How non-profit organizations can handle financial hardships and a difficult economic environment

Sean Malloy, McDonald Hopkins LLC

Shawn Riley, McDonald Hopkins

If you serve on the board of a non-profit organization, you may be familiar with this scenario: revenue is down, donations are smaller and more tightly restricted, government assistance has become all but non-existent, and costs have continued to rise. While the near panic of 2008 and early 2009 is in the rear view mirror, the economy is far from fully recovered, and non-profit organizations are no better off than their for-profit brethren.

Shawn Riley and Sean Malloy of McDonald Hopkins’ Business Restructuring Services Department sat down with Smart Business to talk about what a troubled non-profit organization can do to help face the challenges posed in these troubled times.

Why are so many non-profit organizations struggling?

Riley: A number of reasons. Non-profits face many of the same business challenges as for-profit companies. Money is tight everywhere, so growing top line revenue or even keeping it steady can be difficult. Many non-profits also rely on charitable donations for a large portion of their revenue. While there are different estimates about the overall level of charitable giving, most data show that it dropped in 2008 and 2009, and recovery in that sector, like the economy generally, has been slow.

What should the board of a distressed non-profit be doing to face challenges?

Malloy: The minute a board starts to see financial trouble on the horizon, it has to take active steps toward solving the problem. It is easy for non-profit boards to let inertia take over instead of actively managing. The leaders of a nonprofit are usually on the board out of a desire to give back to a community or a goal, but it is important to think about it as a business, especially when signs of trouble begin to appear. The board needs to make sure there is solid financial reporting and metrics by which to measure success. Most importantly, the board’s members need to admit they have a problem and not put off dealing with financial distress until the next quarterly meeting or when it turns into a true crisis.

Riley: It is also critically important for a board to understand where its duties lie. In a for-profit company, fiduciary duties are owed to shareholders. This is not the case for a non-profit. The board of a non-profit owes its primary duty to the entity’s mission. So the first thing the board should do is make sure that it is aware of the mission — it can then evaluate the ‘going forward’ strategy in that context. Sometimes a real focus on the mission has been lost as the entity has struggled. Looking deeply at the mission and how best to continue to accomplish it can help a board reorder priorities and make key decisions.

Once these priorities are evaluated, how should the non-profit execute on its goals?

Malloy: Our best and first advice is usually to get experienced help from a financial professional. Non-profit boards are made up of smart, accomplished and caring people. But the reality is that they were probably chosen for the board based on connections in the community, experience or interest in the industry and fundraising ability. While that is great in good times, it does not  provide the expertise  necessary  to deal with a financial crisis.

Riley: In many ways, once the priorities and goals are set, restructuring a non-profit is similar to doing the same thing for a for-profit company. We often recommend hiring a financial adviser with turnaround experience. They can usually suggest ways to cut costs and  grow  revenue  in ways that  are  not obvious  to the current  management  and board.

What if things get really bad? Is bankruptcy an option for non-profits?

Riley: Yes, it is. Having said that, bankruptcy is an expensive process and we try to help our clients restructure their finances without filing a bankruptcy case. Banks and other creditor groups have become more and more sophisticated and can be willing to work with companies to provide relief and avoid bankruptcy. The good news for non-profits is that there is a section of the U.S. Bankruptcy Code which provides that creditors cannot force a non-profit into involuntary bankruptcy. So a bankruptcy case is usually only filed when the board makes an informed decision that the protection of the Bankruptcy Code is the best structure under which to restructure the organization.

Malloy: There are some situations when bankruptcy is the best option for a non-profit. One example might be a non-profit hospital where revenue is not matching operating costs and pre-bankruptcy attempts to turn around operations have not been able to close the gap. In a case like that, filing a bankruptcy can stop creditor collection efforts and give the hospital the cash flow needed to ensure that patient care is maintained at a high level while negotiations with creditors occur. Every factual situation is different.

Are there other unique aspects of non-profit restructuring?

Malloy: One unique issue is donated funds. The board and management should be careful to continue to manage donated funds appropriately, even in an insolvency situation. Donations that are made for a restricted, specific purpose cannot be used for general operating expenses or turned over to the non-profit’s creditors.

Riley: Despite the unique issues for troubled non-profit organizations, the board needs to remember that creditors who are owed money will assert their rights. They will not just go away because the organization has a non-profit mission rather than an economic goal. As a result, the board should make sure there is current and sufficient directors and officers insurance in place. And as we said before, the most important thing is to be active — and not wait too long when trouble starts to brew.

Shawn Riley and Sean Malloy are members of the Business Restructuring Services Department of McDonald Hopkins LLC. Reach
Riley at (216) 348-5773 or [email protected] Reach Malloy at (216) 348-5436 or [email protected]

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