Curmudgeonly Comments: Online Capital Markets for Nonprofits?

This is a guest post from George Overholser of the Nonprofit Finance Fund. This post follows the bullet point format George used when he wrote the Bullet Point Manifesto guest post last year.

By George Overholser

George Overholser

  • Someone recently defined nonprofit “mid-caps” as organizations with revenues in the $5 million to $25 million range.
  • We need to keep in mind that the definition for for-profit mid-caps is 200 times as big:  revenues in the $1 billion range.
  • This matters because there are metaphors flying around that we need our nonprofit mid-caps to provide more financial disclosure to the “capital market”, just like for-profit mid-caps.
  • This is the equivalent of asking a guy who owns a couple of pizza restaurants ($5 million in revenues) to begin publishing detailed quarterly public reports of his financial and quality assessment results.  Problem is, his office is the kitchen table, and he needs to get up at 6am every morning to roll the dough.
  • Wall Street is the wrong metaphor for an online “nonprofit capital market”.  Wall Street only works for companies that are literally hundreds of times bigger than typical nonprofits.  Wall Street companies get easy access to equity, precisely because they are already so advanced that they can afford to provide exceedingly high levels of financial transparency.  But the vast majority of firms (for-profit and nonprofit alike) are nowhere near the size required to afford the cost of making these types of disclosure. That’s why the vast majority of firms are capitalized privately, by intimate investors who get to know them personally.
  • Let’s not kid ourselves into thinking that strategic equity-like investments should be made based on the snippets of data that an exhausted executive director posts on a web site.
  • If information is to be shared online, the better metaphor is Amazon.  The better information to share is more akin to marketing information than to investor information.  Keep it simple:  What am I buying with my donation?  What gets done as a result?  What does it cost?  And… for those very few that have gone through the arduous and expensive process of scientifically documenting impact, yes, what is the impact?
  • DonorsChoose is a great example of this.  Check it out:  a highly intimate and transparent giving experience that has no need to share information about the financial health of the DonorsChoose enterprise, management team, strategic plan or theory of change.
  • Simply “asking harder” for information does not address the issue.  The problem is not one of candor.  Rather, the data does not exist, and cannot be afforded by such small and stressed-out organizations.  Asking harder merely adds to the trauma.
  • If a prospective investor comes along, who is prepared to write a big equity-like check, then have a face-to-face meeting, so that real due diligence can take place.  In the meantime, I would love to see online marketplaces focused on products and services… like Amazon and DonorsChoose!

    1. Kevin Hodgkins says:

      The IRS’ 2005 SOI Exempt study shows ~25% of 501(c) exempt organizations falling into the $5M-$25M annual revenue category. This data is a sample of ~25,000 exempt organizations. I will take it for granted that their statistics are valid and not too much different from 2009/10.

      Using my own unscientific sample from this data filtered down to those firms with between 5 and 25M in annual revenue I find that they are very UNLIKE the small pizzeria owner. Sample firms include the Atlanta Convention Bureau (12.5M revenue), Unitus (5.5M), Daybreak Inc (5.7M), Ferrum College (24.5M). Many of these organizations, especially at the higher end certainly have the capability of providing financial reports and probably some level of narrative based outcome reports.

      I agree with Mr. Overholser (using his terminology) that the “buying” side of the funding marketplace needs developed before the “building” side and that is a good place to start. The “building” side of the funding marketplace needs built as well though, and it starts with firms providing as much information as possible. Investors (contra donors) will determine their investment level based on the value they ascribe to the firm’s activities according to the information available and their individual valuation calculus. This may mean that their is no investment made, or it may lead to a one-on-one meeting before placing a large investment, or it may mean a large investment completed through the online marketplace.

      The key is to start the marketplace, not to worry about its makeup and information standards at this time. It will develop over time just as for-profit capital markets did.

      I thank Mr. Overholser for his writings on nonprofit capital, they were valued and cited in my recently completed MPA thesis; UNLEASHING THE POWER OF NONPROFIT ENTERPRISE: THE HISTORY AND ECONOMICS OF NONPROFIT ENTERPRISE AND HOW EQUITY CAPITAL CAN MULTIPLY ITS IMPACT found at .

    2. I’m the “Someone [who] recently defined nonprofit “mid-caps” as organizations with revenues in the $5 million to $25 million range.” George taught me almost everything I know about “patient capital” and he was extremely generous in reviewing drafts of my book, so it is with some reluctance that I offer just one small point of clarification: I do not think that “we need our nonprofit mid-caps to provide more financial disclosure to the “capital market”, just like for-profit mid-caps.”

      Mid-cap nonprofits desperately need growth capital to bring their proven innovations to many more people. Those million dollar-plus asks are greater than traditional fundraising can provide but smaller than the kinds of “equity-like checks” that financial intermediaries like NFF Capital Partners or SeaChange Capital Partners broker for a small number of exceptional organizations. To attract that kind of growth capital, mid-caps need to walk a middle path between the depth and breadth of information common in traditional fundraising and the really rigorous prospectuses and other due diligence documents required for equity-like investments. Rather than just explain their programs and provide anecdotal stories of success, mid-caps need to convince donors who want to maximize the impact of their giving that (1) they have a compelling plan for exponential growth and (2) they will make very good use of larger, longer and less restricted grants to carry out their ambitious plans.

      Mid-cap nonprofits that want to attract growth capital funding certainly don’t need to provide as much information as $1 billion for-profits are required to produce under Sarbanes-Oxley or stock-exchange rules. But they do need to provide enough information about their finances, their organizational capacity and their results to convince impact-minded donors to place substantially bigger bets on “investing in what works.”

