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Sector Change is Coming: Are We Ready?

The turn of the 21st century saw conversations around the (un)sustainability of independent school business models in the US. Looking back, these discussions came across more as intellectual pursuits than as a reality faced by a large number of independent schools. It was believed that a reckoning would soon come. Enter the Great Recession a few years later, and, suddenly, many schools paid heed to business models. Much fretting and hand-wringing ensued, with economic uncertainties hobbling many boards and leaders, leading to predictable actions, the most popular of which were (1) raise money from those in a position to give, despite the uncertainty, and (2) blend-and-extend debt service, whereby a school would blend its existing debt (e.g., mortgage) with a lender’s currently-offered rate (at the time), while extending the term of that debt. The relief provided by these approaches encouraged schools to kick the proverbial can down the road. The argument for the unsustainable independent school business model took on more clarity as a result of the recession, and NAIS annual conference sessions dedicated to business models had great attendance (we co-led one, and there were 100+ people in the room). The reality was more of an academic discussion, however, as it had been a decade prior. It wasn’t ‘real enough.’

The easy money period that followed the recession allowed schools to accumulate ever-higher debt and concomitant debt service that they could (hypothetically) afford. Behind the scenes, though, downward enrolment pressure in many schools continued to grow, with arguably a majority of schools (which didn’t/don’t have much of an endowment) increasing their discount rate in order to keep students or attract new ones, with ‘steady’ enrolment numbers providing a false sense of security while feasible financial ratios deteriorated. Just as higher education costs became stratospherically expensive due to easy money from Title IV (allowing them to increase their prices, with students borrowing more money to pay those prices), independent school costs increased in order to support building expansion and administrative growth. There are exceptions, of course, to the narrative above. Some schools have weathered the past 20+ years just fine, but if we’re honest, they’re the minority of schools. We would hesitate to identify 25% of schools in the “weathered it just fine” category; based on myriad conversations with association leaders, accrediting bodies, board members, and heads of schools, we would put a ceiling of 10% on it, conservatively.

The chess pieces are now fully deployed on the board. Change is coming to the K-12 independent school sector in the US. It has already begun, one might proffer. It would be misleading to provide a range of years (e.g., three to five) during which this change will happen. Instead, we might consider the notion of an era, in the vein of ‘what is the nature of our era?’

Closure: schools are hardened against this choice, but the consequences of profligate spending (buildings, administrative bloat, and more), inadequate management of resources from a fiduciary perspective, and fighting downward enrolment pressures related to myriad factors that aren’t just demographic in nature, are now coming home to roost. Too many governing board members look at the school’s balance sheet and see large numbers (e.g., $15 million in assets), failing to recognise that those assets aren’t liquid — they represent the value of buildings and land. And so financial distress continues. Expect more schools to identify closure as their best option; they’ve delivered to the best of their ability, but they have run out of road, financially speaking. They may or may not have explored the options listed below.

Consolidation (Merger and Acquisition): for many years now, independent school markets where supply of schools is greater than demand for school places (enrolment) have remained unchanged, creating a bubble of unsustainability.  Due to trends mentioned earlier, as well as birth rates and downward consumer choice pressures in the elementary (lower school) grades in particular, merger and acquisition opportunities are abundant in the sector. Whether governing boards are moving from ‘being aware’ of such a possibility toward assessing and pursuing such options remains to be seen. We work as a specialist in this area, and are supporting schools that are doing this. To a school, they have been studying opportunities for some time, and are now beginning to act, as their five-year planning cycles are showing the necessity of consolidating. Otherwise, they face the reality of considering closure in the not-too distant future. 

Bankruptcy (Chapter 7, Liquidation): in states where Chapter 7 is allowed, independent schools whose governing boards have not planned judiciously for a winding-down of the school may well end up needing to terminate the school corporation’s business altogether, liquidating all assets to pay off creditors and dissolve the corporation. Likely a messy process and unfavorable public relations.

Bankruptcy (Chapter 11, Reorganisation): in states where Chapter 11 is allowed, independent schools whose governing boards hold onto hope that the school might yet survive may end up choosing to enter into reorganisation of their finances, when unable to work with existing creditors on contracts and debt. This route is public, and requires public relations expertise to mitigate the risk of further enrolment difficulties with respect to families who may not wish to be affiliated with a school in Chapter 11. A popular option to retain enrolment might be to find international students desperate to get into the US system, and who may be unaware of the school’s Chapter 11 filing: full-pay international students would be a boon to such schools, as the higher tuition price-point would be viewed favorably within an updated financial framework for the school. Yet we recognise that this approach obfuscates the reality of domestic families’ ability to pay the fees, and that will create another problem when/if a school emerges from Chapter 11. In all likelihood, it will be a matter of time before the school is in a similar situation again.

For-profit Ascendancy: for-profit educational groups (or, at the very least, profit-minded individual investors) see opportunity in the K-12 education sector. They’re hungry for brands—they’d rather buy one than have to build one. Whether acquiring a school outright, merging an existing school into another existing for-profit school, or taking control of operations via advanced corporate structures, one needs to be aware that we are in an era of ascendancy of for-profit schools. Traditionally viewed as anathema by the US non-profit independent school market, a hard truth is that many non-profit independent schools have been unwittingly run/managed poorly by their volunteer boards, and for-profit approaches provide for a more transparent look into school finance, brining the ability to raise capital via the markets rather than donors. Imagine no Annual Fund “to close the gap between tuition and what an education at school XYZ actually costs.” Why should non-profits not be required to run a balanced budget that is based on their product, showing viability as a business, when the rest of the world must do so? There is a generative question for boards to wrestle with.

Foreign Ownership: a distinct and growing subset within for-profit ascendancy, commercially-minded educational groups from outside the US have been studying the US market for some time. They see massive opportunity, whether performing business roll-ups by acquiring existing nonprofit independent schools that are in financial distress, or pursuing greenfield opportunities to establish their brand(s) in a given marketplace, these groups are resourcing independent research and feasibility studies to determine where to begin. It’s not when to begin; it’s where (and how best, structurally). International education has been on a tear for the past 20+ years, with burgeoning enrolments and premium-seeking parents; expect to see growth of international school brands soon in a location near you.

The take-away from this post is: watch this space. Although we do expect the aforementioned activities to pick up noticeably in the next 18-24 months, more importantly we see these activities continuing for the next 10 to 15 years. Governing boards and school leaders need to be aware of these movements, and, in many cases, may do well to take advantage of them, in the interest of their school communities, despite the hard philosophical discussions and reckonings that will need to take place. Independent school membership associations, especially those that accredit independent schools, need to ensure that they have meaningful protocols in place to support schools during this era; that may mean updating existing protocols and policies, or perhaps creating new ones, including wrestling with whether to allow for-profit schools into accredited school membership. One can also envision other independent school accrediting bodies coming into existence to accredit for-profit schools, which will create downward pressure on associations that serve only non-profit schools. Regional accreditors that accredit both non-profit and for-profit schools also stand to experience a certain degree of ascendancy during this era.

Sector change is coming. Are we ready for it?

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