Sean is a visionary leading the charge to transform philanthropy. He is CEO of Tactical Philanthropy Advisors, a philanthropy advisory firm. He is also the author of the very popular Tactical Philanthropy blog and writes a monthly column for the Chronicle of Philanthropy. He is a member of the World Economic Forum’s Council on Philanthropy & Social Investing and his insights on philanthropy have been referenced in The New York Times, Wall Street Journal, Washington Post, and Financial Times.
Nell: At the first Social Capital Markets Conference (SoCap) in 2008 one of the keynoters said “we’re not here to talk about nonprofits.” We’ve come a long way from there to this year’s devoted track around philanthropic capital and the nonprofit space at SoCap. Where do you think the initial hesitance to connect philanthropic and impact investing came from? And how do we continue to integrate the two worlds?
Sean: I think that one of the segments of people who are attracted to impact investing are people who think philanthropy doesn’t work. While I view philanthropic and for-profit social capital to be part of a single continuum of capital, many people seem to feel that they are fundamentally different. Like most new ideas, early adopters often think it is a silver bullet that will “change everything”. Some early adopters of impact investing or other forms of for-profit social capital wrongly believe that impact investing will replace philanthropy. I think this is a fundamental misunderstanding. Continuing to integrate the two worlds will require helping the various points on the capital spectrum better understand each other. At the end of the day, capital shouldn’t be viewed through an ideological lens, but should simply be deployed based on what sort of capital fits the situation.
Nell: The SoCap session on nonprofit rating systems like Charity Navigator and GiveWell demonstrated that there is still quite a divide between GIIRS (the impact investing rating system) and nonprofit rating systems. What is your sense of this? Do you think there is potential to somehow combine GIIRS (or something else) and nonprofit rating systems so that there is one comparable impact measurement system?
Sean: I would guess that any truly effective impact measurement system should be functional across both for-profit and nonprofit activity. A good impact assessment system wouldn’t care about the tax status of the entity producing results, it would just care about the results and the cost of obtaining them. That being said, I think evaluating a nonprofit organization is really quite different from evaluating a for-profit organization. So even if we have a unified impact assessment framework some day, I would guess that organizational assessment will utilize different systems and approaches for nonprofit and for-profit organizations.
Nell: How would you like to see the conversation about connecting philanthropy and impact investing evolve at SoCap11? What are your hopes for next year’s conference?
Sean: I’d like to work to profile more examples of ways that for-profit and philanthropic capital worked together to produce social impact. Our session on Evergreen Lodge at this year’s conference looked precisely at this question, but I’d like to see more examples. I’d also like to see examples of ways philanthropic entities have used for-profit investments or subsidiaries well or for-profits have effectively used philanthropic activities to drive profit and social results. However, one of the most important goals is simply getting the different players into the same room and getting them to come to understand each other better. While Kevin Jones and I had a good time talking about the Social Capital Markets as a meeting ground for the Barbarians and Byzantine, in reality none of us are barbarians.
Nell: Beyond SoCap where do you think the important conversations about unlocking philanthropic and government capital for social impact are happening?
Sean: This is an interesting question. SoCap is special because it is one of the only (the only?) conference that is specifically about capital for social impact without regard for sector. But versions of this conversation are happening around Grantmakers for Effective Organizations, The Social Innovation Fund, online and in a different sort of way at the PopTech conference.
Nell: At the last general session of SoCap Woody Tasch of the Slow Money movement said he doesn’t think mission-related investing will ever be adopted by the majority of foundations. What are your thoughts on that?
Sean: Social Responsible Investing, the practice of screening out stocks of tobacco companies, defense contractors and the like from investment portfolios, is not practiced by a majority of investors. Yet, SRI is very mainstream and has significantly altered the behavior of publicly traded companies. Today, SRI mutual funds are one of the fastest growing areas in money management. So I don’t think that the majority of funders have to adopt mission related investing for the concept to be deemed a success. It should be noted that SRI took a good 20 years or so to go mainstream. So it could be some time before mission related investing is considering mainstream.
Nell: And more broadly, what do you think it will take to change how philanthropists (both foundations and individual donors) use money to support social impact? How do we make more donors builders instead of just buyers?
Sean: Today, I think that very few people in the social sector really understand what “philanthropic equity” is and how capital differs from revenue. Nonprofit accounting does not acknowledge that capital even exists in the sector. Nonprofits can only book cash coming into their business as revenue or a loan. There’s no official way to account for equity-like capital. So I think that there needs to be a pretty major education effort to get the whole sector very clear on how fundamentally different it is for a funder/donor to “invest” philanthropic equity in a nonprofit vs paying a nonprofit revenue to execute programs. Personally, I don’t think much progress will be made until nonprofit accounting changes. Until that happens, it doesn’t matter much what we call “growth capital”, it is all just revenue to the nonprofit.
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.