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social impact bonds

The Fundamental Flaws in How We Finance the Nonprofit Sector

NFF SurveyToday the Nonprofit Finance Fund (NFF) released the results of their sixth annual State of the Nonprofit Sector survey and the data underlines a growing crisis in the financial sustainability of our nonprofit sector.

56% of nonprofit leader respondents reported that they were unable to meet demand for their services in 2013, this is the highest rate since the survey’s inception six years ago. And the scary part is that this inability to meet demand is not because of a temporary down period in the economy, but rather because of deeper dysfunctions in how we funnel money to the sector. As Antony Bugg-Levine, CEO of NFF put it, “The struggles nonprofits face are not the short-term result of an economic cycle, they are the results of fundamental flaws in the way we finance social good.”

The survey gathered responses from more than 5,000 leaders from U.S. nonprofits of all sizes, domain areas, and geographies.

The top challenge by far for nonprofit leaders, with 41% of them reporting it, is “achieving long-term financial stability.” And this is evidenced in several ways:

  • More than half of nonprofits (55%) have 3 months or less cash-on-hand.
  • 28% ended their 2013 fiscal year with a deficit.
  • Only 9% can have an open dialogue with funders about developing reserves for operating

These struggles with financial sustainability stem in large part from a lack of understanding among funders of the true costs of social change work. Roughly 53% of nonprofit respondents’ funders rarely or never fund the full costs of the programs they support. And for approximately 24% of respondents their government indirect cost rate (the amount government allows for indirect, or “overhead” expenses) declined over the last 5 years, while about 47% of respondents are subject to a government indirect rate of 9% or less. That is nearly impossible.

For the first time, the survey included questions about impact measurement, a growing interest among funders, ratings agencies and others in the sector. But these questions just further underline the financial Catch-22 in which nonprofit leaders find themselves. 70% of nonprofit leaders report that half to all of their funders want to see proof of the impact of their programs, but 71% of nonprofit leaders also report that funders rarely or never fund the costs of impact measurement.

At the end of the day, government and private funders are putting greater demands on nonprofits whose services are increasingly needed, all while funding is becoming more difficult to secure. It’s a vicious downward spiral.

More than ever this survey demonstrates a need for the nonprofit sector and those who fund it to take a hard look at how the social sector is financed. We are not sustainably financing the social change work we so desperately need. And if we don’t address that, the downward spiral will simply continue.

Here are some fundamental changes to the financing of the nonprofit sector that I’d like to see:

  • Government must move to a more reasonable indirect rate. No one can deliver an effective program with only 9% allocated to administration and other “overhead” costs.
  • Funders who want to see impact measures need to step up and fund the work and systems necessary to make it happen.
  • Nonprofit leaders and funders need to have more open and honest conversations about the hurdles standing in the way of the work.
  • Nonprofit leaders need help figuring out sustainable financial models.

In the six years of NFF’s comprehensive and unparalleled view into the world of nonprofit leaders the story is not getting better. Let’s hope this data serves as a wake up call for the social sector. We must collectively realize that if we really want social change we have to figure out how to finance it effectively and sustainably.

 

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10 Great Social Innovation Reads: February 2014

readingFebruary witnessed some dissatisfaction with the current state of funding for social change, but also some trailblazers playing with new financial vehicles. I always wonder whether true change to money for social good will come with the next generation. Do Millennials hold the key to fundamental shifts in how we finance social change efforts? We shall see.

Below is my list of the 10 best reads in the world of social innovation in February. But, as usual, please add what I missed in the comments. If you’d like to see an expanded list, follow me on Twitter, Facebook, LinkedIn, or Google+.

You can also find the list of past months’ 10 Great Reads here.

  1. As we work toward social change, its important to embrace the gray areas. Writing in the New York Times Simon Critchley takes us back to the 1970s BBC documentary series “The Ascent of Man” to make a point about the importance of uncertainty in our search for solutions. As he puts it, “Insisting on certainty…leads ineluctably to arrogance and dogma based on ignorance.” And Fay Twersky seems to agree when it comes to strategic philanthropy, arguing in the Stanford Social Innovation Review that “we need to challenge the certainty creeping into [philanthropy].”

