Last fall I wrote a blog post arguing that small nonprofits need access to philanthropic equity (money to build their organizations) just as much as larger, more sophisticated nonprofits do. My post was in response to George Overholser’s Social Velocity blog interview where he argued that philanthropic equity (or growth capital) campaigns, where a nonprofit is raising money to build the infrastructure of the organization, are not feasible for small nonprofits. George’s argument and my subsequent post set off a chain of events that led Social Velocity to work with Charlotte Chamber Music to plan and prepare for a philanthropic equity campaign. Over the course of the next several months I will give you an insider’s view of our work with CCM in order (I hope!) to prove my argument that philanthropic equity campaigns can and should be accessible to any nonprofit that has a vision for something bigger and the determination to put that vision to action. Today is the first post in this Raising Money to Grow On series.
In George Overholser’s September 2010 Social Velocity interview he argued that philanthropic equity campaigns just aren’t feasible for small nonprofits:
What about the small organizations that DO aspire to undergo a big transformation?…I believe that it is absolutely vital that we come up with a way to better capitalize these smaller organizations. Sadly, though, at this stage of capital market evolution, it is still quite expensive to prepare for a successful nonprofit equity campaign. Unless several million is being raised [the costs are] prohibitively high. This constrains us to campaigns of $5 million or more, which, in turn, constrains us to organizations that are already pretty large.
A Social Velocity blog reader, Elaine Spallone, Executive Director of Charlotte Chamber Music took issue with George’s argument and responded in the comments:
As the ED for a very small nonprofit (<$300K) I am greatly disheartened to essentially read “yes, we can cure the large guys, but for the rest of you -80% – well good luck! No answers for you yet.” WOW…Really is education and awareness for buyers to support the whole organization vs. its programs enough? (Although I agree wholeheartedly, a needed step.) I believe there has to be a way to “create compelling ‘asks’ for equity capital” that is less expensive. There has to be way to finance a small organization’s desire to meet the needs of the community, which could mean doubling their impact. We are asked to relearn, redo, change our practices to support (finance) the organization’s mission to change the world, but is no one considering the relearning, redoing or changing the expensive processes/methods so all nonprofits can benefit?
Since that is exactly why I launched Social Velocity, to help smaller nonprofits benefit from new ideas like philanthropic equity, Elaine and I began to talk about the challenges that Charlotte Chamber Music was facing.
Elaine felt that CCM was stuck. As a small, but beloved arts organization they had a great product, but they couldn’t get beyond the vicious cycle of never having enough money, never being able to expand their presence and impact. They had a solid board, and a great vision for the future, but lacked philanthropic equity to build the organization to achieve that vision. They had been talking to consultants about conducting a capital campaign to raise money for a permanent artistic director and a new or refurbished building. As Elaine recalls:
At first, we thought we had to launch a major campaign to raise funds for an Artistic Director- that was our major missing piece, and we seemed lost as to how to make that leap in securing significant funds. That is where we were stuck — for over a year.
But I counseled Elaine that they couldn’t get unstuck until they created a strategic direction and plan to get there that included the various infrastructure elements they needed to get to the next step. Again, Elaine recounts:
What Nell helped to clarify in the beginning is that investing in infrastructure will change our picture. It’s not just about one person [an artistic director]. We were a step ahead of ourselves. To get there, we needed to create the compelling plan for philanthropic equity…we were missing a huge step by not having a detailed plan for our future.
I suggested that they launch a philanthropic equity campaign, to raise money for an artistic director, fundraising infrastructure, technology, systems, all the things they needed to build a more effective, sustainable organization. But, before they think about a philanthropic equity campaign, they needed a compelling strategic direction and a plan for getting there. Because people don’t invest significant money in an idea, they invest in a coherent, compelling, executable, exciting, measurable plan for the future.
We put together a proposal for how Social Velocity could help Charlotte Chamber Music create
- A compelling, investable strategic plan, and
- A pitch and prospect strategy to raise the philanthropic equity needed to execute on that plan.
Elaine then went to her board and a few key major donors to make the case that in order to get out of the vicious starvation cycle, expand their impact, and become the top-tier arts organization they knew they could be, they had to invest in an organization-building process. A couple of key donors stepped up to make the investment to hire Social Velocity.
In the next post in this series, I’ll discuss how we went about creating a compelling, investable strategic plan and the pivotal moment when Charlotte Chamber Music realized that they had a tremendous opportunity to develop a new model for the 21st century arts organization.
Photo Credit: naitokz
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In this month’s Social Velocity interview we are talking with Laura Tomasko. While she shares her millennial generation’s passion for social innovation, she sees a real opportunity, that many dismiss, for government to play a role. Laura serves as manager of Public-Philanthropic Partnerships at the Council on Foundations. She is a proud StartingBloc Social Innovation Fellow who holds a Master of Public Administration from the Maxwell School of Citizenship and Public Affairs at Syracuse University, where she served as the Vernon Snow Fellow in Nonprofit Management. You can follow her on Twitter at @lauratomasko.
You can read all of the interviews in our Social Velocity interview series here.
Nell: Many of your contemporaries are as passionate about social innovation as you are, but they tend to dismiss government. Why don’t you? Why do you think there is hope for government to be reinvented?
