The Importance of Establishing Operating Reserves for Nonprofits

(Photo by iStock/Mike_Pellinni)

One of the most impactful grant programs the Kendeda Fund has ever undertaken was funding our nonprofit partners’ operating reserves. At the end of 2023, Kendeda will be “sunsetting”—winding down three decades and nearly $1.2 billion in grantmaking—and this relatively modest ($7.6 million) and decidedly “unsexy” grant initiative began as a way to prepare our grantee partners for life “after Kendeda.” But it has had such an outsize impact on partner organizations and the people they serve that we feel compelled to share what we learned in the hope that other philanthropies might consider similar programs.

According to the Nonprofit Operating Reserves Initiative (NORI), “Operating reserves” are the portion of “available unrestricted net assets” that an organization’s board maintains and/or has formally designated (or reserved) for use in emergencies, to sustain financial operations in the event of significant unbudgeted increases in operating expenses and/or losses in operating revenues. The minimum operating reserve ratio, at the lowest point during the year, suggested by the NORI is 25 percent, or three months of the organization’s annual expense budget.

A minority of nonprofits have more than six months of cash in reserve, according to reports like the Nonprofit Finance Fund’s State of the Sector; many have less than three months of operating reserves on hand. While living that close to financial insolvency may be common, it is extremely risky for any nonprofit, not just those whose funders are sunsetting. This lack of financial security can have a complicating ripple effect throughout an organization, making it hard for leadership to make decisions, address crises, and forecast future opportunities.

“An operating reserve fund lets us be agile and think ahead, rather than react to immediate funding needs,” as Gary Burnett, Heart of the Rockies Initiative put it; “It lets us exist and operate in a strategic, proactive space rather than a fear-based, resource-scarce mindset.”

In early 2019, with the foundation’s sunset still five years away, Diane Ives, Fund Advisor for our “People, Place & Planet Program,” began to brainstorm ways to set up grantees for success after Kendeda’s funding stopped. “I focused on operating reserves because we know that the nonprofits that are the most impactful and resilient are those that have a healthy balance sheet,” explained Ives. “Additionally, there is a clear set of best-practices, benchmarks, and demonstrated impact with operating reserve funds.”

Ives’ goal was to develop a robust funding program that would strengthen the core operations of Kendeda’s grantee partners, now and in the future, to build an operating reserve fund that would be the equivalent of at least three months’ operating expenses (and give them the resources, support, and space to do it in a way that made sense for their organization). As Ives has reflected:

“There is an ingrained belief that a ‘nonprofit’ denotes a poverty-mentality, that groups should make-do with the resources they have and to put all resources to immediate programmatic use. But in times of crisis, whether a nonprofit faces internal challenges, or a full-blown global health, economic, and racial injustice crisis, a healthy balance sheet is what allows nonprofits to survive and even thrive.”

What We Did

Kendeda invited 37 grantee partners from across our seven program areas to submit proposals. All were multi-year grantees who expressed an interest in the opportunity and demonstrated fiscal stability. We focused primarily on organizations with annual budgets of less than $5 million who did not yet have six months of reserves already on hand.

All of the proposals submitted to Kendeda had three key components:

• An application for a grant of up to $30,000 to support the organization in building its fundraising capacity. Though optional, these dollars were offered to help groups determine the feasibility of raising the operating reserve funds before obligating them to do so.
• A letter from the organization’s board chair acknowledging that the board was fully committed to building an operating reserve fund. We requested this knowing that operating reserve initiatives worked best when they were championed and governed by the board.
• A plan showing the group intended to raise at least 12.5 percent of their annual operating budget (equivalent to one and a half months) in order to qualify for the 1:1 match from Kendeda. The match felt like a value incentive which would encourage organizations to articulate (for their donors and themselves) the importance of a reserve. And the net result would ensure at least three months in reserves for the organization.

What We Expected

On the whole, this was a cohort of grantee partners that were well known to the Fund, so we anticipated a certain level of success. However, nearly half of the nonprofits invited were smaller, younger organizations with limited fundraising capacity and annual operating budgets of less than $1,000,000.

For some of those groups, raising up to $125,000 on top of their annual fundraising was a significant lift. Additionally, only 17 of the 37 groups had any form of reserve fund, and most of those had less than three months in reserve. This meant the 20 organizations without any reserves in place would have to sell the concept internally and develop board and investment policies for how the dollars would be managed. Finally, while the program was conceived prior to the COVID-19 pandemic, it was rolled out in 2020 amidst fear of an economic shut down and all the uncertainty that brought.