  2. And speaking of changing philanthropy yet another study of Millennial philanthropists claims that this new generation of donors will be quite different than their predecessors. As Phil DeMuth writing in Forbes puts it, these new donors “are no longer interested in providing an annuity to some tax-deductible charity organization.” They want to see results, and they want to get in and get out.

  3. But Lucy Bernholz is frustrated by the pace of change, at least in how little the financial vehicles philanthropists use are changing. She argues that in this year’s list of the top 50 philanthropists  “the financial vehicles for philanthropy…look not unlike [those] in 1954 or 1914.”

  4. Tris Lumley from New Philanthropy Capital voices frustration as well, but with the general state of nonprofit finance. He puts forward a new model for the social sector that removes the “funder-centricity” of the “anti-social sector.”  Because, as he argues, “the result of this funder-centricity at its worst is that the social sector exists not for those it’s supposed to help, but in fact for those who work in it, volunteer in it, and give money to it.”

  5. There are some bright spots, at least in the United Kingdom. The country leads the way in the social impact bond trend.  Emma Tomkinson provides a map of social impact bond activity in the UK versus the rest of the world and the UK Centre for Social Impact Bonds provides a great site of resources on the new tool.

  6. And even here at home there are some trend setters, particularly the F.B. Heron Foundation, led by the visionary Clara Miller who also founded and led the trailblazing Nonprofit Finance Fund for 25 years. Clara has announced the F.B. Heron Foundation will account for the mission return of 100% of its assets. Unheard of and definitely interesting to watch.

  7. There is a constant tension in the nonprofit sector between funding new ideas and funding the growth of proven ideas.  Writing in the Chronicle of Philanthropy, Alex Neuhoff, Laura Burkhauser, and Bradley Seeman fall squarely on the side of growing proven solutions, arguing that in order to reach a higher performing nonprofit sector we must “follow the “recipes” that earned proven programs their stellar ratings.”

  8. There was much for Millennial changemakers to chew on this month. First, there is a growing drumbeat questioning the relevance and value of college. Does the higher education model really work anymore? It’s a fascinating question to contemplate. And Naomi Schaefer Riley does so in the “College Tuition Bubble.

  9. I’ve been on a real Steven Pressfield (author of The War of Art) kick lately. His worldview is that each individual was put on earth to create some specific greater good, but Resistance constantly fights to keep us from achieving it. If you need inspiration to overcome Resistance, read his post “How Resistance Proves the Existence of God.” Love it.

  10. And for those who are pursuing a life of social change despite the lure of a more traditional path, look to Thoreau for inspiration. For as Maureen Corrigan explains in her NPR review of a new biography of the man, “Thoreau’s youth seemed aimless to himself and others because there were no available roadmaps for what he was drawn to be…If Thoreau had committed to a professional career right after Harvard, his parents might have rested easier, but the world would have been poorer.”

Photo Credit: beggs

 

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Moving Social Finance Forward: An Interview with Ted Levinson

Ted LevinsonIn today’s Social Velocity interview, I’m talking with Ted Levinson. Ted is the Director of Lending at RSF Social Finance, a San Francisco-based financial services non-profit dedicated to transforming the way the world works with money. Levinson manages RSF’s flagship $75 million Social Investment Fund which provides debt capital to US and Canadian social enterprises.

You can read past interviews in the Social Innovation Interview Series here.

Nell: RSF Social Finance is really the leader in the social finance market, you’ve been doing this long before anyone started talking about a “social capital marketplace.” Given that long history, how do you view the current state of the social capital market? Are we where we need to be to funnel enough and the right kinds of capital to social change efforts? And if not, how do we get there?

Ted: RSF has a twenty-nine year operating history, but it’s still early days for the field of social finance. The industry is at the same stage of development as natural food stores were thirty years ago – we’re established, we’re growing, we’re doing good work, and yet we’re still considered a fringe movement. I believe we are on the cusp of mainstream acceptance which will mean a much broader audience of impact investors (especially young people and unaccredited investors) and far greater demand for social capital from the growing number of social enterprises that are just now becoming investment-ready.

There’s been a shift in society’s view of natural food stores – we’ve overcome our fear of the bulk bins and now all grocery stores look more like natural food stores. I expect the same thing to happen with our conventional financial institutions which are just now beginning to pay attention to social finance.

