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Nonprofits: Due for Due Diligence

Posted by Patricia Q. Connolly on May 8, 2019 12:36:29 PM

Red "Due Diligence" Binder on Office Desk with Pen and PaperIf you were approached to invest in a business, a major part of your decision making process would include doing your due diligence. In addition to conducting a preliminary financial review, you would look at the market, competition, and the company’s governance structure. You would also examine the leadership to ensure those involved have the knowledge and expertise needed to succeed. And even after doing that, you might decide to dip your toe into the water first, making a small initial investment as you get to know how the business operates. Eventually, you may become ready to make larger investments over time as your ROI and confidence in the business grew.

Now return to the first sentence of the above paragraph and replace the word “business” with “nonprofit.” Would you go through the same steps? At the Center for Nonprofit Governance in the Gupta Governance Institute at Drexel University in Pennsylvania, we emphasize the value created when boards and investors consider the business of nonprofits.

According to the Independent Sector 2016 state profile, there are 63,345 nonprofits in Pennsylvania alone, employing 727,200 individuals. That is 15 percent of the state’s workforce. Foundations invest more than $2.4 billion annually in nonprofits, and individuals invest an additional $6.5 billion. Nonprofits are the largest industry in the state, and the success of these organizations is vital to the prosperity of the communities they serve.    

Investors often support nonprofits because of their passion for the mission, but proper due diligence is just as important for ensuring a return on their investment in the nonprofit sector as it is in the for-profit sector. There’s just a difference in what that “return on investment” is. In the for-profit space, a return on your investment means you see a financial gain; whereas, in the nonprofit space it means you see the organization successfully carry out its mission over the long-term. A firm understanding of the state of the organization’s governance and business helps contribute to a better investment decision. And asking leadership the following basic governance questions before investing will encourage the nonprofit to apply a business lens to its operations over time: 

What is the size and composition of the board?
Research shows that smaller boards are more collaborative and make decisions faster (GMI Ratings 2014 study for WSJ). While nonprofit boards are decreasing in size (Leading with Intent: 2017 Index of Nonprofit Board Practices), many, unlike their corporate counterparts, boards are often large because their members are utilized for their ability to personally invest or seek investors for the organization. However the larger the board, the more challenging it can become to communicate effectively, particularly around strategy and risk. If a board has more than 20 members, I suggest you ask additional questions, such as: “What is the committee structure?”, “What are the roles and responsibilities of the committees?”, “How do the committees report information to the full board?”, and “What is the process to ensure the full board engages in a robust discussion to provide strategic oversight?

A board’s composition impacts how it leads. A board that has diversity of thought goes beyond affirming the need of equality, it has the ability to harness the full potential and promise of each person’s unique perspective and different way of thinking In conducting your due diligence, I suggest you explore and define the organization’s values as they relate to diversity, inclusion, and equity.

How many days of cash on hand does the organization have? 
In addition to reviewing the financial statements, this is a basic but important question. The answer to this will vary across industries; however, knowing the number of days that an organization can continue to pay its operating expenses given the amount of cash available will provide quick insight into its current state. More importantly,  it will raise a red flag about the viability and financial health of the organization if it doesn’t know the answer.

How do you assess and mitigate risk?
Too often, risk is an afterthought to strategy. Questioning how the organization deals with risk will provide insight into whether or not it actively identifies and addresses potential risks. Organizations that are not proactive in mitigating risks will be vulnerable to potential disruptors that could negatively impact the ability to deliver its mission.

If more investors think twice about investing in organizations who are unable to answer these kinds of questions, it will cause nonprofit boards and management to have serious conversations around the strategy that powers the mission to ensure a viable future. In the long run, if enough individuals make this a part of their investment decision, they will be helping a vital industry grow stronger and have a greater lasting impact as a whole.

Topics: similarities in for-profits and nonprofits

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