Why It’s Hard to Grow

November 1, 2012       Thomas McLaughlin      

There is a notable lack of attention paid to growth in the nonprofit sector, and it’s not because we’re just starting to come out of The Great Recession. There is a larger structural reason why growth is so difficult in the nonprofit sector no matter what the economic outlook. Being able to recognize that reason is the first step in overcoming this structural locked brake.

Three Types of Growth

Why do nonprofits need to grow? All successful private business entities face the same dilemma: the program model or models that were initially successful change over time.

In a process a 20th century economist labeled as “creative destruction,” better ideas replace good ones, and newer organizations come along to displace the previous ones. To keep pace, nonprofits need to do their own internal creative destruction, eliminating or modifying old programs and developing new ones, hopefully more of the latter over time.

This is the rough and imprecise phenomenon often referred to as “growth.” There are three main types of nonprofit growth and what they require is quite a bit from an organization. The easiest kind of new revenue comes from boosting the amount of a service already being provided. But that requires add­ing staff time and associated costs, and that outlay might take a while to be earned back.

Effectively, the organization risks running a cash deficit as long as the demand for service is steadily increasing at the same or greater rate as capacity is being added. This kind of growth might also require additional staffing or pre-purchasing supplies or even acquiring tangible assets such as real estate or vehicles.

Growth can also come from adding new programs. This kind of growth requires additional staff positions, new management capacity, and very likely some level of capital investment in addition to the increased cash needs that incremental growth demands.

A third type of new revenue that is growing steadily today is growth through mergers. This kind of growth can greatly exceed growth through any kind of program increases. It usually exceeds the effort needed to launch a new program and it almost certainly entails more dedicated staff time, more one-time costs, and possibly increased capital investment.

Capital Funds

The umbrella term for what all these growth methodologies need is capital. A dollar of capital is unlike a dollar of revenue, because a dollar of revenue flows out of an organization in the form of expenses almost as soon as it comes in as revenue. Capital dollars, on the other hand, stick around.

Nonprofits have only three sources of capital: profit, loans, and capital donations. For-profit entities can sell shares of ownership to raise capital but nonprofits do not have that option. Those three sources are nonprofits’ only source of capital.

“Nonprofit” is an unfortunate word choice in this context. The legal origin of the term was simple enough. Most corporations are expected to provide profit to their owners and shareholders, but since nonprofit corporations do not have owners they cannot provide profit anyway, thus the term “nonprofit.”

A more accurate description might have been “not a profit-distributing corporation,” which would explain why the simpler-sounding “nonprofit” became popular.

For whatever reason, cultural and even moral interpretations of this legal construct prevailed over the technical description. Today, many government funders and even foundations unblinkingly accept this concept as a requirement. One of the reasons why non­profits are more attractive to government funders than for-profits is that this interpretation of “nonprofit” virtually eliminates the possibility of the governmental funder being taken advantage of in contractual relationships.

But the insidious aspect of the terminology is that it has also taken on a cultural imperative for some organizations. There is sometimes a sense of pride among some boards of directors, for example: “We plow our profits back into our services.” This is admirable for its proud commitment to a clear worldview, but it effectively eliminates profitability as a source of growth capital.

A refusal to allow profitability, wherever that impulse comes from, is equivalent to a refusal to grow. This is because of the often unsuitable nature of the other two sources of capital — loans and capital donations. Loans can be a difficult source of capital for growth because most lenders prefer the collateral of tangible assets, such as a building rather than the imprecise and vague promise of revenue from a new program. Capital donations, which normally come in as part of a sophisticated multi-year capital campaign, are an equally difficult source of capital funding.

Some Alternatives

How can nonprofits with no profit (for whatever reason), no borrowing capability, and no ability to raise capital donations still grow? The answers lie in a mixture of tactics and tricks explained below, but the primary implication of this situation is that any growth achieved will almost certainly be slower and less robust than through the traditional approaches.

The first alternative to traditional growth capital is sweat equity. Put in plain terms, someone — probably many people — needs to work harder and longer and not get paid more for it. Alternatively, existing duties need to be reduced or eliminated to keep the work level stable. Many nonprofit managers do this instinctively, of course, but in the absence of true growth capital this is always one of the first mandated alternatives.

Yes, there’s math

A second approach is to isolate some of the regular cash flow stream and divert it to the new project. This will only work for organizations that have more than adequate cash flow. To see if it’s possible, identify your total spending for last year. Subtract the total depreciation cost for that year from the total spending and divide the result by 365 days. That’s your average total spending for each calendar day. Divide your total cash balance by this figure. If the result is more than about 40 days in cash you might have enough cash to subsidize a small growth project.

Keep in mind that this is nothing more than overspending temporarily covered by excess cash flow. If the growth project does not quickly produce its own revenue, all this means is that overspending occurred. A slight variation on this theme is to use consultants to work on growth-related projects, although this amounts to overspending as well. The advantage would come from using consultants who are more knowledgeable about managing the type of growth you seek than anyone inside might be.

Profit is an economic and financial term, not a morality test. Streetsmart managers know that growth is necessary for the vast majority of nonprofits. Running a tight operation with little room for growth might seem to be a noble objective but it limits an organization in the long run. Try to dedicate a bit of that nobility to the future. NPT

Thomas A. McLaughlin is the founder of the consulting firm McLaughlin & Associates and a faculty member at the Heller School for Social Policy at Brandeis University. He is the author of Nonprofit Strategic Positioning, published by Wiley & Sons. His email address is tamclaughlin@comcast.net