What the field really needs is to expand the financial products available to social enterprises and address some of the existing gaps. Frustrated social entrepreneurs may disagree, but I think the angel capital and large-scale venture capital spaces are meeting the needs of for-profits. Incubators, business plan competitions and seed funds are providing modest amounts of funding to emerging non-profits and for-profits. RSF and some of our friends including Nonprofit Finance Fund, Calvert and New Resource Bank are addressing the middle market market.

The big voids in social finance include:

  • True “risk capital” for non-profit social enterprises. We need more foundations willing to place bets on high-potential organizations.
  • Bigger finance players or (better yet) a more robust consortium of social finance organizations that can band together to meet the $5 million + needs of high growth social enterprises such as Evergreen Lodge, Playworks and other organizations that are reaching scale.

I believe the field will get there but we’re playing “catch-up” now and social entrepreneurs are an impatient bunch.

Nell: RSF does something pretty revolutionary in that you combine philanthropic giving with impact investing, whereas these two sides of the social capital marketplace have not yet really found a way to work together in any large scale or significant way. Why do you think that is? And what needs to change in order to encourage foundations and impact investors to work more closely together?

Ted: We call our approach of combining debt and philanthropic dollars “integrated capital,” and we think it’s going to have a profound effect on impact investors, philanthropists and the social enterprises it serves.

Most non-profit social enterprises rely on a combination of earned revenue and gift money. There’s no reason why a single transaction can’t bridge these two forms of capital. With integrated capital we can leverage philanthropic grants or loan guarantees to push high-impact loan prospects from the “just barely declined” category into the “approved” category. In fact, even some for-profit social enterprises are eligible for this. Our loan to EcoScraps – a fast-growing, national, composting business was made possible by a foundation that shared in some of RSF’s risk.

Integrated capital is possible because RSF works with individuals and foundations that have overcome the prevailing view that how you invest your money and how you give are distinct activities. We’re also fortunate to work with an enlightened bunch of people who recognize that philanthropic support for social enterprises isn’t a crutch or a sign of a failed enterprise.

Our work at RSF is driven by a belief that money ought to serve the highest intentions of the human spirit. Conscientiously investing money, giving money and spending money can all further this goal.

Nell: What do you make of the emerging social impact bond movement? Is this a social finance vehicle that you think will work?

Ted: I’m deeply hopeful and deeply skeptical of the future of social impact bonds. I’m hopeful because our government is notoriously risk-adverse and slow to adopt new ways of improving education, reducing recidivism, or curbing our runaway health care costs. I think spending money on early interventions could go a long ways towards improving these fields societal challenges, but paying now to save in the future is at loggerheads with the short-term view which prevails in politics. Social impact bonds are a clever way to push the risk on to investors who are willing to take a longer view for the potential of a big upside.

I’m also a fan because social impact bonds are an alternative to the financial engineering which brought us collateralized debt obligations. They demonstrate that Wall Street doesn’t have a monopoly on financial innovation.

That being said, I’m skeptical that this market can ever reach a stage where transactions costs can drop enough to make it economically viable. Bringing together the multiple parties that are required for such a transaction (the government, the investor, the non-profit, a monitoring entity, a social finance organization, an attorney and possibly a foundation) just seems unaffordable to me.

Nell: What sets the nonprofits and social enterprises you invest in apart? What characteristics do you look for in the investments you make?

Ted: All of our borrowers fall into one or more of three focus areas – sustainable food systems, the environment and education & the arts. These borrowers all have capable, committed management who recognize that financial sustainability is a prerequisite for lasting change. Our best borrowers have strong communities supporting them whether it is donors, customers or suppliers.
Evaluating these stakeholders is a key component of our underwriting process at RSF.

Our experience demonstrates that performance improves when social enterprises engage all of their stakeholders. RSF’s long-standing support of fair trade is an example of this commitment. We also regularly expect borrowers to solicit their community members to join RSF’s investor community as a precondition to approval. We take community seriously at RSF!

Our borrowers are all addressing major social or environmental problems such as a lack of adequate housing for developmentally disabled adults (Foundation for the Challenged), inefficiencies in the wind industry (FrontierPro) and poverty and environmental degradation from rice farming (Lotus Foods.) As social enterprises, they’re primary activities are DIRECTLY making the world a better place. We believe our borrowers have the potential to scale their organizations and make a real dent in these problems, or become a model for others to do the same.

