Financial satisfaction: "sticky" money helps organizations avoid annual deficits.

On your way back, would you please pick up a grant?

Everyone knows it is not even close to that easy to get a grant. Still, come time to fill a budget hole, many nonprofit managers are tempted to act as though getting a grant is that simple. Streetsmart managers know that as government continues to retreat as a funder, it's wise to build as balanced a portfolio of revenue streams as possible.

That's a good philosophy, but when the organization needs to climb out of a deep financial hole it's often grants they turn to most readily.

From the perspective of funding sources with lifesaving potential, grants are in fact usually better than government funding, individual fundraising, or even earned income in that all of these alternatives typically take a lot longer to be productive.

But grantseeking is not nearly as powerful a response to financial trouble as maw think because grants aren't potent in the ways that a nonprofit in a hole needs them to be. The reasons for this situation are subtle and deeply rooted in the economics of nonprofit management. Here's the logic.

The really dangerous situations are not one-time deficits in an otherwise healthy organization, but those that recur regularly in a weakened one. In this type of situation the manager has two problems, only one of which is easy to recognize. The obvious problem is the effects of the yearly deficits. These include strained cash flows, pressure to make short-term financial decisions at the expense of long-term health ("Let's just patch the roof, not replace it."), and possible funder scrutiny. It's bad enough that if any of these things go on for a long time they can seriously compromise operations. It's the second problem that makes it much worse.

The second problem is that recurring deficits weaken an organization's capital structure. That's a far deeper hole than that created by a single year's deficit, because capital holes are much harder to escape. Why? Because when faced with a capital hole, most of your traditional funders look the other way.

People who create or work in foundations don't generally get into that line of work to be organizational emergency medical technicians, and government officials have every incentive to look for another, healthier partner. Holes are custom-built, and they discourage visitors.

Think of capitalization as "sticky money" (see the column "Sticky Money," February, 2005). Most funders' dollars get into the organization and flow out again, such as grants, fees for service, and government contracts. These funds are "flowing," that is, they get into the organization as revenue and almost immediately go out again in the form of expenses.

Capital funds stay within the organization. The various ways capital funds are raised determine the overall capital structure. Nonprofits raise capital funds from profits, borrowing, and capital campaigns. By far, the most desirable (yet probably most difficult to produce) types of capital come from accumulated profitability because there are usually no strings attached to earnings.

By contrast, capital campaigns inherently encourage strings to be attached because they are usually conducted for very specific projects such as a new building or a specific cause, such as a professor's chair in a university. When donors give sticky money to such a cause it is considered restricted to that purpose and the nonprofit is obligated, morally and perhaps legally, to use the funds for that purpose. Borrowed capital also usually has strings attached since the lender typically makes the loan for a dedicated purpose.

Deficits punch holes in capital, which rattle the organization's financial stability. Deficits eat away at unrestricted net assets first, which is where the choicest additions to capital can be found. Left unchecked, yearly deficits can so deplete the buildup of unrestricted net assets that there is either nothing left or, worse, the only type of capital that is left is that which was restricted for certain purposes by the donors.

Since donors rarely give capital to a nonprofit for the purpose of covering deficits, the deficit-ridden organization at some point is always forced into an impossible situation. Either it can no longer cover recurring deficits, or it must invade net assets explicitly restricted for a different purpose.

This is why grants alone don't fix deficits. While foundation grants rarely arrive in a contract-like form of dollars-for-precise services, there is always a clearly understood expectation that the nonprofit is going to provide an amount of services equivalent to the money being given. There is, in short, no significant profit possibility in a grant.

What does work? Realistically, the answer is likely to be a series of steps.

First, the streetsmart manager has to end the deficits. This is not optional. Once unrestricted net assets are lost they are extremely hard to bring back. So the first step is to protect whatever remains of the capital structure by not running any more deficits.

This is a difficult enough step for most organizations, but the next one is even harder: the capital structure has to be restored. Again, grants won't help much. Contractual services won't help, either, because in many instances these too are at or close to a break-even proposition. In a similar situation, for-profit companies could sell more stock or issue bonds. The equivalent options for a nonprofit are more limited--sustained profit or a capital campaign. Grants alone won't do it, because of their flow-in-flow-out nature. Only sticky money will help.

Interestingly, for both for-profit companies and nonprofits, the success of these strategies rests on the same footing. Outsiders, who would be contributing the capital, have to believe that the organization will be viable in the future. In both cases, those outsiders would be right to ask why they should put more capital into the organization when previous capital was lost.

The answer to this simple question has to be that the future environment will reward the nonprofit's faith, and that the organization has the operational capability to pull it off. Assessing the first part might be difficult, assessing the second part is a bit more straightforward.

A major part of evaluating the undercapitalized nonprofit's future prospects is its service model, the unique way or ways that it fulfills its mission and the underlying assumptions it makes about how users and funders will respond.

For instance, one mid-20th century model for treating substance abuse through long stays in supportive, bucolic settings slowly eroded when funders demanded and did not get proof of effectiveness. Hospitals are still a valid service model, but the length of time they are used for any given type of treatment has declined substantially. If a discredited or dubious service model caused the fiscal problems in the first place, raising money to do more of the same makes no sense. A valid service model in the face of funder or user indifference doesn't work either.

Ensuring operational success is the second half of the equation. Even valid, desirable and adequately funded services can't survive long if their operations are sloppy, ineffective or worse. Operational success in areas like basic budget development and monitoring can be undermined by unqualified staff. Equally as plausible is a competent administrative staff trying to operate under poor governance procedures or an irresponsible or ineffective leadership team.

Even if the service model is in place along with effective leadership, a committed management structure and good administration, it will take time to succeed. Healthy capitalization isn't lost overnight, and it can't be gained in that period either. Recovery is usually possible, albeit painful, but ironically the prescription for climbing out of trouble is the same as for maintaining an effective, healthy organization. On your way, look out for holes.

Thomas A. McLaughlin is a national nonprofit management consultant with Grant Thornton in Boston. He is the author of the book Nonprofit Strategic Positioning (John Wiley and Sons, 2006). His email address is [e-mail]