Capitalization Planning

Great art is often created without lots of money and can be enjoyed for many years. Great arts organizations without the right kinds and amounts of money, however, struggle to see another day.

Mission success for nonprofit arts organizations is reflected in the creation, sharing and appreciation of meaningful work. Each organization has a different artistic vision and goals, as well as its own strategy for reaching and engaging audiences. Behind every successful organizational strategy there should be a sound approach to obtaining and stewarding the financial resources required to support mission execution over time. This is a capitalization plan. At its essence, a capitalization plan serves as a roadmap for ensuring an organization has the cash and other assets it needs to manage risk and pursue opportunity.

Strategic plans often lack a rigorous financial foundation. They fail to consider the long-term financial resources needed to support program goals. And when they do include a financial plan, they often conflate regular revenue (ongoing) with capital (periodic), or neglect capital needs altogether. While financial projections that quantify the future revenue and expenses associated with a strategy are critical components of any strategic plan, they are not enough. Consideration must also be given to the organization’s long-term balance sheet –or capitalization– needs.

A capitalization plan is really just an approach to building the right balance sheet. It should consider the kinds and degrees of artistic and organizational risk an organization can and wishes to tolerate, as well as the creative ambitions to which its leaders aspire. Specifically, a capitalization plan should address an organization’s financial health and goals in the following three areas: liquidity, adaptability and durability.

• Liquidity: having adequate cash to meet ongoing operating needs
• Adaptability: access to flexible funds to adjust to evolving circumstances
• Durability: assets to address a range of future needs

While the amount of adequate liquidity may differ by organization, cash is king for all nonprofits, regardless of size. Many organizations also need periodic access to flexible capital to pay for adaptation –whether related to growth, restructuring, program revitalization or even downsizing. 

Most arts organizations don’t own property or have ambitious growth plans. For them, a capitalization plan that focuses on liquidity and adaptability may be sufficient. This plan would articulate the amount of cash required to manage the cyclicality of receipts and disbursements and to recover from (or adapt to) the occasional mis-step or loss of funding. With sound financial planning and management, these funds are most readily secured through cash-generating surpluses—and set aside in reserves. Capitalization plans for such organizations might also include an approach and timeline for raising or saving cash to invest in infrastructure or other new capacity, such as: technology upgrades; replacement of equipment, sets and costumes; upfront investments in new staff; and artistic experimentation.

Growing or complex organizations, which often have endowments and substantial fixed assets (i.e., facilities), should be clear in their capitalization plans about the resource requirements of long-term durability. This means building up cash (for liquidity and adaptability) alongside other fixed or permanently restricted assets and sometimes making choices to defer long-term investments if liquidity is not sufficient to support them.

Consider the case of a mid-sized theatre company that, due to consistent success at the box office and with donor development, is taking the next step in its growth trajectory. Its strategic plan calls for purchasing a new facility that houses two additional theatre spaces. The organization achieves its $5 million capital campaign goal, but the costs of the building run over budget. To cover the shortfall, existing cash is depleted and a ten-year term loan, secured by the building, is required. Once the facility opens, expenses increase as more performances and staff are added. For the first time in many years, the organization runs a sizable deficit because anticipated audience growth does not materialize and loyal funders and donors have been tapped out by the campaign. Within three years, deferred maintenance on the original facility reaches a crisis point and cash on hand dwindles to negligible levels.

This organization’s critical error was not planning for the short and long-term capital and operating requirements of program and facility expansion. It is all too common to fall into this trap. Raising capital for bricks-and-mortar alone can be a herculean task, and many organizations fear that their project won’t get off the ground if the price tag is too high.

A capitalization plan helps organizations identify the range of needs that a capital campaign should address and make strategic choices about what they can realistically raise and therefore, do. Such a plan would have directed this organization to include funds for some or all of the following in its fundraising strategy:

• 2-3 years of flexible capital sufficient to cover temporary operating deficits post expansion, until regular revenue catches up with expenses
• working capital adequate to cover low cash months of the year
• several months of cash to respond to opportunities and weather unforeseen risk
• a board-designated reserve for future improvements to both facilities. 

A capitalization plan would have also articulated future annual surplus targets that would be fed into the budgeting process and used to maintain and grow working capital and reserve funds. These surplus targets would be informed by a creative marketing plan to engage sustained audiences and a fundraising plan for raising realistic amounts of recurring contributed revenue from individuals and institutions.

As it stands, the organization’s creativity, resiliency and relevance are in jeopardy. Liquidity is depleted. Adaptability can no longer be strategic. Durability is in question.

Many strategies for change, as seen in the example above, require an upfront capital investment for one-time or future ongoing expenses that aren’t yet fully supported by revenue. They also need to be supported by a combination of fixed and liquid assets appropriate to the organization’s future state and mission. Successful change can be a costly and risky endeavor unless it is accompanied by a plan to sustain itself with reliable revenue (supported by viable evidence of a market of patrons and donors) and a healthy balance sheet.

If an organization (regardless of its size or facility intensity) has plans to undertake major change –the kind of change that will result in new or different programs or ways of operating– its capitalization plan should address the following questions:

• How much “change capital” (upfront money) is needed to achieve the shift?
• From what sources will this capital come?
• How will the capital be invested to build future revenue that can offset any new annual (as opposed to one-time) costs? 
• What kinds and levels of working capital and savings will be needed to support the evolved organization?

Finally, capitalization planning cannot be done in isolation. It must be inextricably linked to and supportive of a strong strategic plan, inclusive of meaningful market research and achievable financial projections of revenue and expenses. Such connected, iterative, and ultimately rigorous planning can help an organization to make the case to funders, board members and other important stakeholders for more of the right kinds of money to support its artistic vision, mission and impact. This process can also help leaders understand the financial resources needed to achieve a given set of goals—and to consider options in advance should obtaining those resources not come to pass. Thoughtful planning with a capital perspective can help prepare for the unexpected—whether unsettling or energizing.

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