During most of the go-go 2000s I lived in the epicenter of the housing boom, Sarasota, FL, where we know a thing or two about debt (and nonprofit debt). So I wasn’t at all surprised to read this morning’s New York Times article about the Harlem School of the Arts, which over the course of years ran up debt and executive pay simultaneously, putting the organization on a path to oblivion.
What is surprising to me is how uncommon it is that individual donors realize that finding out the debt of any nonprofit is as easy as clicking a few web links, and while the information about debt won’t by itself tell you whether to donate to a nonprofit, that information plus a few questions to board members can tell you whether to exclude the nonprofit from your donation choices very quickly.
And, if you like the idea of thinking of a nonprofit donation as being metaphorical to a for-profit investment, looking at this data can be a lot of fun. So let’s look at the data mentioned in the NYT article and then talk about its implications.
Take a look at the 990
The public document that shows a nonprofit’s balance sheet (among many other things) is called the 990, and my preferred site for finding 990s is GuideStar. So head over to GuideStar, do the required registration, and pull up the page for the Harlem School of the Arts. They’ve got three years of 990s, and if you want more you could always just ask the nonprofit.
There’s lots of interesting material in these 990s, but we’re thinking about debt, so take a peek at the liabilities on p.4 of the 2005 return.
(Click to enlarge)
The first column is the liabilities at the beginning of the statement period, and the second column is liabilities at the end. So from 7-1-05 to 6-30-06, a mortgage of over $300,000 disappears, and there’s an increase in “Other liabilities” of nearly $300,000. The Statement 7 mentioned other Other liabilities breaks that it into two not very illuminating categories.
So these changes merit some explanation, but before we go there let’s see what happened during fiscal year 2006 to liabilities.
Hmmm… not very encouraging. A $700,000 increase in “Other Liabilities.” That sounds like such a miscellaneous category, but evidently it’s not. And the 2007:
Well, the rate of increase of “Other liabilities” seems to be declining, but we’re still adding liabilities. How would the board explain this?
“Wait!” you might say. “They may have added a whole lot to their liabilities, but what about their assets? We might be more inclined to dismiss over $1 million in Other liabilities if their assets have increased by $1 billion!” Fair enough. Let’s skip back to p.1 and look at their net assets. Here’s 2005:
An operating deficit, but they still have assets. 2006:
That deficit’s getting bigger. 2007:
Uh-oh.
The nonprofit may not volunteer this information to you
Let’s imagine how a similar but fictional assessment might play out in the decision to donate.
You’re out to lunch with reps from a nonprofit with big debts, even though you’ve not yet discussed them. The director of development called a few months ago to ask you to increase your annual gift from $100 to $1000, and you sent in $5000. He queried your name in a database and found out that you’re (ahem) doing well. Then he went to the CEO with this information, who passed it along to the board.
Two board members know you, and everyone decided to make a move, so now you’re dining with all four of them. They want you to donate $100,000, which they privately see as the next step to an even bigger donation.
So what about these big liabilities? Before you met with these people, you did well to check the 990s, because it’s by no means assured that they’ll tell you about the liabilities. They’re thinking about them — boy, are they thinking about them — and their grantmakers know about them, because grantmakers are in the business of evaluating this information and acting on it quickly.
You disclose that you know about the debt. They say that times are tough, which is true, and that tough times for the economy mean tough times for nonprofits, which is also true. How sympathetic are you feeling at this point?
It can be ok to donate to a nonprofit in debt, IF…
There are certainly good uses of debt (I’m about to buy some coffee using debt, and I feel great about it, e.g.). But just to push this example to its extreme let’s imagine that the debt was brought about for bad reasons. Someone embezzled money, someone bought something stupid, someone made a mistake that required $1 million to clean up… whatever.
The four people you’re dining with — or rather, the two board members, because they’re the ones who really count — can take one of two approaches to responding to the debt, and their decision in this regard will determine whether the debt should disqualify the nonprofit from your donation consideration.
In the worst case, they’ll pretend the debt doesn’t exist. They’ll be able to get away with this as long as their cash position enables them to make payments and as long as their bank doesn’t call the loan. If the debt is collateralized, that’ll be a help. You might see board members pretending in this way if the debt was incurred by the predecessors of current board members and the current board doesn’t psychologically “own” the problem. Why should they bend over backwards to erase the debt? The debt is someone else’s fault!
In the best case, the board members will own the debt psychologically regardless of who incurred it or why. You want to look across the table and in your gut assessment see people who can discuss the nonprofit’s situation honestly, who (you believe) will stop at nothing to get rid of the debt, and who have made major personal commitments (relative to their own wealth) to pay down the debt. If the key players have the motivation and credibility to get the nonprofit back on the right track, then the debt alone shouldn’t disqualify the nonprofit from your giving decision.
If you think they’d sooner shutter the nonprofit than take the tough steps to fix it, then you certainly shouldn’t donate.
For board members: debt depresses fundraising receipts
I’ve seen plenty of board member take the worst case approach. If pressed on the subject of the debt, their response is typically that it’ll go away if management can create incremental operating revenue. And this can be true if the size of the debt is small. I hope, for example, that I can make the money this month that will enable me to erase the debt I’ve incurred for this exquisite cup of coffee.
Boards who take this quixotic approach will tend to go through CEOs pretty quickly. Either the CEO will fail to achieve the revenue gains required and get fired, or the CEO will courageously press the board to fulfill its responsibilities and get fired. Board members like those at the Harlem School of the Arts should know that they actually look better if they admit failure and take steps to rectify it than if they try to scapegoat the people below them after everything has fallen apart.
But perhaps the most important thing board members should know is this: just as they are not bending over backwards to disclose to donors that their gifts service debt, donors are not bending over backwards to disclose to them that their paltry contributions are a function of the nonprofit’s debt.
Want to increase revenue? Get rid of your debt and ride the wave of incremental revenue created by the increased confidence of sophisticated donors who pay attention.
If it’s six figure debt, ok, maybe an enterprising CEO can make it go away without your help. Heck, you might even be able to pass 5-figure liability down to a director of development. But if you’re seven figures in the hole, it’s exceedingly unlikely that your CEO will be successful at solving your debt problem without a credible public commitment from you.
For board members: it’s all on you
My belief is that, if a nonprofit incurs a debt while you’re a board member, you’re responsible for ensuring that it’s paid off. I believe that this obligation follows you even if you leave the board.
I also believe that, if a nonprofit incurs debt before your time, the debt becomes your responsibility once you join the board. To join the board of a nonprofit is to commit publicly to ensuring its financial well-being. If you can’t commit to paying off the debt out of your own pocket and out of funds that you raise, you shouldn’t sign up.
Ok, enough moralizing…