For example, we were one of the first lenders to Revolution Foods when they were operating out of a defunct fast food restaurant in Alameda, CA. Today they deliver over 200,000 healthy meals a day to public school children.

Similarly, we think DC Central Kitchen’s model of combining culinary training for adults with barriers to employment with a robust meals business (they deliver 5,000 meals a day to schools and homeless shelters) is a winning approach that can be replicated throughout the country.

Nell: Some have argued that nonprofit leaders lack a level of sophistication when it comes to financial strategy and use of financial tools. Obviously you find nonprofits and social enterprises that are able to effectively employ sophisticated financial vehicles, so how do you respond to that argument?

Ted: Rather than argue I prefer to let the results of our borrowers speak for themselves. DePaul Industries, for example, is a $30 million non-profit that employs over a thousand disabled Oregonians. The Portland Business Journal ranked them one of the most admired companies in the state and they did this all with 98% earned revenue. Network for Good processes over $150 million of online donations every year while Digital Divide Data has a decade of year over year revenue growth in the field of impact outsourcing.

I see no lack of financial sophistication in the non-profit sector. I do, however, see a lack of risk-taking, which can sometimes be misinterpreted as unsophistication when compared with the for-profit world. It’s a shame this mentality is so pervasive because of the importance and urgency of the work that so many non-profits do. Many icons of industry have biographies filled with risky expansion, leverage, false starts and failures. We need to de-stigmatize failure in the non-profit sector and adopt that same boldness which has led to so many of the biggest successes in the commercial world.

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A Monster List of Resources For Nonprofit Innovation

Since today is Halloween I wanted to continue a tradition I started last Halloween of providing a list of resources about nonprofit innovation. I’ve created the list below by culling from our constantly evolving and much larger list of resources on the Social Velocity website. Below I’ve handpicked the tools I think are most useful for wielding the money sword, connecting to the larger social innovation movement, and finding inspiration. Please add to the list in the comments of this post.

Happy Halloween!

Wielding the Money Sword

Connecting to the Social Innovation Movement

Finding Inspiration

What have I missed? What books, conferences, articles, tools do you find inspiring and insightful? Add to the list in the comments.

Photo Credit: dimland

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10 Great Social Innovation Reads: August 2012

There was much discussion in August about money. We heard that foundations should be more open to risk and should engage with nonprofits to find the best solutions. And we found out some fascinating information about how Americans give. And there were some exciting developments in the newest social sector funding vehicle, the social impact bond. What a great month!

Below are my top 10 picks for what’s worth reading in August in the world of social innovation. But please add what I missed to the comments. And if you want to see more of what catches my eye, follow me on Twitter, Facebook, LinkedIn or Pinterest.

You can see the 10 Great Reads lists from past months here.

Here’s August’s 10 Great Reads in Social Innovation:

  1. It looks like social impact bonds are starting to take off in America. This innovative social financing partners private investors, public bonds and nonprofit organizations to solve social problems. Goldman Sachs has gotten on board with a $10 million investment in a New York City program to reduce prison recidivism rates.

  2. Writing in the New York Times, Georgetown University professor Peter Edelman breaks down the factors contributing to a 15% poverty rate in America and what needs to change to improve it.

  3. I can’t tell you how many times I hear complaints from nonprofit leaders that social media won’t really improve fundraising. Try these on for size. Geri Stengel (guest posting on Beth Kanter’s blog) shows how the Genocide Intervention Network found major donors through social media, HubSpot offers 7 Creative Ways Nonprofits Can Use Social Media to Drive Donations and Kivi Leroux Miller explains How Social Media and Fundraising Fit Together.

  4. Guest blogging on the PhilanTopic blog, Derrick Feldmann argues “We need donors who are truly willing to embrace risk and invest significant dollars in potential solutions that may not yield immediate results but get us closer to our ultimate objective, even if it’s only by demonstrating what doesn’t work.” Amen to that! And Rodney Foxworth seems to agree.