    3. Kevin, from the abstract, your thesis looks fascinating. I’ll be sure to check it out when I get a chance.

      I’m sure George will weigh in on his own, but I agree that a nonprofit capital market should be built now and figured out along the way. While your rebuttal makes a lot of sense, I think George’s argument gets really compelling for for even smaller organizations. In the nonprofit space, orgs with as little as $1mil in revenue can be of interest to social investors and I think it is critical that we respect the need for emerging organizations to maintain a degree of privacy that would not be appropriate for larger orgs.

      Thanks for adding your thoughts. This is all part of the development process that your comment points to.

    4. George Overholser says:

      Thanks Kevin, Steve and Sean.

      This is a great conversation.

      One thing to know is that almost all of the 15 deals we’ve worked on at NFF, involving $300 million of philanthropic equity commitments, (not our money, I hasten to add!), have been organizations that fall into the $5 to $25 million revenue range. True, they are not like small pizza shops. (I was thinking about a string of big Bertucci-style ones, but your point is well taken.)

      And, yes, certainly all of our clients are able to produce financial reports, as should even very small organizations. On the other hand, the reporting they do requires all sorts of interpretation. Unlike true for-profit mid-caps, which, being more than 100 times bigger, have entire investor relations departments to help answer questions from debt and equity analysts, these organizations are very thinly staffed. Also, their business models are often far from fully formed. Unlike true mid-caps, they are riddled with all sorts of extraordinary expenses and extraordinary revenue items that require nuanced interpretation.

      Like many venture capital investments, they have a lot of what, in the vernacular, is called “hair” on the deal. “Hair” means that the investment thesis is not straightforward, that a simple review of the numbers does not tell the investor what the investor needs to know about the risks and potential rewards related to the the investment. Is the management team up to it? Is the way money comes in scalable? Is the board active and aligned? Is there a well-crafted strategy? Does the operational plan support the strategy? Does the technology work? What’s going on competitively? Is there a track record of crisp execution? A culture of performance? And so on.

      My main point is that we are fooling ourselves if we think good growth capital investments will take place in the absence of deep due diligence. Online databases simply can’t tell the story.

      Online platforms can, however, do a good job at describing the simple stories of “What’s for sale?” and “How much does it cost?”… Like Amazon.

      Think of it like this: when we buy tutoring from Kaplan for our own kids, we don’t examine Kaplan’s books. Why, then, when we buy tutoring for someone else’s kid’s do we necessarily have to act like an equity investor?

      And…. when Kaplan first raised its equity growth capital, no doubt it wasn’t in the form of hundreds of small checks, via a web site. Why not raise a high performing nonprofit tutoring organization’s capital from a small number of deeply involved investors?

      I’m hot on this topic because I so often see sub-scale nonprofits go through hell as they try to respond to constant custom data requests from small check-writers. Much better, I think, to go through the due diligence process once and for all with a small handful of big checkwriters, so that future revenues can be raised around the simpler story of money in exchange for program execution.

    5. George Overholser says:

      (So maybe, Steve, we are saying the same thing!)

    6. The NFF Capital Partners model is definitely superior for the kinds of deals you’re getting, and many more organizations — including those above $25M — should explore SEGUE. But how many deals could NFFCP hope to handle? 100? 500? That leaves well over 50,000 mid-caps in the $5-25M range. Of course, the vast majority of them aren’t ready to make a compelling case for growth capital, but I’ll bet at least a few thousand are. I submit there’s a mid-cap investment market waiting to form comprising large numbers of unaffiliated givers (primarily individuals) who would want to pool their support for high-impact nonprofits that would be eager to provide much more information than sub-$5M NPOs typically offer donors, but much less information than NFFCP requires for full-blown due diligence. If those donors want a way to “invest in what works” at a scale that might actually move the needle of social progress, and those NPOs want to make the effort to show that they can pull it off, I say that’s an experiment worth conducting.

    7. It seems to me that the individual donors who would want to participate in an online giving marketplace would likely invest relatively small amounts of money and therefore not require the sorts of due diligence that George us use to. But these markets could over time provide significant amounts of aggregated growth capital.

      I think one of the key attributes of such a market would be information about “lead investors”. In other words a donor who did minimal due diligence could find great comfort in the idea that the Gates Foundation had invested $5 mil in growth capital within the last year and a number of other large institutions were in for $5000k each. But I agree with George that those “lead investors” would require far more access and info than the online market could provide.

    8. kevin jones says:

      many existing for profit marketplaces have tiered engagements that allow what you are suggesting, Sean. Everybody gets something, big players get more, deeper. The difference is in this space the big money does want to show what it is doing and why. That’s a real advantage the non profit capital market has over the for profit capital market. Signaling is a virtue, not loss of the the time value of money for the smartest operators.

    9. Chris says:

      I like George’s example of buying test prep books from Kaplan without inspecting Kaplan’s accounting books. But interestingly, I think we start caring about the selling firm’s financial position when that financial health influences the value of the product/service we receive. For example, a car company’s sales suffer when the firm starts teetering on the edge of bankruptcy–because it puts future service and parts (an aspect of product value) in jeopardy. While most nonprofits don’t offer “service and parts” five years after the original purchase (donation), they do struggle with measuring and communicating the social value purchased by a donation. Lacking clear signals of quality (social value), some donors look to financial health as a signal (and component of quality)–like they do when buying a car–even though it’s a very poor proxy for quality. I think what this means is that nonprofits have to get better at articulating the value of what donors are buying; and the sector in general has to help smaller donors recognize that they are buyers, not builders, and a firm’s finances often have little to do with what immediate good will come from this year’s donation.

    10. Which takes us back to Kevin Hodkins’ point, I think: :The key is to start the marketplace, not to worry about its makeup and information standards at this time. It will develop over time just as for-profit capital markets did.”