It was not a competitive process, however. Each grantee who qualified and raised funds toward their goal was guaranteed to receive a matching grant from Kendeda. Going in, we conservatively estimated that half of the cohort (perhaps as many as 20 organizations) would accept the challenge and raise operating reserve funds.

What Actually Happened

Much to our surprise (and delight), 34 of the 37 groups qualified for the match, returning with board-approved policies for the management of the fund and clear plans to raise up to 12.5 percent of annual operating expenses. Only three grantees opted out of the program, citing limited fundraising capacity or other challenges.

In the end, 29 groups claimed 100 percent of the available match, three claimed more than 80 percent, and only two groups weren’t able to claim any of the money due to leadership changes and fundraising challenges. That penciled out to a 94 percent success rate, far greater than we had ever envisioned when we established the program.

When all was said and done, the Kendeda Operating Reserve program paid out more than $1 million in capacity-building grants, and $6.6 million in matching operating reserve grants, generating a total of $13.2 million in reserve funds for the 32 grantee partners.

Lessons Learned

The project was a success by nearly every measure. It also revealed a few important lessons that other funders might want to consider if launching a similar initiative:

1. Board buy-in was critical. We required a letter from each organization’s board chair in the application process indicating that the board was ready to engage in building, maintaining, and managing an operating reserve. The benefits here were two-fold. First, the letter prompted important financial conversations between executive staff and board members; second, when it came time to raise funds for the match, several organizations were pleased to see individual board members make significant personal gifts towards the match.
2. Fundraising capacity grants were key to success. Offering capacity grants of up to $30,000 before the match gave our grantees time and space to think and plan creatively about how they would approach the challenge. It also allowed executive directors to talk candidly with their boards about obstacles and opportunities. Capacity grants were used for everything from updating fundraising software and providing staff and board with development training, to hiring consultants who developed communication strategies and fundraising plans. What we heard repeatedly from our partners was that these grants helped build capacity for the entire organization, not just for fundraising for an operating reserve, and allowed them to evaluate fundraising and operating strategies in a more holistic way. The main challenges we heard came from those who initially wanted to hire a development professional; many groups struggled to identify and attract qualified candidates, and instead pivoted to engaging consultants or hiring a less experienced professional they could train.
3. Building a reserve fund helped instill fiscal discipline. Because the pandemic shut down travel and meetings, quite a few grantees found themselves with unexpected surpluses that they were able to allocate to a reserve fund and qualify for the match. This process was eye-opening for many grantees and helped them realize “nonprofit” doesn’t mean no surplus. Several organizations reported developing fiscal policies around allocating annual, or even monthly, surplus funds to their reserve fund.
4. Financial health can help attract and retain donors and talent. We know that donors are more likely to invest in a fiscally sound organization, but we also heard that the challenge from Kendeda resonated with new and existing donors and prompted additional giving. One unanticipated benefit we heard was how having a reserve fund helped some organizations attract staff. One new executive director shared that the reserve fund was a factor in her decision to take the job: “It was an indicator that Kendeda and the board had confidence and commitment to the long-term health of the organization,” she explained; “It also showed me that by earmarking up to six months of staff salaries, the board was demonstrating that the organization was a caring employer.
5. Reserves boost organizational confidence. In many cases, having cash on hand helped rewire how organizations approach their work and helped them move from a scarcity mindset to one of growth and stability. Being relieved from cash-flow stressors gave grantees confidence to be strategic and forward-thinking. One partner explained how having a reserve fund “ignited a shift in our thinking, making financial resilience a priority for our management team and board of directors. Additionally, knowing that we have a reserve that is almost equal to our line of credit means that we didn't have to draw on our line of credit at the beginning of our program season when we typically draw up to half a million dollars from the bank. In 2022, this saved us thousands of dollars in interest payments.”

The Gift That Keeps Giving

The benefits of reserve funds for nonprofits cannot be overstated. They help advance mission. They promote strategic decision-making. They signal financial health and stability to prospective funders. And they reduce organizational stress in a multitude of ways. Seth Wilson, executive director of Blackfoot Challenge, a Montana-based conservation organization, summed it up powerfully when he explained that an operating reserve “provides us with the opportunity to respond swiftly to unexpected crises or opportunities in the future—this gives us more security and confidence as we will inevitably face new challenges.”

As the pandemic taught us, the nonprofit sector and its leaders play an outsize role in providing services, advocacy, vision, and thought leadership—especially in times of crisis. To do their best work, nonprofits deserve financial stability and the peace of mind that having an operating reserve can provide. 

Read more stories by Christine Hunt.