Ep. 6: The Landscape of Financing for Nonprofits

Published in

Network for Good: Strategic Discovery

11 min readAug 31, 2023

By Maddie Vann

Episode 6 in Network for Good’s “mini-podcast” where we are sharing key learnings for how to bring durable capital to sustainable outcomes

TL;DR / Highlight: The funding landscape for nonprofits is complex and most nonprofit executive directors aren’t also CFOs. Meanwhile, most financial products and services are not built with nonprofits in mind as the target customer. This presents a significant need and opportunity to provide better financing institutions that are purpose-built to specifically serve nonprofits.

I recently sat down with Network for Good CEO, Abby Ross, to talk about the landscape of financial institutions that serve the ecosystem of mission-driven organizations. Our research explorations into nonprofit financing — and the different buckets of owned capital, debt capital, and contributed capital — are informing Network for Good’s future strategy.

Here is the transcript from our conversation:

Maddie: Our team has been curious about the existing financial institutions, products, and services that support the nonprofit ecosystem today. To kick off our conversation today, Abby, can you talk to me about why capital isn’t durable for nonprofits today?

Abby: I think the most glaring stat is that 50% of nonprofits only have one month of operating runway. This isn’t because of mismanagement. This is ultimately a kind of demonstration that nonprofits don’t have the outlook or the sustainable, predictable path to make sure that money is coming in at the same clip that they need to be spending it to provide services, do advocacy work, or run programs.

A lot of this ties back to the challenges that come from the “nonprofit overhead myth.” We’re ultimately asking nonprofits to solve massive challenges, but we’ve capped the way that they do that and the way they get access to capital. Ultimately, the overhead myth suggests a point of view that nonprofits should only really be spending say 15% on the organization and the rest into programming.

And that barrier means that they can’t access capital or spend the capital necessary to grow and scale an organization. This means limited advertising to go and get more donations, or spend market rates for talent to be able to lure folks from the private sector. And ultimately it means that there’s no opportunity for nonprofits to take big swings and take risks. In fact, that’s actively penalized. So the incentive structure for funding nonprofits are inherently “one hand tied behind their back.” Dan Palotta’s Ted talk highlights it really well when he says you can’t use money to lure talent away from the for-profit sector. You can’t advertise at the same scale the for-profit sector does to get new customers. You can’t take types of risks to pursue new customers the way the for-profit companies do. You don’t have the same amount of time for them to find you as in the for-profit sector. And you don’t have a stock market to fund all of this, even if you could do these things. So there’s an extreme disadvantage of nonprofits compared to the for-profit sector, which means that there’s really no way for them to have that lasting and durability of capital to put against building an organization that is tooled to solve the massive problems we’re asking them to solve.

Maddie: And that Ted Talk of Dan Palotta’s that you referenced is from 2013. So this is a more than 10-year old problem set and still a massive set of challenges for nonprofits today. So, given that backdrop and context, if we start with the basics, how are nonprofits financed today?

Abby: So there’s three main buckets: 1) First, is owned capital–basically the surplus greater than expense. It’s a common myth that you say the word nonprofit and people think you need to lose money. That’s not in fact the case. You just can’t distribute profits to shareholders. So nonprofits can and should be thinking about an owned capital strategy. 2) Then there’s debt capital–borrowed funding with payback terms. 3) And then there’s contributed capital–program expenses, capital campaigns, money from donors, and grants. And I think that in the nonprofit sector we tend to think about contributed capital as such a huge bucket.

There’s lots of innovation going into how nonprofits can get more contributed capital, especially from donors. But actually, only about 10% is money from donors. When we first started doing our analysis about the durability of capital to nonprofits, we realized it’s a really crowded space helping nonprofits become better fundraisers and getting money from donors. But nearly 80% of capital for nonprofits is earned for providing their services.

Maddie: So if a nonprofit, within that context and with these existing financing buckets, wanted to expand their offering or invest in something new, how are they equipped to do that today?

Abby: They could fundraise for it, grants, dial for dollars. And that is why there are these development partners that are trying to do this. But it’s hard to do extra, in addition to running capital campaigns, which are a massive undertaking.