Laura: I don’t dismiss government because I believe that cross-sector partnerships benefit social innovation. People, organizations, and sectors all have strengths and limitations. Partnering affords an opportunity to merge skills and areas of expertise for the purpose of achieving a common goal. Like any institution, there are ways that government could improve. But I don’t believe that government needs to be reinvented to be a helpful partner in social innovation. In classrooms and professional settings, my generation recognizes the value of partnerships and discusses how to blend social innovation and government. Increasingly, master’s degree programs in public service emphasize social entrepreneurship. Fellowship programs like StartingBloc train emerging leaders to drive social innovation across sectors. Last fall, I facilitated a conversation among StartingBloc fellows on the role the public sector plays in social innovation, and I saw that these next generation leaders recognize the valuable role that government can play in social innovation.
Nell: Where do you think government fits into the social innovation movement? What should government’s role be?
Laura: Government provides an incredible platform for convening people and connecting ideas. Right now, we are seeing federal innovation initiatives that elevate results-oriented programs and incentivize public-private partnerships. The White House Office of Social Innovation and Civic Participation used its platform to draw attention to federal initiatives such as the Social Innovation Fund and the Investing in Innovation Fund. The Corporation for National and Community Service and the Department of Education, the federal agencies that respectively house those initiatives, attracted interest from public and philanthropic entities that want to work together to support innovative community-based models for change. These examples demonstrate the ability of government to draw attention to social innovation and encourage the development of partnerships to sustain the movement.
Nell: What are you working on right now at the Council on Foundations’ Public-Philanthropic Initiative? What gets you really excited there?
Laura: I serve as the Council’s manager of the Public-Philanthropic Partnerships Initiative, a program that marries my passion for social innovation and government. The goal of the initiative is to increase substantially the quality and quantity of government-philanthropic collaborations. We serve as a conduit between foundations and the federal government by cataloging opportunities, developing partnership tools, and generating analysis and commentary about current partnerships. As foundations work with the public sector, we are here to offer support and coordination assistance. During the Council’s Family Philanthropy Conference last month, I met with our members and had conversations about collaborating with government to scale up promising programs. Philanthropy plays an important leadership role in society, and I get excited by the opportunity to bring together people and ideas and facilitate connections.
Nell: How confident are you that public and private money can come together to create significant social change? There wasn’t a large government presence at past Social Capital Markets (SOCAP) conferences, for example, but that might be changing. What will it take to get private and public money to collaborate more?
Laura: I believe that public and private money can come together to create social change. To encourage more collaboration, both the public and private sides need to understand and trust one another. The barrier of unfamiliarity creates misunderstandings and missed opportunities for partnerships. Greater understanding of the risks and opportunities can build trust and lead to significant social change. The SOCAP conferences are excellent platforms for breaking down barriers, increasing understanding, and fostering relationships among for-profit investors, social entrepreneurs, government officials, and philanthropic leaders. In your interview with Kevin Doyle Jones, one of the SOCAP founders, he described SOCAP10 as a time for translation as people learn to work together. A few months ago, I was excited to hear Secretary of State Hillary Clinton announce her intention to bring SOCAP to the State Department in fall 2011. With the talented SOCAP team leading the way, I am optimistic that participants can move past translation and into action, developing public-private collaborations in the social capital markets.
Nell: What sorts of changes would you like to see in government, at the local, state and federal levels in order for it to be more effective and instrumental in the social innovation movement?
Laura: The social innovation movement focuses on the root causes of social conditions. It looks to new and creative means for improvement, rather than continuing to treat the manifestations of problems. Innovators, optimistic about the potential for change, focus on the assets of clients and aim to use resources in new ways. With an end goal in mind, they emphasize measurement, evaluation, and collaboration when appropriate. Government can help these efforts by aligning incentives in a way that encourages innovators to address the root causes of social conditions and by supporting programs that emphasize results. Through federal innovation funds, we are seeing government invest in ventures at a level commensurate with past and potential impact. In addition to emphasizing the importance of measurement, I think that government should seek opportunities to work with philanthropy as a knowledge partner. For example, community foundations can offer local governments innovative solutions for addressing critical needs in the community.
Nell: There has already been a bit of controversy around the Social Innovation Fund, the federal government’s first official foray into the social innovation realm. What do you think about this first attempt by the federal government to play a role? Is it working or is too soon to tell?
Laura: I like the Social Innovation Fund (SIF) because it raises the visibility of philanthropy’s leadership in social innovation. The SIF offers a model for how government can leverage funds and expertise to identify promising and innovative mid-sized nonprofits. Once selected as intermediaries of SIF funds, grantmaking organizations identify and grow high-performing nonprofits. This is an important aspect of the SIF design because government defers to philanthropy’s knowledge when finding effective ways to meet community needs. In addition to encouraging public-philanthropic partnerships, I like that the SIF focuses on evidence, a desire to scale success, and the need for growth capital. George Overholser has provided incredible thought-leadership about the field of nonprofit financing. Sean Stannard-Stockton, president and CEO of Tactical Philanthropy Advisors, wrote a great post that applies Overholser’s distinction between builders and buyers to the SIF. Steve Goldberg also has offered detailed commentary about why the SIF is so important.
Even among those who like the SIF concept, some have criticized its implementation. As with any initiative in its early stages, it is helpful to have conversations about what is working and what could be improved. From my perspective, I see two good measures of success for the SIF. The first measure is whether the community-based organizations that receive public-private funds and resources can achieve their desired impact. Community-based organizations have just begun receiving funds, so we still have to wait and see. The second measure is whether state and local governments elect to implement similar models moving forward. Even before the SIF, state and local governments showed interest in social innovation and entrepreneurship. I am hopeful that these initiatives will continue to exist and new ones will develop. The more of these models that exist, the more opportunities will be available for philanthropy and government to collaborate in supporting social innovation.