  5. On the Stanford Social Innovation Review blog Sheetal Singh writes that there is a new active, engaged citizen movement in America, but that nonprofits are missing the opportunity to participate. She argues that “nonprofits need to realize that the “new citizens” are no longer passive recipients of their services; they demand engagement and inclusion. If nonprofits don’t adapt to this paradigm, they will be left out of the conversation.”

  6. One of my new favorite bloggers, Mark Hecker, does it again with a great post encouraging nonprofit and government leaders to be “fearless” in setting goals that will knock social change out of the park.

  7. A new study by the Chronicle of Philanthropy reveals how Americans give to charity. It turns out you give more if you have less or live near those who have less. But there is much more data to explore on their website. Fascinating.

  8. Forbes uses the World Wildlife Fund of The Netherlands as a case study to demonstrate the Five Steps to Growing Your Social Impact.

  9. Lucy Bernholz takes issue with foundation application processes and calls instead for a model “where foundations and nonprofits are working together – from idea generation through proposal, implementation and assessment – to actually solve problems.” Wow, imagine that.

  10. The Gates Foundation blog demonstrates how support of public libraries is a critical part of transforming developing countries.

Photo Credit: Library of Congress Archives

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The Savvy Nonprofit Business Model: An Interview with Kate Barr

In this month’s Social Velocity blog interview, we’re talking with Kate Barr, Executive Director of Nonprofits Assistance Fund, whose mission is to foster community development and vitality by building financially healthy nonprofit organizations. Kate has led the organization’s growth as a premier resource for training, strategic financial counsel, and financing for nonprofit organizations in Minnesota. Kate enjoys helping nonprofits consider the relationship between their mission and program goals and their financial and organizational strategy. She frequently writes and speaks on nonprofit financial and strategy and is lead blogger for Balancing the Mission Checkbook.

You can read past interviews in our Social Innovation Interview Series here.

Nell: Nonprofits Assistance Fund is all about helping nonprofit leaders become more financially savvy. Why do you think strategic financial management is so important for nonprofit leaders and what holds some nonprofit leaders back from achieving it?

Kate: I think about it this way: if strategic direction in general is important for nonprofit organizations, then strategic financial management is equally important as a component of that direction and vision. When a nonprofit develops a strategic plan they are also adopting a financial strategy. Too often, though, that financial strategy is underdeveloped because the vision and strategic goals don’t incorporate the business model that’s required to support the plan. At Nonprofits Assistance Fund we unpack the financial aspect of a nonprofit business model into four inter-connected components: revenue mix; cost of effective programs; infrastructure; and capital structure. I see the biggest obstacle to understanding financial strategy is the singular focus that many nonprofit leaders place on revenue, revenue, revenue. If we could just raise enough money, they think, it will all work out. In reality the business model is more complex than that. The extreme revenue pressures that many nonprofits have faced over the last few years have uncovered the vulnerability of business models. Fortunately, savvy leaders are stepping back to understand the strengths and weaknesses of their financial strategy and being more intentional about identifying and creating a business model that can work.

Nell: A few months ago you wrote a rebuttal to the Center of Philanthropy’s recent survey that claimed nonprofit managers lack solid financial knowledge. What would you say is the actual extent of financial knowledge among the leaders of the nonprofit sector? And what can we do to improve it?

Kate: Yes, I was critical of the study because the findings were based on an extremely narrow test of knowledge to define financial literacy. As we said in the column, the report did not make a connection between the “lack of financial knowledge” based on the survey and the health and vitality of the nonprofits and their missions in the community. Frankly, the fact that so many nonprofits have been able to respond to huge increases in demand for service without going over the cliff is testament to some pretty remarkable financial skills. The direct answer to the question, though, is that the financial knowledge is mixed. Anyone with financial management responsibility needs to understand the terminology of nonprofit finance and know how to read and make use of financial information. Leaders of nonprofits need to have both technical knowledge – what I would categorize as financial management skills – and leadership capacity to navigate changes to their business models. There has been a lot of progress in building financial management skills as the field has become more professionalized. There are many training opportunities for skill building, both in person workshop and online learning (including Nonprofits Assistance Fund’s training workshops and webinars). Financial leadership capacity requires more than a few classes. It takes experience, knowledge, and guts to align mission, strategic plan, and financial structure in a way that build sustainable community impact. I think the ideal nonprofit leader combines passion for the mission with excitement for the business challenge.

