jwilzewske: nonprofit

Showing posts with label nonprofit. Show all posts

Sunday, January 30, 2011

Chamber Music Ensemble Finance: Incorporating as a Non-Profit

W e have thought about incorporating and/or becoming a not-for-profit but just haven’t made the time to speak with someone about the technicalities of it all, while adding up the pros and cons... If we had our way, practicing, playing, teaching, and performing would be all that filled our days! Each of us in the quartet feels anxious about how we can make a ‘go’ of it, financially. This adds to the stress in our lives. And stress no doubt affects the practicing, playing, teaching, and performing. So I’m not really sure why we haven’t yet made the time to speak to someone about creating a nonprofit org to help the quartet’s finances...”
— Anonymous, first violin, leading string quartet, via email.

T he weeks my wife and I spent in England last November revealed to us just how prevalent forming non-profit ‘friends’ or ‘affinity’ organizations has become, for soloists and small chamber ensembles and composers, in the wake of recent years’ public-sector budget cuts and lower concert ticket sales during the recession. Standing chamber orchestras and choirs and annual music festivals and presenters and the like have typically had non-profit friends orgs for fund-raising and financial support, but what we saw in England, in concert after concert, was that individual artists and trios and quartets, etc., now had formed them as well.

I n the U.S., finances for people in the arts are at least as tenuous as elsewhere, but there has not yet, so far as I can tell, been such a move en masse to incorporate as a nonprofit organization and to use this org as a vehicle for increasing and stabilizing a group’s finances as is being so frequently done by chamber performers and composers in the U.K.

B ut the trend in the U.S. has begun. The variety of purposes and budgets is quite large. For example, composer friend of mine has recently used her 501(c)(3) to successfully raise the funds necessary for having a new work performed and recorded in Europe. A quartet I know has recently had their 501(c)(3) run a campaign to raise the money needed to cover expenses for an Asian performance tour. Campaigns like these entail extra effort for the artists above and beyond their existing commitments—‘Friends Association’ gatherings, green-room and aprés-performance meet-and-greet activities, and so on. But the process can be far more successful financially—and far faster—than trying to raise money through grant applications, residencies, adding yet more performances to already-packed schedules, and so on.

T his CMT blog post gathers together some resources/links that may be of interest to you if you are considering incorporating as a nonprofit 501(c)(3) org. Here is a list of the basic steps:

Determine what type of nonprofit organization you are. Some links below provide information needed to establish a new non-profit.
Write your mission statement. The mission statement is a concise expression that covers in one or two sentences who the organization is, what it does, your purpose, services and values.
Form your Board of Directors. Each state has regulations that set the minimum size of a Board (typically, three) but the best number of people for you should be determined by the needs of your organization. Based on what your organization would like to accomplish, you should decide what skills you need the people on your Board to have. You want qualified individuals who are passionate about your mission, who are willing to give of their talents and time and money, and who will be able to effectively attract other people to do the same.
File your Articles of Incorporation. These are written statements of creation of an organization files with the appropriate state agency. They protect both you and your Board members from legal liabilities that may be incurred by your organization, making your corporation the holder of debts and liabilities, not yourself or other individuals and officers who work for your organization. In the U.S., the specific requirements governing how to incorporate are determined by each state. You can obtain the information you need to proceed with this step from your state Attorney General’s office or your Secretary of State’s office. I highly recommend consulting with an attorney who is experienced in the area of nonprofit law so that you do not make one of the many mistakes that people make when they try to incorporate by themselves. In most cases, this should cost less than $1,000 to do, money well-spent.
Draft your Bylaws. Bylaws are the written rules that say how the organization operates. Although bylaws are not required to file for 501(c)(3) status, they will help you in governing your nonprofit org. Bylaws should be drafted with the help of an attorney and approved by your Board early in your organization’s development.
Prepare a written budget document for your non-profit org for the current year, in an Excel or OpenOffice or GoogleDocs spreadsheet. A budget is the dollars in anticipated income and expenses, for your operating plan--the cashflows to achieve the objectives of your organization. Your new org may create a budget by projecting potential income and expenses: figure out how much money you have to raise and spend to accomplish what you intend to do during the current year.
Establish a record-keeping system for your non-profit org, separate from the record-keeping for your group or for each of you as individuals. Legally, you must save all Board documents including your meetings’ minutes, your financial statements, Bylaws, Articles of Incorporation, financial reports, and other records. You should contact your appropriate state agency for more information on what records you are required to keep in your files and for how many years you are required to retain them.
Establish an accounting system for your nonprofit group. QuickBooks®, Quicken®, or other software can help.
Apply for your federal Employer Identification Number. Regardless of whether or not you have employees, nonprofits are required to obtain a federal Employer Identification Number (EIN), also referred to as the federal ID number. Available from the IRS, this number is used to identify the organization when tax documents are filed. You use Form SS-4 when applying for your EIN.
File for 501(c)(3) status for your org. To apply for recognition of tax-exempt, public charity status, obtain Form 1023 and Publication 557 (links below) from the local IRS. The filing fee depends upon the size of the organization’s budget. I strongly recommend getting the assistance of a certified public accountant (CPA) to help you prepare your Form 1023 filing.
File for state and local tax-exempt status for your org. Contact your state Department of Revenue, your county or municipal Department of Revenue, local Departments of Revenue, and county or municipal clerk’s offices for information on how to do this in your jurisdictions. Your lawyer or your CPA can help you with this.
Fulfill the applicable ‘charitable solicitation law’ requirements. Your organization’s plans include fundraising, so be aware that many states and a few counties and cities regulate organizations that solicit funds within their borders. Usually compliance involves getting a permit or license and then filing an annual report and financial statement. Contact your state Attorney General’s office, your state Department of Commerce, your state and local Departments of Revenue and your county or municipal clerk’s offices to get more information. Save copies of the letters you sent to these offices in your org’s files, plus copies of whatever correspondence you receive back from those offices.
Apply for a nonprofit mailing permit. Second- and third-class rates are substantially less when nonprofits mail to a large number of addresses. For more information on eligibility, download a copy of U.S. Postal Service Publication 417, ‘Nonprofit Standard Mail Eligibility’ (link below). In order to qualify for nonprofit rates, your mailings must be soliciting monetary donations and not promoting or otherwise facilitating the sale of any goods (e.g., CDs) or services.

Sunday, March 30, 2008

Few Chamber Orchestras Are Too Big to Fail: Market Size, Scale and Sustainability

The culture of electronic media and the internet and the culture of social interaction continue to erode classical music and chamber music concert attendance. In the U.S., possibly some of this erosion is augmented by the economic downturn, but the trend has been relentlessly underway for many years now. Lifestyle and arts consumption choices of shifting generations continue to thwart traditional concert attendance, despite the fact that there are today more high-quality concert events and more diverse programming than ever before.

How long can this go on? Which organizations are likely to survive? How much does size (assets; revenue; financial strength) insure sustainability? Are there norms that are embodied by the strongest and best of the current contenders in this nonprofit chamber music marketplace, that other organizations in the field ought to aim for? Do the treasury management decisions of such leading organizations constitute norms that others should emulate? As weaker organizations begin to fail, will we see some of them get aggregated by joint-ventures or M&A into other larger ‘survivor’ organizations in the same geographic vicinity? And, if so, what are the financial ratios that potential acquirers should look for in due-diligence?

These are questions that are not readily answerable. But it does seem that tough, Darwinian survival-of-the-fittest times are ahead.

Just as you would do if you were evaluating companies and stocks, it’s helpful to consider the competitive landscape for chamber music ensembles by applying some financial-ratio analysis, to characterize the field quantitatively and monitor the players and the outcomes.

Form 990 data for 501(c)(3) U.S. chamber orchestras

The log-log plot of the revenue vs. assets-to-revenue ratio shown above is for 35 nonprofit standing chamber orchestra organizations in the U.S. for the most recent year for which data are available, 2006. It provides at-a-glance comparison of top-line revenue and capital-output efficiency. I extracted the data from the federal IRS Form 990 tax documents that are publicly available via Guidestar and other sources. It’s easy to do—took me less than one hour. You may like to do this for your own organization, or for organizations that you make contributions to, to see how they are doing amongst their peers.