Part 6 of our ongoing blog series, Financing Not Fundraising, demonstrates the critical importance of money for building nonprofit capacity and describes how to find it.
There must be a recognition in the nonprofit sector, and among the philanthropy that funds it, that nonprofits need money to support not only their direct services, but also the infrastructure (technology, systems, evaluation, training, fundraising) of the organization. Nonprofits will only get better at creating social change if they have a strong and effective organization behind their work.
In case you’re new to this series, our Financing Not Fundraising blog series seeks to address the reality that fundraising in the nonprofit sector is broken. In fact, traditional fundraising is holding the sector back by keeping nonprofits in the starvation cycle of trying to do more and more with less and less. The nonprofit sector needs a financing strategy, not a fundraising one. That means that nonprofits have to break out of the narrow view that traditional FUNDRAISING (individual donor appeals, events, foundation grants) will completely fund all of their activities. Instead, nonprofits must work to create a broader approach to securing the overall FINANCING necessary to create social change. You can read the entire series here.
George Overholser, from the Nonprofit Finance Fund, is the pioneer of this critical distinction in the nonprofit sector between money to BUY services and money to BUILD organizations. The idea is simple. There are two types of dollars in the nonprofit sector. Those that BUY nonprofit direct services (dollars for more beds for the homeless, more hours of ESL instruction) and those that BUILD a stronger nonprofit organization (dollars for technology, systems, fundraising staff, etc).
A nonprofit that wants to get out of the vicious fundraising cycle needs to make a commitment to building their organization and finding, and convincing, donors to fund that building effort.
Let’s take fundraising infrastructure for example. Most nonprofit organizations lack sufficient infrastructure to bring enough money in the door. They don’t have enough money to hire experienced fundraisers, buy efficient and effective technology to track donors, create compelling messaging and collateral, train their board in fundraising, and so on. But with dollars to invest in staff, technology, planning and expertise, the organization could transform their fundraising function into one that raises many more times the amount of money that they currently do.
So how does a nonprofit organization find money to build their organization? Here are the steps:
- Create a Plan. Develop a road map for the future that includes a budget for the real costs of the real infrastructure and capacity you need to get there.
- Determine the Ask. Split the overall cost for these infrastructure elements into reasonable ask amounts given the relative capacity of your donors.
- Create the Pitch. Create a compelling capacity funding pitch that connects these infrastructure elements to an increase in your ability to create impact in the community. A more seasoned development director means that you can raise more money, more effectively, more quickly. With that additional revenue, your services can reach more people.
- Analyze your Donors. Look for the individuals, foundations, and corporations who love what your organization does, have the ability to give at the ask levels you determined in #2, and could be made to understand the argument that money to build can allow your organization to do so much more.
- Explore Alternative Funding. Find new ways to fund capacity building. For example, PRIs, or program-related investments, (essentially loans to nonprofits) could be used to build fundraising infrastructure because once a nonprofit’s capacity to raise money has been increased, the loan could be paid back out of the additional revenue. Explore creative options like this with funders.
- Make the Ask. Present your plan and pitch to the donors you have identified and educate them about the critical importance of capacity capital.
Money to build nonprofit organizations isn’t just lying around. Indeed, most donors claim that they aren’t interested in funding anything beyond direct services. But with a compelling argument for how money to build an organization can result in much greater impact, many more donors can become builders.
If you want to learn more about applying the concepts of Financing Not Fundraising to your nonprofit, check out our Financing Not Fundraising Webinar Series, or download the 27-page Financing Not Fundraising e-book.
Photo Credit: y_katsuuu
I’ll give a full rundown of my Day 1 experience at SoCap in a later post, but first I have to admit my excited anticipation of this year’s Social Capital Markets conference encountered some disappointment yesterday as the third annual conference kicked off. The day began with a co-keynote address by Sean Stannard-Stockton, from Tactical Philanthropy and organizer of this year’s first philanthropy/nonprofit focused track at the conference, and Kevin Jones, co-founder of SoCap. Kevin and Sean’s figurative two-step was a nod to the on-going confusion about where/whether philanthropy and the nonprofit sector fit, or how they fit, into a conference who’s heart and founding are heavily in the double bottom-line, impact investing camp.
Sean gave an eloquent speech arguing for the inclusion of the nonprofit/philanthropy sector in this movement to create a social capital market, arguing that “We don’t speak the same language, but we have the same goals,” and “We need to come together to be better able to find what we are both looking for.” But Kevin still referred to Sean and his track as the “nonprofit clan” and Sean as its “emissary.” I’m not sure why there has to be this awkward line between impact investing and philanthropy, but apparently there is still quite a bit of discomfort with the connection between the two worlds. As Stacy Caldwell, Executive Director of Dallas Social Venture Partners, so eloquently Tweeted yesterday:
I’m not sure that we are past the “awkward” stage yet.
To me, it seems so obvious that the nonprofit and government sectors, who hold the majority of money up for grabs in the social impact space, must be full and equal partners in the creation of the social capital marketplace.
But we are still speaking two different languages. And I’m not sure we’re pushing the conversation forward.
The first breakout session I attended yesterday was the Tactical Philanthropy Track’s “Decriminalizing Fundraising” session with two of the rockstars of nonprofit fundraising: George Overholser, from Nonprofit Finance Fund, and Dan Pallotta, author of Uncharitable. But I have to be honest with you, and it pains me to say this about two people I admire quite a bit, I was underwhelmed. The session was just a recap of the spiels George and Dan have given many times before, rather than a cutting-edge discussion and demonstration of how we change the broken funding of the nonprofit sector. If you missed the session, or haven’t read any of Dan or George’s writings, Adin Miller did a great job of summarizing the session on the Tactical Philanthropy blog. But the conversation didn’t go nearly far enough. As Adin said:
In general, the audience seemed to agree with the speakers’ position. There were little to no objections to their key points. The questions from the audience reflected more practical inquiries related to changing perceptions and attitudes toward nonprofits and freeing them up to truly grow the sector. And yet, I feel the conversation has just started and that we need a lot more insights into new strategies and tools to truly decriminalize fundraising.”
There ARE new tools and examples of organizations doing exciting things to finance their social impact in the nonprofit space. I would have loved to hear about those, instead of these old arguments about the need for new tools. And I would have loved to see a discussion about what infrastructure and structural changes need to happen in the sector to push funding forward and how we make those happen.
In the sessions on impact investing and the general sessions later in the day there is a constant movement to push the conversation forward, to unveil new tools, to detail new approaches, to describe new infrastructure in order to push the impact investing sector forward. There is a very palpable sense that this new market is ours to create, “We are the ones we’ve been waiting for,” as Lisa Hall from the Calvert Foundation said in a later session on impact investing. But yesterday at SoCap I didn’t see that same confidence, that same rigor, that same diligence, that same drive in the nonprofit/philanthropy side of the market to create new funding vehicles, new solutions to the broken funding structures we encounter every day.
Let’s see how today goes…
In our two part interview with George Overholser of the Nonprofit Finance Fund, George made an argument that gave me and some of my readers pause. He argued that only the largest nonprofits can really benefit from his “radical” idea of using a capital campaign to build their organization (instead of a building). But with Social Velocity I have seen small and medium-sized nonprofits raise capital to grow their impact or build a stronger, more sustainable organization, albeit on a smaller scale.
George believes that raising capital for building an organization is currently only feasible for the largest nonprofits, as he argued:
Only a small percentage of nonprofit organizations actually aspire to undergo major growth, or any of the other disruptive transformations that are inextricably linked to a capital investment…Still, what about the small organizations that DO aspire to undergo a big transformation?…I believe that it is absolutely vital that we come up with a way to better capitalize these smaller organizations. Sadly, though, at this stage of capital market evolution, it is still quite expensive to prepare for a successful nonprofit equity campaign. Unless several million is being raised [the costs are] prohibitively high. This constrains us to campaigns of $5 million or more, which, in turn, constrains us to organizations that are already pretty large.
This argument got me and some of my readers thinking. As one reader wrote:
As the ED for a very small nonprofit (<300K) I am greatly disheartened to essentially read “yes, we can cure the large guys, but for the rest of you -80% – well good luck! No answers for you yet.” WOW…Really is education and awareness for buyers to support the whole organization vs. its programs enough? (Although I agree wholeheartedly, a needed step) I believe there has to be a way to “create compelling ‘asks’ for equity capital” that is less expensive. There has to be way to finance a small organization’s desire to meet the needs of the community which could mean doubling their impact. We are asked to relearn, redo, change our practices to support (finance) the organization’s mission to change the world, but is no one considering the relearning, redoing or changing the expensive processes/methods so all nonprofits can benefit?
I agree wholeheartedly, and that need–to strengthen and grow smaller nonprofits–is why I launched Social Velocity. There is a category of capital that smaller nonprofits, who aren’t interested in or able to achieve major growth, can access. It can be capital to grow a successful program to other clients, other cities, other regions. Or it can be capital to strengthen and make more sustainable the organization. For example, as any small nonprofit will tell you, it is nearly impossible to get a funder to pay for a Development Director, a donor database, marketing collateral, a new website and so on. These are the tools that will allow the “sales team” to raise the income necessary to run programs. What if these smaller nonprofits could hold a mini-capital campaign to raise the capital necessary to increase the enterprise’s ability to raise income. Or to purchase technology to increase operational effectiveness? Or to grow, not to scale, but significantly?
True, a $5 million equity capital campaign is beyond all but the largest, most sophisticated nonprofits. But there is still the vast majority of organizations that are struggling within the vicious starvation cycle of not having the right elements of their built enterprise necessary to effectively deliver or grow programs. Yet money can be raised to build out that enterprise.
Social Velocity has worked with a number of small to medium sized nonprofits to create a pitch for capital to help the organizations strengthen their revenue function, grow programs, and so on (read about this here, here and here). The idea is the same as George’s, but on a smaller scale. With a good plan and the right pitch, any nonprofit can raise the capital required to achieve more social impact through a strong, sustainable, bigger enterprise. A nonprofit equity campaign is not just for the largest and wealthiest nonprofits. The principle can be applied to even the smallest nonprofit, and in that way, George’s radical idea could become revolutionary.
Photo Credit: Stuart Conner
As promised, today we are bringing you Part 2 of our interview with George Overholser from the Nonprofit Finance Fund. You can read Part 1 here.
Nell: You have argued before that to transform the nonprofit capital market we need a few capital deals at the top of nonprofit market. How do you think the bottom 80% of nonprofits (those with budgets under $1M) fit into a transformed nonprofit capital market?
