the stress of their jobs. Pressure to delay withholding tax payments and even 403(b) salary reduction (!) deposits were often yielded to. Weak boards applied different rules to an arts organization than their own for-profit companies used.

Not-for-Profit CEOs (remember, they used to be called Executive Directors, but CEOs get higher salaries and more respect...) are more qualified today than they used to be. But they still don't get the training and seasoning that a big corporation's promotion process provides. And when artistic directors have too much input, board candidates for the top job can slip down in the list.