Last year, Nonprofit Finance Fund released a report looking at the performance of the philanthropic equity deals they have done over the past four years. I was remiss in not writing about it at the time and I thought doing so today would be a good follow up to my last post about “crowding out” of private donations.
You can get an understanding of what philanthropic equity is via this column I wrote a couple of years ago. In short, “revenue” is earned income or fundraising done from donors who are making the donation so that the nonprofit can deliver their programs to the intended beneficiaries. “Equity” is donated money that is given by donors who are making the donation to support the growth of the nonprofit organization. In the for-profit world, customer money is revenue and investor money is equity.
George Overholser explained this concept in his seminal paper Building is Not Buying in which he termed donors providing revenue as “buyers” and donors providing equity as “builders”.
Four years ago, then president of Nonprofit Finance Fund Clara Miller gave George and Craig Reigel the go ahead to launch NFF Capital Partners. The group offers services to nonprofits that wanted to raise philanthropic equity. One critical aspect of the service is their Sustainable Enhancement Grant (SEGUE) accounting methodology. Since nonprofit accounting books all money coming into the organization as revenue, the team needed to build an alternate accounting system to track the philanthropic equity.
By 2010, NFF Capital Partners had led 11 philanthropic equity deals totaling $116 million and advised on another $196 million.
Their performance report shows that since initiating the deals, the nine nonprofits for which there is multiyear data have grown program delivery at an annual rate of 57% and grew revenue (excluding the raised philanthropic equity money, since it was properly accounted for as equity, not revenue) at an annual rate of 36%. This growth rate puts the organizations into the top 2% of fastest growing organizations in their cohort (organizations with budgets between $1 and $20 million).
The full report offers a short case study of each deal of which I’ll highlight two:
- DonorsChoose.org worked with NFF to raise $14 million in philanthropic equity with Omidyar Network and AIG as lead investors. To-date, DonorsChoose has burned through $6.5 million of their equity on the way to building their fee-supported business model, which is on track to achieving full sustainability. They now spend no time engaged in ongoing fundraising. Program delivery has grown at an annual rate of 58% and revenue has grown at a rate of 65%.
- Year Up raised $19.3 million in equity while working with NFF. Lead investors included Jenesis Group, Strategic Grant Partners and New Profit. Year Up depends on a combination of fundraising at the national and local site level as well as revenue from the corporate internships at which they place students. Since raising equity, they have grown students served by an annual rate of 31% and revenue at a rate of 18%. Year Up views themselves as now being at 74% sustainability with sustainability based on the degree to which local fundraising from the public and internship revenues cover total expenses.
The nonprofit sector suffers from a massive inability to scale. Since 1970, only 144 nonprofits have grown to surpass the $50 million a year in revenue mark. During that same time, 46,136 for-profits have cleared the $50 million hurdle. There is nothing fundamental about the nonprofit corporate structure that prevents growth. Yet accounting standards that fail to recognize nonprofit equity strip away the single most important building block to growing an organization. Without equity, an organization is forced to live on the revenue they gather each year and lack the ability to make meaningful investments in growth opportunities.
It is critically important that equity accounting be officially recognized in nonprofit accounting standards.
4 Comments
Sean,
Thank you much for the kind words. As usual, you’ve hit the crux of the story.
As you point out, the stories of building transformative, substantial nonprofits are all too rare. Our work at NFF on an accounting treatment for philanthropic equity is about shining a bright light on the recurring economics of enterprises, i.e. the rest of the story. Today, organization that choose to offer that transparency can create those reporting structures. Our sector will be well served when FASB requires all recipients in equity infusion provide this transparency.
Accounting standards are developed to protect the interests of stakeholders. 501(c)(3)’s stakeholders are, by definition, their communities. When FASB ensures that protecting community interest in the financial health of a nonprofit carries the same burden as protecting a profit seeking investor’s interest in the financial health of a commercial enterprise we will have a meaningfully different set of tools. Sean, thank you for advocating such standards.
When that happens, the important part of the story will not be the millions of dollars raised in equity campaigns, but rather the many more millions of dollars of services provided annually by those enabled by these equity campaigns. Call me a geek, but I cannot wait to be able to discern the differnce by reading posted audited financials.
Craig Reigel
Glad I hit the mark Craig. Don’t all nonprofits have equity, even those that don’t proactively raise it? When someone starts a nonprofit with $10,000 of their own money and free rent from a foundation that let’s them work out of an empty office, isn’t their $10,000 and the free rent equity? So shouldn’t all nonprofits be subject to equity accounting, not just those that proactively seek an equity infusion?
Sean,
In essense all nonprofits do have equity. In your example, $10,000 invested by the fouder should be equity (it acts like paid in capital, and is held on the balance sheet unless and until it is spent). The free rent probably should be regarded as a contribution and revenue, although the point becomes moot as it gets expenses in the same time and never finds its way to the Statement of Financial Position (balance sheet).
In the for-profit universe, one of the essential attributes of equity is that the ownership stake it buys is negotiated, and in fact the characterisation on the balance sheet is strictly a function of that negotiated agreement. It is essential both how much money comes in, and what claim on the net assets of the organization are offered in return.
Among nonprofits, donor intent (essentially the agreement under which the funds are accepted) rules the treatment of contributions. Philanthropic equity standards should be consistent with that. One might see among net assets a line item for Philanthropic Equity invested showing intentional equity investments, and another line for accumulated net assets reflecting other sources of “equity”, including both contributions and accumulated surpluses.
When I asked that FASB take this on, I did not say it would be easy.
It’s good to hear that some innovative thinking is going into nonprofit accounting and funding. Nonprofits must have support that covers infrastructure and capacity building if they are to scale as rapidly as social problems seem to be scaling.