An owned capital strategy is what we did at Network for Good because of the brave move to spin out a for-profit entity, but ultimately we’re an exception, not the rule. Owned capital is challenging for nonprofits. There’s not a lot sitting on their balance sheet in terms of assets.

And you also have to remember that most nonprofits are small — 92% of all nonprofits operate with less than a million dollars a year, and a lot of money is going in and out of the door for direct services, paying people, etc. — so you don’t have that opportunity of interest collecting from a bank account.Or there’s debt capital.

Maddie: I attended a Propel nonprofits webinar recently about debt capital for nonprofits, and there were so many questions. I feel like we don’t talk often about debt capital for nonprofits, or at least it’s not really in the mainstream in my orbit at least. Abby, tell me, where would a nonprofit go today for debt capital?

Abby: So banks are the number one source of debt capital for nonprofits. In fact, Nonprofit Finance Fund did a 2022 State of the Nonprofit Sector survey and it turns out that 68% of nonprofits who borrow capital did so from banks. And about 29% is from government agencies, like the SBA.

Maddie: What types of banks is it that are making loans to these nonprofits?

Abby: So you’ve got your big four banks and most of those do not have a specific account type for nonprofits, but they do offer small banking services. You’ve got your top 20 banks and some of those do have some nonprofit specific accounts, like M&T bank is one and they offer nonprofit checking accounts. And then again, they get bucketed into this product for small business banking. Credit unions are also nonprofits themselves, and they have products that are more tailored to nonprofits and small businesses rather than large banks. For example, mission-specific credit unions support entities in that sector. We had a great conversation with the folks at Clean Energy Credit Union, for example, but they are ultimately pretty niche and very geographically focused. And then there’s the CDFIs (community development financial institution) and they have a lot more levers to offer for nonprofits. Propel Nonprofits, like you mentioned, is a good example of this. And they have offerings that include loans that are tailored to nonprofit needs and capacity building initiatives. Those include building knowledge and skills in specific areas like governance, board set up assistance, matching funds, financial insight coaching, QuickBooks help, accounting tools that might help on the OPEX side of things. So those are the different tranches of banks that are currently servicing the nonprofit sector.

Maddie: As we’ve dug into this over the last month and tried to understand it better, we’ve had our very awesome interns, Kaniqua and Anya, who helped us understand more about this financial landscape. And specifically, they did some work to dig into what we know about Network for Good’s nonprofits. We found that, of the nonprofits who received electronic funds transfers from NFG in 2022, about 20% of them bank with the big four banks, so that aligns to what you’ve been talking about–and that includes Chase, Bank of America, Wells Fargo, Citibank. And then 75% bank with other large banks. And only 5% are banked with local banks. And that seems pretty representative of the bigger landscape we’ve been talking about. As we think about that, Abby, what are some challenges with the current models for debt capital faced by nonprofits?

Abby: First and foremost, there’s just the fact that mission and business models are a bit of a mismatch between nonprofits and banks. There’s also expensive loan terms. It’s really challenging for boards to approve putting nonprofit money against repaying a loan. Also nonprofits have the perception of being risky. So that’s why they have those higher interest rates. And a lot of times tenure requirements for financing are a challenge. There’s tenure requirements for financing, financing history, and not a lot of executive directors are able to put collateral up for what’s required. So they’re ultimately at a disadvantage across the board. But we found that most commonly nonprofits look to debt capital and they need bridge loans to bridge gaps between financing from donors and the total funding needs to provide the services that their community is asking of them. So nonprofits are still borrowing for this, and at the end of 2021, nonprofits held about $400 billion in outstanding loans.

Maddie: So this isn’t an uncommon practice. Debt capital is very much a tool that nonprofits are using, it’s just perhaps not always part of the discourse.

Abby: Yeah, and I think the interesting piece is the Harvard Business Review actually had a really interesting piece on this which talked about how most traditional financial intermediaries, like banks, are focused on short-term returns and deem unsecured lending to charities and social enterprises as risky. These are not the customers that banks are going out to seek; and this lack of affordable funding limits nonprofits to be able to deliver on their mission or to do big things like have an impact or take big swings or get to systems-level work. We haven’t really set them up for success from a financial institution situation.