Nell: There is a phenomenon in the nonprofit sector that when business people join a nonprofit board they often leave their financial and business acumen at the door fearing it could muddy the charitable work of the organization. Why do you think this is and what can we do to overcome that tendency?

Kate: I’ve seen two different dynamics when this happens with board members: wishful thinking and misunderstanding. The wishful thinking problem arises when board members believe that nonprofits operate outside of the market and that their good work can be performed with minimal cost and simple revenue streams. The misunderstanding is just another version of the “nonprofits should operate more like businesses” myth. Nonprofits are businesses. This “advice” underestimates the complexity of nonprofits as business enterprises. Board members can’t be effective unless they understand how the enterprise works and what the board’s role is in planning and governing. Overcoming this tendency starts with board leadership and carries through recruiting, orientation, and ongoing board development. The executive director or CEO has an important role to work with the board chair or governance committee to prepare and support board members’ ability to understand and build the business.

Nell: One of the most exciting developments in the last year or so is the growing interest in and experimentation with social impact bonds, or pay for success bonds, a public/private funding vehicle for nonprofits based on outcomes. Minnesota has already begun to experiment with a $10 million pilot. What, if anything, has Minnesota learned so far and what do you see as the future for this new financial vehicle?

Kate: There is a lot going on in efforts to develop models and financial structures to pay for results, including social impact bonds, pay for success contracting, and the Minnesota pay for performance pilot. The Minnesota state legislature approved a $10 million state appropriation bond to test a pay for performance approach for some state funded programs. The Minnesota pilot is the first experiment to use an actual bond offering as the financial structure. The advisory committee started meeting early this year and has just issued a Request for Information for nonprofit service providers in workforce development and supportive housing. What we’ve learned so far in developing the Minnesota pilot is that every question leads to three more questions. Part of the complexity stems from the goals. In each of the models in development there are actually multiple goals: identifying program designs that work; saving the state money; attracting new funds; and sharing or transferring financial risk. Any one of these goals requires capacity to deliver and appropriate measures for success. Combining all four goals, as most of the models do, creates something of a bear to design and evaluate. Some of the open questions in Minnesota include: the methodology for the economic measure of success; the role of evaluator; the time-frame for measuring and valuing ROI to the state; access to the data that will be used for monitoring; the market for the bonds; and the appropriate level of risk for nonprofits to bear. The Minnesota pilot does not transfer the financial risk to the bondholders in the same way as the SIB model so there is also a working capital gap for the service providers. We are assessing what will be needed for our loan fund to help with that. As for the future, while there is great enthusiasm for these ideas and pilot projects we have to keep in mind that this is all still early stage with lots of lessons to be learned before we even know if these can attract significant new funds.

Nell: One of the big debates in the nonprofit sector centers around a distinction between program and administrative (or “overhead”) expenses. Rating agencies are just starting to realize that this distinction is damaging to the nonprofit sector. But how do we really move beyond this and get a majority of funders, regulators and others to recognize the danger of evaluating nonprofits based on how they spend money versus how they achieve results?

Kate: Is this even really a debate anymore? There’s pretty universal agreement that the functional expense ratio doesn’t measure nonprofit effectiveness, efficiency, or accountability. The challenge now is communication and education. This one ratio has so dominated every nonprofit financial measurement that we are forced to try and undo decades of practice. Nonprofits bought into the ratio, too, and reinforced it with pie charts and donor messages about how “every dollar goes to program”. Is it any surprise that donors listened and believed us? It took years to create the “standard” that expense ratio is the most useful measure for nonprofit financial results. Unfortunately it’s going to take time to re-educate. We have to start within the nonprofit field itself. There are still many nonprofits that promote their low overhead ratio in fundraising because, they claim, it helps them to attract and retain donors. It’s easy to calculate and communicate. Rather than battle the monster that we helped to create, I think we need to change gears, replace the ratio with more meaningful information about impact and financial health, and raise expectations for results. I really appreciate that Financial Scan, the new product from Guidestar and Nonprofit Finance Fund, doesn’t even include the functional expense ratio on the financial health dashboard or accompanying analysis reports. None of the other ratios – that are much more useful – are quite as simple, though. We’re going to be having this “debate” for some time to come.

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