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Restructuring in the charity and not-for-profit sector
A change of perspective?
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There are a number of specific challenges when dealing with the sector, which can make them more complex to successfully restructure.
Phil Reynolds Restructuring Advisory
There are a number of specific challenges when dealing with the sector, which can make them more complex to successfully restructure.
Phil Reynolds Restructuring Advisory
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Publication
Restructuring in the charity and not-for- profit sector: A change of perspective?
Synopsis
Continued financial challenges for many charities combined with ongoing public scrutiny of the sector and enhanced regulatory supervision appear to be driving more charities to consider their ongoing viability, even before the issues caused by COVID-19. There are a number of specific challenges when dealing with the sector, which can make them more complex to successfully restructure over their commercial counterparts.
Phil Reynolds Partner Restructuring Advisory London +44(0)20 3005 4270 phil.reynolds@frpadvisory.com
This article first appeared in Volume 17, Issue 2 of International Corporate Rescue and is reprinted with the permission of Chase Cambria Publishing - www.chasecambria.com.
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Restructuring in the charity and not-for-profit sector: A change of perspective?
What is the size of the sector?
There are 168,186 charities registered in England and Wales. 1 The majority (87%, or 145,714) have an annual income below GBP 500,000, with 39% below GBP 10,000. A small minority (1.3%, or 2,263) have an income above GBP 5 million. There are 6,139 registered charities in Northern Ireland 2 and 24,487 in Scotland. 3 This puts the total of charities registered in the UK at just under 200,000. The sector contributed approximately £17.1bn to the UK economy in 2016/17, representing 0.85% of total GDP. To put this amount in context, the contribution of the sector is a little less than the GDP of Honduras (£17.4bn, ranked 107 out of 121 countries), and a little more than the GDP of Cyprus (£16.6bn ranked 110). 4 Just under 870,000 people worked in the voluntary sector in the UK in June 2018, equivalent to 2.7% of the UK workforce. For comparison, the voluntary sector
workforce is just under three-fifths of the size of the NHS workforce, (the single largest employer in the UK with a headcount of around 1.5 million) and more than two and a half times that of Tesco’s workforce (one of the UKs largest employers with 324,000 staff in 2018). 5
What are the common issues that cause financial difficulty?
The Charities Commission reviewed the reasons why charities entered into financial difficulty and identified changes outside of the charities control, such as expiry or withdrawal of grants from local and central government agencies, or the impact of the wider economic climate has had on income, as the principal causes for distress (see Figure 1). 6
Figure 1
23%
Dependency on public funding
23%
Other
14%
Set up/restructure costs
Charities Commission: causes of financial difficulty
13%
Pension scheme
13%
Unplanned overspends
8%
Future funding uncertain
6%
Contingent liabilities
Notes
1 Charity Commission <www.gov.uk/government/publications/charity-register-statistics/recent-charity-register-statistics-charity-commission>, 1 November 2019. 2 Charity Commission Northern Ireland, <www.charitycommissionni.org.uk/charity-search/?pageNumber=1>, 5 March 2019.
3 Office of the Scottish Charity Regulator, www.oscr.org.uk/>, 1 November 2019. 4 UK Civil Society Almanac 2019 <www.data.ncvo.org.uk/impact/>, 18 November 2019. 5 UK Civil Society Almanac 2019 <www.data.ncvo.org.uk/impact/>, 18 November 2019. 6 Charity Commission, <www.charitycommission.blog.gov.uk/2016/09/29/what-to-do-if-your-charity-is-facing-financial- difficulties/>, 1 November 2019.
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Phil Reynolds
Financial difficulties
It can be argued that rather than external events being the cause of distress that this is a symptom of the Trustees and management failing to pay enough attention to the external environment to enable appropriate contingency plans to be implemented. In this respect regular forecasting is vitally important although the practical reality is that not all organisations in the sector, in common with other SMEs, budget effectively or provide management information of a sufficient quality (or vitally in a timely manner) to enable the Trustees and management to make informed decisions. The tendency for charities to operate with thin management teams and the difficulties many charities find in recruiting sufficient financial expertise to their management and Trustee boards can also make both the production and vitally the scrutiny of financial information more difficult. The particular risks in this sector come from delays in obtaining funding from long-standing donors and the loss of contracts for services, with many organisations effectively providing outsourced services for central or local government and non-government organisations (NGOs) this is a particular area of concern. Such issues need to be reviewed carefully to ascertain whether they are merely temporary slippages or part of a longer-term pattern. Are donors or funders experiencing financial difficulty themselves and pulling back on their philanthropy? Are central or local government contracts going to be withdrawn/reduced? Many organisations have a close working relationship with their funders/customers and Trustees should be able to freely discuss such issues with them and agree the future direction of the relationship. In my experience there is sometimes a marked reticence to outline the difficulties being faced and to seek help despite the fact that the organisation in difficulty was set up to provide help to others. Having recently dealt with with a legal services charity whose Chair approached me with a request to help them close the charity, my first question was whether the Trustees approached their key funders, the main law firms who provide the pro-bono support, with a request for help and the answer was ‘no’. My response was ‘what is the worst the funders can say given you are already looking to close?’. We therefore helped the charity come up with a robust business plan and related funding requests to provide continued services at a number of different levels. The response from the funders was positively received and was provided at the high-end of the requested range.