George: I absolutely believe that the nonprofit capital market needs to extend everywhere, not to just the high profile “darlings” that seem to get all of the attention, but also the millions (!) of smaller nonprofits that truly make up the lion’s share of our vital nonprofit sector.
So why focus first on multi-million dollar growth plans? This is an excellent question!
One part of my response comes in the form of a reminder. Remember: MONEY AND CAPITAL ARE NOT THE SAME THING. Every nonprofit needs money to operate. But quite appropriately, only a small percentage of nonprofit organizations actually aspire to undergo major growth, or any of the other disruptive transformations that are inextricably linked to a capital investment. Very few for-profit companies with revenues of $1 million or less are interested in taking on equity. Nor should they! Small is beautiful! They are the bedrock of our economy. The same goes for our smaller nonprofits.
Still, what about the small organizations that DO aspire to undergo a big transformation, perhaps to double their ongoing impact, for example? Why not focus on them?
Well, I believe that it is absolutely vital that we come up with a way to better capitalize these smaller organizations. Sadly, though, at this stage of capital market evolution, it is still quite expensive to prepare for a successful nonprofit equity campaign. Unless several million is being raised, the hundred thousand or more dollars of required planning, documentation, due diligence, marketing, reporting and campaign management expense is prohibitively high. This constrains us to campaigns of $5 million or more, which, in turn, constrains us to organizations that are already pretty large.
In some ways, we shouldn’t be surprised. There are hundreds of professional fundraising consulting firms that assist with traditional capital campaigns, involving billions of dollars each year. But they, too, are unable to justify their fees unless the campaigns involve a lot more money than most “small” nonprofits are prepared to take on.
I hope that some day there will be a less expensive way to create compelling “asks” for equity capital, but that day has not yet arrived.
As a field, we are still in the very early days of showing how (learning how!) philanthropic equity can help organizations thrive. As such, it seems prudent to focus initially on the limited number of comparatively high-profile organizations that seem best prepared to implement their social impact growth plans. This has led equity funders to partner, at least initially, mostly with organizations that have already shown they can scale. To date, NFF has worked on 16 transactions, involving $310 million of new philanthropic equity raised. Every one of those 16 organizations went into their campaigns armed with track records that showed, compellingly, that they already know how to grow, and are now prepared to accelerate. So far, in just two or three years, the group that we track closely has more than tripled its level of program execution, while also more than doubling the long-term business models that will sustain the execution once the equity runs out. If results like these can be kept up, I expect it will help to attract more and more equity-like funders that serve an ever-broadening range of high-performing nonprofit organizations.
Nell: You have argued in the past that the reason a nonprofit market for growth capital has not materialized is because nonprofit accounting does not allow for a distinction between money to build the organization (investments) and money to maintain services (revenue). But beyond the accounting issues there is also a fundamental lack of understanding about finance in the sector. What do you think will change that?
George: I envision an evolution where funders become more and more specialized. Most funders, I envision, will migrate towards playing the role of BUYER. They will be the real connoisseurs that search among providers to learn what works best. Then, without seeking to change those providers, they will fund the providers to do what they do so well. Collectively, the buyers will be an important part of the field’s overall portrait of sustainability. I would include government as being among the most important buyer-type funders, but so, too, would be the many philanthropic funders who seek the most effective existing ways to achieve social impact with their money.
I would expect a smaller number of funders to focus on playing the role of BUILDER — they are financiers, really, or banks. These financial specialists will play a niche role. Because nonprofits can only take on a limited amount of equity, the BUILDER funders will actually have to compete against each other to “win” the right to invest in the most promising nonprofit firms. And the way they will win in this competition is by offering not just money, but also very sound financial know-how, to the organizations they partner with.
Lots of accomplished BUYERS, a smaller number of accomplished BUILDERS. I sometimes explain this line of thinking by describing what happens when you go into a flower shop – suppose you want them to send flowers to your mom in Florida. Clearly, the vast majority of money that flows into this flower shop is money in exchange for flowers (BUYER-type money). Only a very small percentage of the money that flows into the flower shop comes in the form of capital – a bank loan, perhaps, or, in the early days, an initial equity stake. Thus, the vast majority of check-writers are interested in FLOWERS and the benefits that flowers bring. Only a very small minority of check-writers are interested in BALANCE SHEETS and the other technical details of finance.
I am hopeful that nonprofit equity accounting will allow funders to be better at self-selecting into their chosen areas of expertise. Most will need to be BUYERS of program execution. A smaller number of funders will emerge as the financially-oriented BUILDERS that are needed to provide philanthropic equity and growth stewardship.
Nell: Do you think there is something to be gained by having the bottom 80% of nonprofit organizations better financed, more knowledgeable about finance and with more access to patient capital? What needs to happen to get there?
George: This may sound strange, but I believe that the key to helping most nonprofits to thrive has more to do with improving our BUYING behaviors than to do with finding more capital. To me, the problem is not so much that the bottom 80% lacks access to the capital they would need to maintain healthy balance sheets. Rather, they find themselves chronically saying “yes” to funding arrangements that cause them to deplete these capital reserves. The capital can be raised — but the unhealthy buyer relationships cause the capital to evaporate.
