February 27, 2012

Hull House Collapse Is a Cautionary Tale for Boards and Executives

Last month's abrupt closure of Hull House, a venerable organization that provided an array of social services to thousands of low-income Chicago residents, is a pointed reminder that many nonprofits operate with precarious finances. The organization's collapse also provides a sobering lesson for nonprofit boards and chief executives.

Hull House was started by Nobel laureate Jane Addams in 1889 to help Chicago's immigrants build "responsible, self-sufficient lives." Until last month, Hull House had continued Addams's legacy by offering foster-care services, job training, counseling, and literacy and other education programs at more than 40 sites throughout Chicago.

On January 27, its 300 employees received layoff notices and final paychecks, and Hull House shut its doors.

On the day the organization closed, a blogger for Crain's Chicago Business asked a question she said she'd been hearing from many people in Chicago’s nonprofit community: How could a board that included prominent lawyers, management consultants, financial advisers, and corporate executives have allowed a 120-year-old community institution to collapse under its watch?

A good question, with no simple answer.

Hull House board chairman Steven Saunders, in an NPR interview, blamed the economic climate for the organization's failure. Others experts quoted in the story described a scenario that has become familiar over the past four years: A challenging economy creates increased demand for social services but also causes government agencies and foundations to reduce their support.

While the economic climate certainly had an impact on Hull House, its collapse can’t be summed up as a simple case of increased demand and reduced resources. The organization’s Form 990 informational tax returns reveal that Hull House had serious financial problems even before the recession.

Its June 30, 2007, balance sheet showed that its unrestricted net assets were negative $2.3-million, meaning Hull House was millions in the red before the recession even began.

In an interview for a Chronicle of Philanthropy article, Mr. Saunders said that financial reports prepared by management had sugar-coated the situation and that because staff members had maintained a positive attitude, the board failed to understand the magnitude of the financial problems until they were too large to solve.

In the same article, Clarence Wood—a former chief executive of Hull House who retired last year—criticized the board for not understanding the idea of "living on the edge.” According to Mr. Wood, “the reason the staff members like me were staying positive in attitude was that we are very used to social-service agencies always being on the brink of destruction."

Those contrasting views illustrate what may have gone wrong at Hull House. And the same dynamics are being played out in the board rooms of other organizations that face similar challenges.

As I pointed out in a previous blog, most board members are volunteers, and few are adept at reading financial statements. But that was not the case at Hull House, whose board included finance and management experts. Even a cursory review of the organization's publicly available financial documents reveals deep financial problems. And one of the board’s jobs is to exercise independent judgment and ask reasonable questions about the information being presented by management.

In short, responsible governance requires a strong partnership between the board and the chief executive, and each party has to do its job for the system to work. Hull House is a sobering case study of governance failure in which neither the board nor the staff seems to have recognized the crisis while there was still time to turn things around.

Hull House’s situation was far from unusual. Thousands of nonprofit organizations are heavily dependent on government financial support, have no operating reserves or are in debt, and are seeing increased demand for services.

The executives and boards of these organizations need to recognize that being perpetually on the brink of destruction is not normal or sustainable, and it does a tremendous disservice to an organization’s mission and the people it serves.

Without more financial discernment on the part of boards, a more honest and candid partnership between boards and executives, and bolder actions while there's still time, more organizations are going to fold.