Maddie: And you mentioned that right now nonprofits in the U.S. hold about $400 billion in outstanding loans, so obviously nonprofits are borrowing. I asked about the example of a nonprofit who wants to start a new initiative, but that’s certainly not what $400 billion of loans are out for in the United States. So what actually is the primary use of debt capital for nonprofits today?

Abby: From the nonprofit survey I mentioned, they responded that they did take on loans. The majority utilize these for emergencies–to cover revenue gaps and to bridge funding until grants were received. So they knew they were going to get a grant, but it might take 3–6 months to receive that money. So they got a bridge loan so they could start putting that capital to work immediately. And I think this is a prime example of two things: social sector capital is not durable and it underscores that link between emergencies and crises and funding needs for nonprofits.

Maddie: So as we think about that, what’s emerging as an opportunity here for Network for Good, or for the space more broadly?

Abby: So based on all of these findings, I think it’s fair to say that nonprofits are underbanked as a sector. Some of this comes down to the historical context of the consolidation of the banking industry that started in the 1980s. Between M&A, tech, and regulation, this has caused a wide chasm in banking offerings. So you’ve got your big banks and then you’ve got the regional and community banks. So that ultimately means, as a nonprofit, I’ve got two choices: my local relationship-driven community bank, that might know and might work within the community I’m serving; or these massive tech-enabled banks.

But frankly, neither one of these solutions specialize in the mechanics required to finance a nonprofit. And financing nonprofits is tough across the board, for the overhead myth, for the fact that most executive directors are not CFOs, or they don’t have the money to pay financial folks in-house to think about how you can capitalize your organization to do what you need.

There are also organizations that don’t have a lot sitting on that balance sheet, they have small assets, lumpy cashflow, and the operating patterns here are very specific.

Maddie: Like you said, 92% of nonprofits are under this $1 million annual operating budget. So against that backdrop of the opportunity for the broader space, why do you see this as an opportunity for Network for Good?

Abby: Nonprofits want to do the work to meet their mission and they have bold ideas on what sustainable, community-aligned outcomes look like. They just need to know how to get that done. We’re not going to turn every executive director into a CFO, but we certainly can help them tell their story and find the right capital to match what’s going to get at a sustainable outcome. That might mean debt capital, that might mean new models of contributed capital, or even investment capital–so a blended capital mindset.

There’s a lot of organizations that are approaching this as being about building the capacity of nonprofits. And that is required, but I think that’s only a start. I think there are opportunities to create some tailor-made, purpose-built financial products that understand what nonprofits need so they can have time returned back to do their work. And they can access new types of sustainable, predictable capital to have the line of sight into direct services that communities are counting on them for, to take big swings, and innovate, and to even invest in the long slog of advocacy that some of these nonprofits need to do to get at that more sustainable outcome.

Maddie: This idea of finding the right capital came up in a conversation we had recently with participants of the IDEO Climate Resiliency Challenge we supported. You and Shruti, Network for Good’s Director of Donor Advised Fund Operations, spoke on this panel I moderated where we connected with some of the participants and winners of that challenge on the topic of “storytelling for impact.” And the idea of how to pitch a concept or idea ended up veering into the financing space a bit, and blended capital came up as a theme. We had a number of organizations pipe into the chat saying “hold on, what’s that?” and “talk to me about these different capital structures.” And the conversation could have gone down a whole other hour of discussion on that topic. And it’s just like you said, capital and innovative financing models for nonprofits is not necessarily what an executive director is hired to be an expert in; this is a whole other skill-set and piece of the equation.

So as we think about that, you obviously see there’s a reason here that this is an opportunity for Network for Good. And it doesn’t take us away, I don’t think, from the climate-driven disaster focus we’ve been talking about. So help connect the dots for me between this bigger opportunity and the climate driven disaster focus.

Abby: From our climate-driven disaster research, we’ve learned that nonprofits are a critical part of the recovery community. They provide direct services relief as frontline responders. And so climate-driven disasters are a point in time that mobilizes critical components for what I think can yield durable capital for sustainable outcomes. I think disasters serve as a chance to bring supporting nonprofits into a more durable financial system. We have a history of financing nonprofits over the past 20 years and sending them money every month and also in times of disaster. So this could become a really natural extension of introducing them to more fresh and innovative and durable models of capital.

Ep. 6: The Landscape of Financing for Nonprofits

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Written by Network for Good