We began our discussion yesterday about the potential advantages a nonprofit may or may not have over a for-profit Continuing Care Retirement Community (CCRC). We promised to look into this subject in more detail and to keep an open mind for other opinions and comments (see comment section below).
Today we continue the conversation with:
Part One — Not-for-profit is a tax status, not an operating objective. Your CCRC still has to cash flow regardless of tax status.
Both not-for-profit (or nonprofit) and for-profit businesses have to cash flow. As Stephen Covey often reminded, “No margin, no mission.” A CCRC that doesn’t operate with income greater than expenses (a margin greater than breakeven), is soon broke, the mission is unfunded and the property is someone else’s mission or problem. So if you think not-for-profit means willful indifference to operating at a positive margin, you’d be wrong.
The equivalent accounting speak for “net profit” in the nonprofit world is, “net income surplus (or deficit for a loss)” reported in a non-profit’s “statement of financial activities” (equivalent to an income statement in the for-profit world). You want your nonprofit CCRC to consistently deliver net income surplus.
Part Two — Timing is Everything
When Creditors are paid is different then when Shareholders are paid
In Part 2 we explore the differences in timing between payments to shareholders (for-profits) and creditors (debt owed by both nonprofits and for-profits).
We left Part 1 concluding there’s no difference in financial objectives (positive margins) between for-profit and nonprofit CCRCs.
But, you say, for-profits have to pay shareholders. Doesn’t that matter? It can, but paying creditors can matter even more. It’s all a question of timing. When does the money come out to pay creditors and shareholders?
In bankruptcy law, shareholders are last in line. Creditors come first, especially so-called secured creditors like a mortgage holder. Both for-profits and nonprofits need to raise money to build big projects like CCRCs. Shareholders only get paid from profits or net income. That means shareholders are only paid when a community is financially strong enough to be profitable. Creditors get paid from cash flow, regardless of net income surplus or profit. Payments to creditors are mandatory and can be required even when the community is financially weak.
Think about that. When does a payment for construction financing put the residents at risk? When a debt payment is required to a bank or bondholder (creditor) from an underperforming CCRC? Or when a dividend payment from profits is required from a profitable CCRC to a shareholder? To me credit has a timing risk that equity does not.
In fairness, there’s also a risk that shareholders will take profits out without building adequate retained earnings reserves for reinvestment or sinking funds for periodic repairs like new roofs.
Nonprofits can’t go to shareholders for equity. I suspect their building financing has more proportionally more debt than an equivalent for-profit. (That’s an analytics question I intend to explore.) And nonprofits can’t solve excessive debt with an equity injection from shareholders.
The timing risk of debt is reflected in bankruptcy law. There are two ways to go bankrupt:
- When liabilities exceed assets. (This is why lenders have debt-to-equity requirements at the time of making loans).
- Or when an entity is unable to make payments when obligations come due. (Debt payments due and payable can also add additional interest and penalties and accelerate repayment of the entire obligation.)
Okay, I’m skeptical that nonprofit is any safer for residents than for-profit. But I also know that for-profits can have excessive debt loads or get caught with an upside down balance sheet by having to refinance in the middle of a panic (like the Great Recession of 2008).
At best the timing issue is a draw, with no advantage for nonprofits. At worst, the timing of debt payments is a greater burden for nonprofits.
Part 2 concludes with no clear advantage for nonprofits on either financial objectives or timing of obligations.
See Related Articles: