New York Times Features Third Sector CEO & Co-Founder
"For Ambitious Nonprofits, Capital to Grow"
by DAVID BORNSTEIN - New York Times - June 27, 2012
Imagine that you’re an entrepreneur running a chain of coffee bars and you want to raise capital to open up in new locations. You meet a potential investor, and he says, “I’d love to finance your business, but only the chai latte operation, not the coffee, and only to support drinks you sell in Cleveland next year.”
It might sound absurd, but this is the kind of thing that people running nonprofit organizations hear all the time. Whether they are providing housing or preschool or vocational training services, social organizations typically find their funding restricted to specific programs, locations and time frames. That doesn’t make it easy to grow.
That’s why even the best social organizations grow slowly compared with companies. As a result, very few nonprofits ever go national — and those that do take the better part of a century to get there. While things are improving for nonprofits in this regard, the situation is nowhere near as efficient as it is in the business sector, where successful companies like FedEx, Home Depot or Google can raise the money they need to build national or global operations in a decade or two.
What if great social organizations could grow the way companies do? Could we solve our social problems more effectively if we improved the way we finance them? There are actually many modest-sized organizations that get impressive results, doing things like boosting academic achievement, preparing unemployed clients for good jobs, getting homeless people into supportive housing. If they were businesses, they would attract investment. As nonprofits, however, they are like Ferraris on a dirt track. What if we could figure out how to help high-performing organizations get on the highway? Could success become more the rule and less the exception?
One organization that is exploring this question is the Nonprofit Finance Fund (N.F.F.) Capital Partners division, which has developed a creative model for helping successful nonprofits raise what it calls “philanthropic equity” — grants that mimic the institution-building function of for-profit equity. N.F.F. Capital Partners reports that, since 2006, it has advised 18 organizations that have raised $326 million in donations to finance growth, and in turn, those organizations have markedly increased their impact.
N.F.F. Capital Partners was established in 2006 by George Overholser, a former venture capitalist and strategy consultant who saw an unmet financial need in the social sector. The year before, Overholser had helped College Summit, a highly regarded program that helps disadvantaged youth enroll in college, prepare for a growth leap. The organization’s founder, J.B. Schramm, wanted to try to raise college enrollment rates across whole schools and districts in low-income communities rather than student by student. Overholser saw that the organization couldn’t do it by cobbling together a bunch of short-term grants. Businesses don’t raise capital that way. If College Summit were a business, it would formulate a growth plan, go out and raise equity, and execute the plan. They decided to try it out.
Nonprofits can’t raise real equity because they don’t have owners. The question was: Could College Summit convince funders to provide large multiyear grants as if they were investing in a for-profit — and would it change things? “There is a fundamental difference between equity and revenue,” explains Overholser, who recently co-founded a new firm called Third Sector Capital Partners. “The role of equity is to pay the bills while something learns to fend for itself.” Equity pays for mistakes and unanticipated problems — hiring the wrong people, expanding to the wrong locations — as managers figure out how to operate at an enhanced scale on a continuing basis.
Equity isn’t money you live on; it’s episodic. Corporate chiefs may embark on fund-raising rounds for a few months every number of years. This stands in contrast to nonprofit C.E.O.’s, who are continually on a fund-raising treadmill. Philanthropic equity is aimed at building an enterprise. By contrast, grants or fees usually buyservices for needy beneficiaries — housing, tutoring, foster care, health services and so forth.
Simply put, builders and buyers think differently. “If you invest in Starbucks, what you care about is Starbucks being healthy over time and lots of people buying the coffee and, in fact, you want the coffee to be high priced,” explains Craig Reigel, current managing director of N.F.F. Capital Partners “But if you buy from Starbucks, you care about getting the best cup of coffee for the lowest price. The way you think about success is completely different.”
Many large foundations approach their work as builders, of course. But most are buyers. And the biggest funder of all — government — is decidedly a buyer. What would happen if everyone in the nonprofit sector paid more attention to the differences between build and buymoney like everyone does in business? Would it help more organizations grow to their potential?