It’s hard to place blame for this phenomenon. Taken one at a time, most of the grants that an organization relies upon make a lot of sense. But, collectively, when multiple funders converge upon an organization with differing theories of change, or expectations that someone else will pay for overhead, or a hunger for customized reporting, special tweaks to the program, and long conversations about small checks, organizations can’t help but burn through whatever small cushions of capital they may have squirreled away.
We need to raise consciousness among BUYERS that whole enterprises — not just programs — should be kept in mind when they make their grants.
In this month’s Social Velocity blog interview, we are talking with George Overholser, Founder and Managing Director of NFF Capital Partners, a division of the Nonprofit Finance Fund. George is a recognized leader in the field of capitalizing high-performing nonprofit organizations. Since its launch in 2006, NFF Capital Partners has served as advisor on transactions involving over $250 million of charitable investment.
We had such a great conversation with George that we have broken it into two parts. Part 1 is below and Part 2 will be posted next week.
Nell: George, you have a pretty radical idea for getting nonprofits out of the hand-to-mouth starvation fundraising cycle, which you describe as expanding a traditional capital campaign so that the entire balance sheet of a healthy organization gets funded, not just buildings and endowments. How does a nonprofit break out of the mindset that they can only raise large amounts of money for a tangible building or endowment?
George: Ha! Please don’t tell my mom that I’m a radical! In truth, the concept of “Philanthropic Equity” may feel a bit radical, but really it is just an extension of tried and true nonprofit capital campaign techniques that have been with us for generations. Every year, billions of dollars are raised (often tens of millions at a time) to support capital campaigns for permanent, tangible things like buildings and endowments. Philanthropic equity suggests there is a third permanent, tangible thing that lends itself well to a capital campaign: not a building, not an endowment, but a business plan and management team that, if well-capitalized, will build an enduring and effective nonprofit organization.
This isn’t about just money. It’s about capital. And what makes capital different from all of the other money that flows into an organization? Precisely put, capital is all about turning a one-time infusion of money into benefits that recur over and over again. An endowment gets raised once and then provides subsidy every year, forever! Constructing a new building costs $5 million, once. But it wouldn’t be a good capital investment unless the building went on to house effective programs for years and years to come.
And so, the key shift in mindset is for an organization to envision very crisply how it intends to sustain ongoing program execution, once the equity has run out. It needs to paint a “portrait of sustainability” around which the philanthropic equity is raised.
But there’s a catch! The portrait cannot simply involve repeating equity capital campaigns over and over again. That would be cheating! Equity funders, who seek “perpetuities of impact”, would catch on pretty quick.
For example, imagine an internet-based nonprofit that plans to be sustained entirely by its online fundraising pitches. When originally launched, the organization has not yet built its web site, and so the online sustainability model is not ready to work. This is where philanthropic equity comes in. Philanthropic equity (from OFF-line funders) pays the bills while the site is first being built. It also subsidizes the organization in the early years of operation, before a critical mass of online donors has been established.
Once these changes (a new site, a critical mass) have been accomplished, the organization becomes self-sustaining, and — this is key — the site doesn’t need to raise any more philanthropic equity. In this way, a one-time infusion of $5 million in OFF-line philanthropic equity can give rise to $10 million per year of recurring ONLINE revenues that keep the program thriving year after year.
Nell: Why has this idea not caught on throughout the nonprofit sector? And how do we reach that tipping point?
George: Clara Miller is right: “Accounting is destiny!” And I believe that a change in nonprofit accounting practices would be our most effective way to move towards the next nonprofit capital market tipping point. These need not be official changes to GAAP (the federal standards), although that would be GREAT! As we’ve seen with our 16 philanthropic equity clients, an awful lot can be accomplished simply by adjusting the way today’s standard accounting rules are used to track equity.
Until recently, there was simply no way to distinguish nonprofit “equity” as being different from all the other types of money that flow into a nonprofit organization. There was no way to keep tabs on (a) who is and is not an equity investor, (b) how much equity has been consumed by the organization so far, or (c) whether or not the organization continues to take on more equity, in which case it has not yet achieved its chosen “portrait of sustainability”.
In recent years, we and others have begun to learn that equity accounting actually CAN be applied to nonprofits. Unlike for-profit accounting, it doesn’t track who has first dibs on the distribution of profits — after all, this is philanthropy, and there is no financial return to be had. But it DOES track whether or not the organization has achieved its chosen portrait of sustainability. It DOES answer the question of how much equity has been consumed so far. And, like any good naming opportunity, it DOES document who deserves the financial credit for having built an enduring institution.
Why does this matter?
This isn’t just window dressing, or simply a gimmick for creating more pseudo naming opportunities. Most of all, it is about changing incentives, and, therefore, it is about changing behaviors among key funders. That’s because clear accounting allows equity stakeholders to stay keenly focused, in a measurable way, on protecting the nonprofit’s FUTURE ability to have ongoing impact. (Just as someone who paid for a building is keenly focused on knowing it won’t be crumbling to pieces any time soon!)
Equity accounting also places the equity stakeholders into a single pool. It helps to point out that equity investors act in concert with one another, at the enterprise level, to comprise the nonprofit’s capital structure.
Thus, equity stakeholders (if you are lucky enough to have them!) provide a vital counterbalance to all of the other stakeholders, most of whom act alone (not in concert with others), most of whom seek nearer term results than the equity stakeholders, and most of whom need not contemplate the long-term consequences that their near-term desires may imply.