200,000 UK registered charities 870,000 UK voluntary workers 0.85%
Total UK GDP
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Restructuring in the charity and not-for-profit sector: A change of perspective?
Separately, there has been pressure on charities to reduce back office costs and an increasing expectation that all money donated should go to the ‘frontline’. The result has been further pressure on charities’ viability and sustainability. Charities clearly cannot operate unless their core costs are met. The importance of unrestricted income for many charities, which can be used flexibly by the organisation is therefore vital. Reserves are also much more than a statement about the health of the charity. A robust reserves policy is more important than ever before. Based on an extrapolation from the charity commission annual returns, many charities do not know the true position of their reserves, which may result either in the unnecessary retention of funds or an inadequate assessment of the going concern position. Having recently been involved with a Fairtrade development charity that also carried out related commodity trading with the intention that any profits would be reinvested into its charitable activities, it was clear that the operating margin was insufficient to deliver a viable business and that margin improvement and cost reduction measures would be required to deliver both a sustainable business and an appropriate level of reserves.
Management/Trustee Board interaction
The strong emotional attachment to the aims of the organisation is both a blessing and a curse as this commitment can mean that there is a reluctance to make the difficult decisions to restructure the organisation until it is too late, with the belief that the funders will not allow the organisation to fail or that a contract renewal will be secured. This sense of commitment to the mission and culture of the organisation can also prohibit mergers/takeovers despite this being a common tool to help address financial difficulties by the pooling of resources. There were only 81 mergers involving 154 charities taking place in the year to March 2018, less than one in every thousand charities. 7 Similarly, the use of outsourcing particularly to provide skills that the organisation cannot source internally or cannot justify recruiting full time staff (e.g. finance, HR and IT) is an area that needs more strategic focus as can provide substantial benefits both in terms of cost and productivity. The role of Trustees is vital, as they need to provide both the strategic direction to ensure that the charity meets its purpose, act as the guardian of its values and reputation and also steward its assets and finances. The interaction (or lack of) between the Trustee board and management is an area of key focus and the ability of the Trustee board to meet quickly, regularly and take the necessary actions is vital.
Pensions
Part of the social compact with staff was that whilst pay may not be as much as private sector organisations this was compensated by generous pension provision. On a practical basis this was also required in order to compete for staff who may have otherwise worked for local or national government and enjoyed defined benefit pension scheme provision. Historic liabilities of defined benefit pension schemes continue to pose a significant challenge to the charity sector. Liabilities can undermine a charity’s financial sustainability as well as posing as a reputational risk. Many charities that have their own defined benefit schemes and have sought to minimise future risk by closing them to future accrual but pension deficits and their management can be one of the major challenges to the viability of a charity but there are options available to help address these deficits.
A suitable reserve policy
Charities have always faced challenges in funding their core costs. However, this has been exacerbated by the move towards contract funding, which is often tightly defined and does not allow for costs incurred outside the specific terms of the contract or only allows a small percentage of the contract costs to be utilised for overhead.
Notes
7 Eastside Primetimers, A review of not-for-profit mergers for 2017/18 <www.ep-uk.org/wp-content/uploads/2019/01/Good-Merger- Index-2017-18.pdf>, 8 November 2019.
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Restructuring in the charity and not-for-profit sector: A change of perspective?
Reputation issues
Conclusion
At critical times in any organisation’s lifecycle, it is imperative that its reputation is protected. This is especially important for charities as any damage can lead to a decline in donations or the loss of key project funders. This can be seen in the case of Oxfam which lost 7,000 regular donors when it was revealed that staff sexually exploited victims of the Haiti earthquake in 2010. This led to over 100 redundancies in its workforce reflecting the immediate loss of project income and donations. 8 The longer-term impact on bequest income should also not be underestimated as this will take a number of years to manifest.
The sector has passionate, dedicated and committed staff and is far more collaborative than its private sector counterparts, which provides a strong platform for a successful restructuring. The reluctance to undertake contingency planning and to take measures to reduce front line services when finances are or are going to deteriorate, given the strong emotional commitment to the cause, provides a competing challenge. The dual nature of control with a Trustee and Management Board when working well also provides a valuable layer of control and strategic oversight but when this relationship deteriorates, or sufficient challenge isn’t provided by the Trustees this can also complicate matters. Looking forward the use of collaboration up to and including mergers and outsourcing both as a cost reduction and an operational improvement measure are areas that Trustees should be considering more in setting the strategy for their organisation and to assist with any restructuring programme.
Reputation is especially important for charities as any damage can lead to a decline in donations or the loss of key project funders.
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Notes
8 Civil Society <www.civilsociety.co.uk/news/oxfam-suffered-year-s-worth-of-supporter-attrition-in-six-months-since-haiti.html>, 1 November 2019. The Guardian <www.theguardian.com/world/2018/feb/20/oxfam-boss-mark-goldring-apologises-over-abuse-of-haiti-quakevictims>, 1 November 2019.
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