College Summit developed a four-year growth plan that required $15 million in equity (its budget was $9 million at the time). The organization’s board chair, Charles Harris, a recently retired executive from Goldman Sachs who is now director of capital aggregation at the Edna McConnell Clark Foundation (which has a major growth financing initiative of its own), suggested that they raise the money the way a company would seek a “private placement” of capital. “We held a series of roadshow meetings with finance executives to share the opportunity and seek their support,” recalled Harris. “This was not about designing a program on the basis of funder wishes.” They raised the money in nine months.
What amazed Schramm was that it was possible to raise money against a plan and that all the investors signed on to the same goals and reporting requirements — a social entrepreneur’s dream. Over the course of the four years, College Summit built expertise, trained staff around the country, identified new partners, developed new measurement tools and grew from serving 3,600 students to 17,000 per year. It now has a more efficient model and serves about 50,000 students in 175 schools. The challenge, as always, is maintaining itself at this level or, perhaps, scaling up again.
After 2006, Overholser and his partner Reigel developed a standard approach to help others. “We showed them how to set up a process to track and report how things are going, an accounting system to keep the equity and revenues separate, and tools so that everybody — donors, management, the board — can be on the same page and see how it all works,” explained Reigel.
One of their clients, VolunteerMatch, which helps Americans find volunteer opportunities online, raised $4.2 million in equity to upgrade its Web platform and fee-based services. Since 2007, the organization has doubled its impact, facilitating more than 620,000 volunteer connections in 2011. “If we had tried to go a traditional philanthropic route, it wouldn’t have happened,” explained Greg Baldwin, the organization’s president. “You can’t build an operation and scale it if you’re trying to package 15 different programmatic grants that all have different goals based on the priorities of 15 different foundations.” The growth plan got everyone aligned.
Year Up, an organization I’ve written about in Fixes that provides vocational training to disadvantaged youth, also worked with N.F.F. Capital Partners to develop a “prospectus” that enabled it to raise $20 million in growth capital and triple its reach within four years. Year Up supports itself mainly through a combination of philanthropy and fees from companies.
Another web-based organization that made a leap after raising a round of growth funding is DonorsChoose.org, which brokers connections between citizen philanthropists and classroom teachers. In 2006, DonorsChoose.org was generating $2.6 million worth of funding for teachers’ projects. In 2007, it raised $14 million in equity-like funding from the Omidyar Network and several other investors and used the money to improve its technology platform, expand nationally and strengthen its revenue generation. By 2011, the organization was covering its $6 million operating costs with user fees and generating close to $26 million worth of funding for classroom projects, a ten-fold increase in five years.
Whether an organization grows depends on factors beyond capital — including opportunity, need and, above all, entrepreneurial leadership. Most nonprofits, like most businesses, will never grow large. But the ones that have the potential to achieve major impact shouldn’t be stunted by a fragmented grant-making system.
That said, there are risks to seeking equity-like financing. At College Summit, Schramm and his colleagues found themselves under pressure to quickly assemble the right team to mobilize local and national philanthropy and bring in fees from schools to maintain a higher level of operations. “The danger with growth capital is that the organization grows dependent on it,” says Schramm. “If the operation isn’t covering its ongoing costs, you can build up a huge deficit that’s invisible until the money runs out. Then you fall over a revenue cliff.”
Philanthropic equity will likely become more important in coming years. As Tina Rosenberg reported in Fixes last week, with tools like social impact bonds, social investors and governments are focusing more on measurable outcomes. Social organizations are going to have to respond. “Social impact bonds will create another form of ‘buy’ money,” notes Antony Bugg-Levine, chief executive of the Nonprofit Finance Fund. “But many nonprofits are not prepared to succeed in a world that’s based on governments paying for outcomes. They’ll have to transform themselves — and that will require more ‘build’ money so they can invest in better systems.”
The changes are already underway. As governments cut back on the fees they’re paying nonprofits, many groups are faced with overhauling their systems to run more efficiently. These institutional changes also require equity-like financing. In fact, Bugg-Levine calls philanthropic equity “change capital” rather than “growth capital.” Change is afoot.
“Nonprofits aren’t just useful, they’re valuable,” notes Craig Reigel. “That means one can and should invest in them — and that’s different than buying things from them.”