Please don’t get me wrong! These non-equity stakeholders (I often call them BUYERS) are the lifeblood of any sustainability plan. As BUYERS, who seek to exchange their hard-earned dollars for effective program execution, it is right and good that they demand certain accountabilities. Otherwise, our sector would not be performance-driven:
- I am asking you to turn my money into effective program execution, and I would prefer you to have low overhead.
- Please tell me how many tutoring sessions will happen as a result of my grant — the more the better!
- Please customize your program to address the particular needs and communities that my foundation has charged me to serve.
- I don’t need you to tell me about your other funders. Just write a report about my grant and what it accomplished. Again, the more you can accomplish during the grant period, the better!
But for an organization to thrive, it needs a counterbalance to the BUYERS. Equity stakeholders, (when they exist!), provide this counterbalance because they measure success in terms of how much impact the organization makes over the long run. Their presence—and their money—make it POSSIBLE for the organization to push back against unhealthy funding relationships… until healthy and enduring ones can be found. They ask questions like:
- How do we avoid accepting underfunded program grants?
- How do we resist the temptation to add too many new program features?
- What can we invest in today that will make us more compelling in the future, even if it bloats our overhead for a while?
- Can we really afford to keep a sub-par person in this key management role?
- How can we grow more quickly (without imperiling the long-term health of the organization)?
- When we look at the organization holistically, taking all of the funder relationships, program designs, infrastructure, balance sheet — you name it! — into account, does it feel like it will thrive and endure?
- If we write a bigger equity check, will that make it easier for the management team to resist distractions in the critical early days? Will they be more likely to build an enduring institution?
Stay tuned for Part 2 of our interview with George next week.
Last month we kicked off a new, monthly Social Velocity blog interview series where I interview leading thinkers and doers in the social innovation space. Our inaugural interview was with Kevin Jones co-founder of both Good Capital, one of the first venture capital funds that invests in social enterprises, and the Social Capital Markets Conference (SoCap) which marks its third year with the upcoming October event.
This month’s Social Velocity interview is with Clara Miller, President, CEO and founder of the Nonprofit Finance Fund, a national leader in nonprofit, philanthropic and social enterprise finance. Directly and with others, NFF has leveraged $1 billion of capital investment into nonprofits, and provided over $200 million in direct loans. Clara Miller was named among The NonProfit Times “Power and Influence Top 50″ four years in a row and is a board member of GuideStar and Grantmakers for Effective Organizations.
Nell: You and the Nonprofit Finance Fund have initiated this idea of equity capital for nonprofits, or money to “build” organizations rather than the tradition funding to “buy” services. Do you think the idea of equity capital for nonprofits is catching on?
Clara: First of all, I should say that many people have contributed to the idea of a nonprofit version of equity over the years. My NFF colleague George Overholser has been a field leader. He focuses almost exclusively on the version we call “growth” capital, which is used to rapidly build organizations, changing what they do through major investment undertaken around a single set of metrics, business plan, and ideally, with all funders acting in concert.
And yes, I do think the broader notion of “equity”—and for that matter, the importance of the balance sheet in its entirety—is catching on, especially among major foundations, capital campaign veterans and those familiar with these concepts in the for-profit world. The broader concepts of “building” organizations and “buying” services, and how financial roles differ, are resonating strongly with both organizations and funders. We have a foundation partner that has simply put the question, “is this a “buy” grant or a “build” grant?” on the program officers’ intake checklist.
Nell: How do traditional nonprofit capital campaigns, which are predominantly focused on raising money for new buildings, fit into all of this?
Clara: We think these “growth capital” and “equity” principles comprise an ideal way to think about (and operate) a successful capital campaign. Our early work in the 1980s (when we were Nonprofit Facilities Fund, and exclusively financed “community facilities” with loans) revealed that a rash of problems would almost invariably follow capital campaigns for facilities: cash crises, burnout, funder fatigue, “night of the living dead” program operations, the need to lease excess space at below-cost rent…you get the idea. It was a real eye opener. We learned a lot about the need for truly unrestricted “growth capital,” in addition to funds focused (and often restricted) to build and fit out the facility. Among the NFF-documented lessons: that facilities projects typically need 3 to 4 times the bricks and mortar cost for working capital to cover program and administrative growth needs; that the building frequently changed the business model radically, but planning never covered the whole enterprise; and that putting large amounts of cash into an illiquid asset while expanding operations was problematic on a number of levels. Also, many of these building projects came with opportunity costs: organizations weren’t investing in new technology, upgrading skill sets, or replenishing cash reserves.
Beyond facilities projects, capital campaigns frequently focus on other (typically illiquid) parts of the balance sheet: building an endowment, or on the acquisition of, for example, a program asset (such as a painting or piece of medical equipment). Thinking holistically about improving or acquiring illiquid assets, via a campaign for growth capital, can better the situation.
Nell: The for-profit sector currently enjoys a broader and deeper array of financial vehicles than does the nonprofit sector (seed funding, angel investors, growth capital, stacked deals, etc.) do you anticipate that the capital market for nonprofit organizations will become more robust and what will it take for that to happen?
Clara: I’ll push back a little and say that the vast majority of both nonprofits and for-profits (that are small, with less than $200K in revenue) have approximately the same level of access to similar financing vehicles: sweat equity, seed/angel funders/investors (friends and family, the first foundation grants, etc.), credit card debt, bank loans, retained earnings, etc. Then there is “growth capital” or “capital grants,” which a very small proportion can access in either sector. And while large for-profits are much, much larger than large nonprofits, large nonprofits have reliable access to some highly sophisticated funding and financing vehicles that for-profits don’t (and vice versa). Some very large nonprofits have access to for-profit subsidiary ventures and investments—and some are highly sophisticated (universities investing in development of intellectual property and associated products, CDFIs with venture funds, public media with development and sales of program assets, and others). And on the debt side, much of nonprofits’ “capital market” is for-profit-run (bank debt, investments, tax-exempt bonds, etc.)