The upper-right quadrant contains ensembles that are both highly productive (in terms of revenue generation and free cashflow) and well-endowed. The upper-left quadrant contains ensembles that are very active but are relatively under-capitalized. The lower-right quadrant contains ensembles that are relatively well-endowed but are perhaps under-utilizing their available assets. And the lower-left quadrant contains organizations that are financially at-risk. Although this plot is strictly for standing chamber orchestras, the same sort of statistical distribution and scatter-plot could be done for 501(c)(3) chamber music presenter organizations and other groups. Robert Higgins’s and Richard Bull’s and Murray Dropkin’s books (links below) are particularly good, with regard to understanding and acting upon financial-ratio analysis for nonprofit organizations.

eMarketer projected social networking annual ad spend

Possibly the most promising strategy for selling to the evolving chamber music market—of all ages—is social networking and Web 2.0 apps. Besides those environments, there are email affinity-marketing services, such as Emma.com, which are significantly more effective and flexible than services that were available several years ago.

When being chased by a bear, your survival first requires that you are not the slowest runner in the woods and that you are running in the best direction for getting away. I seriously doubt that the Federal Reserve will come to the rescue of any chamber music organizations ...

In this regard, the concept of sustainable growth was originally developed by Robert Higgins, Professor of Finance at the School of Business Administration, University of Washington. The sustainable growth rate (SGR) of any enterprise is the maximum rate of growth in sales that can be achieved, given the enterprise’s profitability, asset utilization, and debt (financial leverage) ratios. The variables in the SGR equation are the following:

the net profit margin on new and existing revenues (P);
the asset turnover ratio, which is the ratio of sales revenues to total assets (A);
the retention rate, which is defined as the fraction of earnings retained in the business (R);
the assets to beginning-of-period equity ratio (T).

To compute an orchestra’s SGR, multiply the four variables together, or, in other words, the SGR = P x A x R x T. Alternatively, the SGR equals the retention ratio, times the return on beginning-of-period equity.

The SGR increases when the operating margin increases, the assets to beginning-of-period equity increases, the asset turnover increases, or the retention rate increases. The sustainable growth model assumes that the firm wants to: (a) maintain a target capital structure without issuing new equity; and (b) increase sales as rapidly as market conditions allow.

Since the orchestras we are discussing are not-for-profits, the profit-margin term is a bit tricky. But the net income in the operating fund is a suitable proxy for what profit-margin would be in a for-profit enterprise, so the SGR equation can in fact be used for nonprofits.

The concept of sustainable growth can be helpful for planning healthy nonprofit growth. This concept forces managers to consider the financial consequences of sales increases and to set sales growth goals that are consistent with the operating and financial policies of the enterprise. Often, a conflict can arise if growth objectives are not consistent with the value of the organization's sustainable growth. If an orchestra’s sales expand at a rate that exceeds the sustainable rate, one or some combination of the four ratios must change. If an orchestra’s actual revenue growth rate temporarily exceeds the SGR, the required cash can usually be borrowed, against the orchestra’s line-of-credit. When actual growth exceeds the SGR for longer periods, management must formulate a financial strategy from among the following options: (1) permanently increase financial leverage (the issuance of debt); or (2) decrease the total assets to sales ratio. In practice, orchestras may be reluctant to undertake these steps. Orchestras are reluctant to issue debt because of high issue costs, and the unreliable nature of debt funding on terms favorable to the issuer. An orchestra can increase financial leverage only if it has unused debt capacity with assets that can be pledged and its debt-to-fund equity ratio is reasonable in relation to other nonprofits. Orchestras can attempt to liquidate marginal programs or intellectual property (such as trademarked broadcast programs or record labels, or branded educational/outreach content), increase ticket prices, or enhance production efficiencies to improve the financial ratios.

In summary, it is possible for an orchestra to grow too aggressively and rapidly, resulting in reduced liquidity and the need to deplete assets. Shrinking attendance and ticket sales is a worse problem, but it is not the only problem that can happen.