Funding matters – the importance of revenue diversification

Nonprofits learned a critical lesson about the importance of revenue diversification during the global recession. Organizations that were dependent on just one or two funding sources found themselves fighting for their very survival. The lesson is age-old: Don’t put all of your funding eggs in one basket.

Ultimately, a diversified revenue stream mitigates the risk of losing any single source of money. When government funding dries up, for instance, you can turn to foundation grants. Or when corporate donations dwindle, you can replace them with individual donations. Healthy non-profits diversify revenue by tapping a variety of resource streams, including:

• Government agencies,
• Large national foundations,
• Family foundations,
• Corporations,
• Individual donors, and
• Earned income.

That said, over-diversifying revenue sources can create its own set of problems. Seeking out, acquiring and managing multiple diverse revenue streams requires specific skills, staff and management capacity.

Finding the Right Balance

When it comes to funding sources, there really is no golden egg. Each revenue stream comes with its own idiosyncrasies. Yet, even if your organization does rely on a single source for the bulk of its funding, it’s important to not rely on a single payer.

So, for example, if you receive 90 percent of your funding from state government contracts, you can minimize that risk by tapping a number of government departments in a number of states.

Your goal should be to establish a base of funding that’s reliable, flexible and varied. Consider these best practices that can help your organization diversify its funding:

• Conduct a funding review. Start by establishing a baseline with a review of your organization’s funding sources. Such a review should include:
• Your current funding mix,
• Restrictions or conditions placed on each funding source,
• Longevity and predictability of each funding source,
• Current funding gaps, and
• Potential future gaps.

Establish benchmarks. Likewise, a benchmarking study can show how your revenue mix stacks up against various peer groups — and identify any dangers. Note that as part of your organization’s audit process, your CPA will evaluate your revenue sources and identify any areas where you may be too dependent on a single source.

Find funding sources aligned with your mission. Funders’ interests often fall into distinct categories. The key is to find these natural matches between your organization and particular funding sources. For example, corporations tend to support hunger and health issues while individuals tend to give to issues that cross socio-economic boundaries, like environmental advocacy. Ultimately, they all give to organizations that have clear, compelling and simple messages.

Develop alternative funding sources. Consider developing revenue streams that are not dependent on the vagaries of state and federal funding or the whims of donors. For example, income from food and beverage sales, program ads and gift shop sales can add to your organization’s bottom line. Just note that this “earned income,” if not properly managed, can trigger tax and compliance issues.

The problem occurs when the earned income comes from a source that is not substantially related to your organization’s tax-exempt purpose. The IRS calls this Unrelated Business Taxable Income (UBTI). To be clear, there is nothing wrong with a tax-exempt organization earning UBTI. Just be aware that gross proceeds of greater than $1,000 will require filing Form 990-T.

However, depending on the consistent and proper allocation of expenses, your organization may or may not owe income taxes. Note also that federal law generally limits UBTI to 30 percent of total organizational income in order to maintain tax-exempt status.

Get Your Board Onboard

Revenue diversification requires a long-term strategy that includes planning, ongoing cultivation and plenty of patience. Make sure your board and leadership understand the importance of revenue diversification – and embrace the need to seek out new sources and combinations of funding.

For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.