The most important barrier to enterprise scale (for either sector) is not so much lack of access to capital as it is a scalable, focused business model with reliable net revenue. Once you have those—or evidence that they are possible—capital will flow.
But that said, we’re talking about a couple of “market wide” dysfunctions. The first is that despite highly resourceful managers, sophisticated board members and billions of dollars of revenue and capital funds, there is no tradition of “enterprise finance” in the sector. “Pretty bad ‘best practices’” designed to make nonprofits more efficient and fiscally prudent cost the sector dearly. Confusion about the direct funding of programs (it’s not possible, most of the time you need to fund an enterprise to deliver programs) means capital is mixed up with revenue, growth with regular operations, and “build” grants with “buy” grants (and a variety of hybrids!). This wreaks financial havoc in growing organizations. Missions—along with the public—suffer.
The second problem is that there’s no really reliable signaling mechanism for organizations to fold their tents, pass their programs to another organization, and go out of business. In the for-profit world, that would be financial failure; in our world, that’s not so straightforward: so we hang in there, meaning resources that might go to a stronger program remain tied up. It also means that the biggest and richest players have (and, largely, keep) the vast lion’s share of resources (even more pronounced than in the for-profit world).
Finally, there is a problem with access to charitable revenue. Promising, mid-sized organizations—especially those serving low-income people (and therefore lacking access to the traditional source of capital in the sector, individual donors) have a difficult time building the operation they need to grow. Foundations are the logical path here, and having foundations embrace “enterprise friendly” practices—including growth capital and build-buy understanding—can go a long way toward changing that dynamic. Establishing a field-wide understanding of basic enterprise finance principles will help insure that growth capital campaigns become true innovation with long-term staying power, rather than a short-term novelty.
Nell: Growth capital for nonprofits is mostly only available to larger nonprofits that have the capacity to prove the results of their model. Do you think growth capital will increasingly become available to the bottom 80% of nonprofits (those with a budget less than $1 million), and how and when do you see that happening?
Clara: Our goal is not that all organizations of every size and business model have access to growth capital and pursue aggressive growth goals ASAP. That’s neither possible nor desirable in either the for-profit or the nonprofit worlds. In both sectors, some business models may not be scalable, and that’s ok—in fact, it’s good. Nobody wants their favorite neighborhood clam shack or Italian restaurant to go public or become a Pizza Hut. Diversity is good; and most people like things about both large and small enterprises. This is true in any sector, where economies of scale and preservation of quality are frequently subject to the laws of diminishing returns. Growth capital is not for everyone, and it is only one tool in the enterprise tool box.
The more important revolution is to make broadly accessible the tools and principles of enterprise finance—with a clear understanding of the realities of the commercial proposition of the sector (i.e., there’s a reason we have a nonprofit sector). There are well-managed and poorly managed (and capitalized) enterprises of all sizes and tax statuses, and there are scalable and non-scalable ones as well. Most critical on the scaling front is that our sector embraces and deploys the broad set of principles that make enterprises of any size or shape effective in reliably achieving great results. Trouble arises when a specific social benefit or innovation is so compelling that we all want the maximum number of people to benefit from it: Our failure to use the principles of growth capital and proper scaling techniques to assure results while growth proceeds is (and has been) tragic for the social sector, and a change in practice can help.
Nell: How do you think the Social Innovation Fund will change the capital landscape for nonprofits?
Clara: I think the SIF already has raised the profile of the ideas around growth capital and scaling discussed here. And it certainly has the attention of a group of large foundations, a significant number of whom are applying as intermediaries. I think it took courage for them to apply, and courage for the SIF to get developed. At the beginning there will be some fits and starts, and government procurement can be dicey (especially when it’s trying to be capital rather than revenue), and foundations are trying to make it work in this way for the first time. That said, it’s very exciting for us to see “growth capital,” which is the core concept, being given a whirl by both the White House and the Foundation world.
Nell: Venture philanthropy funds (that provide growth capital to nonprofits) and social venture capital funds (that provide capital to double bottom-line businesses) currently don’t interact very much in the marketplace. Do you see an opportunity for greater integration of nonprofit and for profit social investing? And if so, what will it take to get there?
Clara: I think there is increasingly frequent interaction between for-profit and non-profit business models (and entrepreneurs) on the conceptual level, and that’s being translated into some compelling platform-agnostic enterprise structures to accomplish social ends in many sectors—health care, research, arts and culture, media, housing—are all examples. And interactions may not be best between two enterprises that are both at the “venture” or “start up” stage. A start-up nonprofit may want to partner with a fully-scaled for-profits (and this is common), while a fully-scaled nonprofit may want to create (or house) a venture for-profit to help reach certain social goals.
On the “deal” level, I think there’s a reason to maintain a bright line between the nonprofit and for-profit tax status. I favor crisply defined hybrids (of which there are a variety) over mushiness (we’re a for-profit but we are good people doing socially beneficial work) because they are more likely to stand the test of time and skepticism, and since ownership and tax structures have bright-line legal and moral duties attached to them.
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