Adapted: Originally posted on Medium May 22, 2020
No one was prepared for a pandemic, but charities weren’t set up for any crisis of any magnitude — here’s why
On March 26th, 2020, Imagine Canada published COVID-19 threatens to devastate Canada’s charities — a call to action for additional government stimulus to ensure the survival of charities and non-profits throughout the COVID-19 pandemic. The release highlighted that without further stimulus, over the next six months, the sector risked losing up to 15.6 billion dollars and up to 194,000 employees. Imagine Canada was right; many charities shut their doors, and others are still reeling, but it is not solely because of COVID-19. When a crisis hits, charities are at greater risk than their for-profit counterparts for two reasons: limited revenue sources and short-term planning.
Risk: Limited Revenue Sources
Unlike the for-profit sector, which relies on market and consumer demand for products and services, most Canadian charities depend mainly on two sources — government funding and donations. A 2015 report from Blumberg’s outlined that of the $251 billion of revenue generated by Canadian charities, $168.5 billion (67%) came from government sources. While government funding, donations and markets all face ebbs and flows, only markets and consumer demand maintain a consistent presence under pressure. People and organizations always buy, sell, and trade things (Economics 101); this is why amid a global pandemic, clothing, electronics and even cars were still being sold and purchased — albeit at less volume.
Counter to market forces, government priorities and donor interests are inconsistent. With every election, charities that rely primarily on government funding risk ceasing operations entirely because of shifts in policy or ideology. Similarly, the interests of major donors (foundations and high-net-worth individuals) are easily swayed.
During pandemics or global crises, most major donors redirect their giving to the areas they perceive are most in need. Major donors shifted their giving in 2004 following the tsunami in Indonesia, in 2010 following the earthquake in Haiti and recently during the COVID-19 pandemic. For example, the Bill and Melinda Gates Foundation, the second-largest foundation in the world, allocated 250 million dollars (CAD 351M) and the full force of their efforts, almost exclusively to finding a vaccine and treatments for COVID-19. While humanitarian aid, emergency services, and healthcare organizations will experience a vast influx of support from major donors during crises, most charities will experience insurmountable losses.
Without major donors, charities reliant on small donations are equally at risk. While large donors are likely to redirect their giving, small donors (primarily middle-class individuals)— who otherwise might give — are unlikely to have the capacity to do so. With one-in-five Canadians reporting difficulty meeting financial obligations in April 2020, 20% of potential donors had significantly reduced giving capacity during the COVID-19 pandemic.
Mitigation: Diverse Revenue Streams
Markets are risky but less risky than putting all your eggs in one basket. Canadian charities should loosen their dependence on government funding and major donors in favour of diverse revenue streams.
Having diverse revenue streams is vital for sustainability; this is true not only for charities but also for businesses. The restaurant industry is a clear example. With most dine-in spaces closed in the early stages of the pandemic, restaurants that also offered delivery service had a chance of survival post-COVID-19. However, restaurants that only offered dine-in service risked never reopening. Charities dependent on government funds or major donors are in the same boat as dine-in-only restaurants.
While the Canadian Revenue Agency (CRA) has strict limitations on the financial activities of charities, there are several approaches charities can consider to diversify revenue.
Canadian charities can own and operate related businesses to generate revenue, so long as the business is run “substantially by volunteers” or “linked to a charity’s purpose and subordinate to that purpose”— I know, word jargon. But, again, the CRA provides clearer guidance on what that means. Essentially, the related business can’t take more time, effort, and resources than the charity’s purpose. The simplest example of this is a hospital parking lot.
A hospital can generate thousands of dollars a year by charging for parking. Therefore, a parking lot at a hospital is a logical service — it provides space for the vehicles of visitors and people seeking non-emergency care. Thus, a parking lot is linked, but subordinate to, a hospital’s purpose.
A Separate Legal Entity (Social Enterprise)
Running a parking lot is not practical for most charities, and other services may not easily link to a charity’s purpose; this is where the social enterprise model can be effective.
Under the social enterprise model, a charity can create a separate legal entity — a corporation. Then, by building a commitment into the corporation’s articles to donate all, or most of, its profits to its charitable counterpart, there is no cap on the additional revenue charities can generate. In addition, corporations do not have the same revenue generation limitations as charities, so how money is made (as long as it’s legal) is fair game — no need to link to a charity’s purpose.
While the social enterprise model can be lucrative, it isn’t easy to establish. A charity must be able to set up and operate a completely separate entity. A corporation requires different executives, independent directors, separate employees even another building. Establishing a social enterprise requires legal and business acumen, financial capacity, stringent planning, time and immense transparency. Still, it is the most flexible revenue diversification approach available to charities.
Risk: Short-Term Planning
Jim Collins and Morten Hansen’s book Great By Choice details, through 20 years of research, the methods that help establish great organizations — it’s the opposite of what you might think. Great organizations don’t find success by being innovative, taking risks, or challenging the status quo. Instead, they are successful because they prepare for the unexpected, focus on stability, practice fiscal restraint, and maintain an unwavering commitment to the quality — not the quantity — of their products or services. Unfortunately, while describing these methods is straightforward, applying them to charities can be difficult.
For many charities, implementing the methods outlined by Collins and Morten would require reducing service capacity and limiting programs in the short term to ensure stability in the long term – this is easier said than done. Reducing the service capacity of groups like shelters and food banks has a tangible human impact; turning away people in need is not something charities often do.
Instead, charities often do as much as they can at the moment. This sort of short-term planning is expected in the sector, but it also risks the sector’s stability. While immediate support is critical, a charity must consider the impact of its work on a cumulative basis — how much it can do in the long term. Balancing these competing priorities can be challenging, and shifting from short to long-term planning also requires a shift in fiscal strategy. One method charities can use to maintain close to current service capacity and ensure long-term stability is building fiscal reserves.
Mitigation: Building Fiscal Reserves
Fiscal reserves are the equivalent of saving for a rainy day, we all should do it, but very few do. Guidance from the CRA indicates that charities are permitted to maintain “justified reserves” to meet immediate needs and specifically to protect against situations of economic downturn. An independent assessment by Grant Thornton suggests that for most charities, “justified reserves” range from six months to two years of a charity’s operating expenses. While six months of operating expenses may not seem like a lot, it’s the difference between the YMCA Canada laying off 75% of its workforce — two weeks into the pandemic hitting Canada — and other charities holding out until the Federal Government provided additional support.
Charities can get creative with establishing reserves. While money is the most accessible reserve to maintain and access, reserves can be assets (property, land, etc.). Charities that own assets or receive asset donations can choose to hold on to them as a contingency — selling them only when necessary.
While all Canadian charities should seek to establish fiscal
reserves, it is worth re-emphasizing that, as with related business activities, the CRA does have restrictions on them. Further, fiscal reserves are reflected in a charity’s financial statements, which may deter donors from giving — if they think the charity has “enough money.” Charities looking to build fiscal reserves should have a reserve fund policy — to articulate to donors and the CRA how the reserve is managed and why it is critical to maintain.
Ultimately, charities’ best protection against pandemics like COVID-19 is to not operate under the traditional charity model. This realization may be an affront to those who perceive charities as purely altruistic — a stark contrast to capitalism. However, charities, like businesses, court customers (donors) and sell products and services (the feeling of helping others).
Charities shouldn’t be penalized for operating businesses, nor should charities lose support today because they are saving for tomorrow. On the contrary, the sooner charities are given the same leeway provided to for-profit companies to work as effectively as possible, the more significant the impact on those who need it most — during a pandemic and every other day.