This is a continuation of my exploration of four core approaches to philanthropy.
- The Charitable Giver
- The Philanthropic Investor
- The Strategic Philanthropist
- The Social Entrepreneur
The Philanthropic Investor seeks to invest resources into nonprofit enterprises in order to increase their ability to deliver programmatic execution. It is classic “builder” behavior as defined in George Overholser’s Building is Not Buying. The Philanthropic Investor, like a for-profit investor, is primarily focused on the longer term increase and improvement in programmatic execution relative to grant size.
Unlike the Charitable Giver who is looking to buy program execution that delivers a good value, the Philanthropic Investor is interested in how their grant dollars can be put to use to build the nonprofit enterprise. While nonprofit accounting does not recognize “equity” on the balance sheet, Philanthropic Investors are providing equity funding, not revenue to their grantees.
All nonprofits have equity even if it it not recognized by accounting standards. Equity is simply money put in to start the nonprofit (which may be the founder’s capital for a very small nonprofit), surplus generated by the nonprofit (any extra money left over from fundraising, fees for service, etc after all expenses are paid) and retained at the end of the year, and any money given to the nonprofit for purposes of growing (as opposed to in exchange for program execution).
When an equity investor in a for-profit or a nonprofit provides equity, their expectation is that the organization can use those funds to grow their organization in such a way that future earnings or social impact will be enhanced. This can be done either by increasing the volume of business (more sales or more program execution) or by increasing the profitability/impact of the existing level of business (ie. reducing internal costs or getting more impact per dollar of program execution).
Importantly, Philanthropic Investors can have varying levels of engagement with the nonprofit. Investors in early stage entities (angle investors/seed funders, venture capitalists/venture philanthropists) often take an active role in shaping the entity in which they’ve invested. However, the entity “owns” their business plan/theory of change. The investor may shape execution and evolution of the entity, but they are funders of the solution/opportunity rather than creators of the solution/opportunity. For more developed entities, equity investors may be passive investors, providing capital if they think the entity has attractive uses for new capital, but not seeking to shape the entity. In addition to the level of maturation of the entity, the relative size of an equity investor will influence the degree to which they seek to shape the entity. Very large funders will often seek at least to be part of the conversation about the future of the entity, while smaller investors will generally remain passive investors.
Whereas the Charitable Giver’s relevant metric is the relative value of program execution compared to grant size, the metric of importance to the Philanthropic Investor is social return on equity. The social return on equity is dependent on the degree to which the nonprofit is able to use the equity invested to expand and/or improve their program execution.
For instance, in the case of the nonprofit tutoring program I mentioned yesterday, the Philanthropic Investor is interested in the degree to which the organization can expand the availability of their tutoring program and/or improve the value of their tutoring services in relationship to the equity provided.
Because nonprofit equity is not accounted for on the nonprofit balance sheet and grants are all booked as revenue, the best guess we can make regarding the social return on equity that a nonprofit is achieving is by assuming their equity is the initial capital provided at startup, plus the cumulative retained surplus since inception.
The challenge facing the nonprofit field is that growing via retained surplus is difficult. Especially during the early stages of growth, most organizations require some sort of external investment of additional equity before they can grow to a level where they are able to self-fund growth out of retained surplus (see page 5 of Building is Not Buying). I believe the lack of understanding around the role of equity in the growth of nonprofits is a primary reason why since 1970 only 144 nonprofits have launched and grown to annual revenues of at least $50 million while in the for-profit field, 46,136 organization have crossed the $50 million revenue hurdle during the same time frame.
Philanthropic Investors provide the equity capital needed to create/build the organizations which can offer the best value propositions to Charitable Givers.
Finally, Philanthropic Investors, like Charitable Givers, no not have a need to be “strategic” in the sense that they do not need to figure out what combination of nonprofit entities they should provide equity capital to in order to maximize impact. Philanthropic Investments are not generally synergistic in that they are focused at the enterprise level rather than at the field level. Philanthropic Investors do not “invest in education” or any other “field”. Their investments are being made in specific nonprofit entities.
Of course, a Philanthropic Investor may have a larger strategic goal. But Philanthropic Investors are distinct from the other four approaches in that their relationship with the nonprofit entity is as a supplier of equity capital and their metric of success of social return on equity.
(Note: Clara Miller and George Overholser, both formally of the Nonprofit Finance Fund, deserve all credit regarding the intellectual underpinning of the recognition and role of philanthropic equity. I’m simply describing the Philanthropic Investor approach to philanthropy, which is charged with supplying philanthropic equity.)
These posts are just terrific, and I hope they become a book someday, followed by a national speaking tour, visits with Oprah, and perhaps a movie starring Matt Damon!
Continuing our discussion from two posts back, you make a good clarification about active vs. passive investment. I don’t view your Philanthropic Investors as having to be “active” (as opposed to “passive”). But I do view them all as being party to an active are-shaping of an organization.
So, for example, philanthropic equity may be needed to finance an organization’s efforts to sustainably double its delivery capacity. Even though the investors of this equity may be “passive”, the goal of their investment is nevertheless to re-shape the organization. Thus, although passive, they are nevertheless parties to a re-shaping effort, and therefore, as investors, ought to know a thing or two about how to choose re-shaping projects that are likely to be successful.
I might also quibble with our use of the word “strategic”, which often leads to confusion, since so many folks mean different things when they use the word.
To me, the charitable giver and the philanthropic investor both need to be strategic in their decision-making. Indeed, they may have the same high-level goal (higher graduation rates, for example), but employ different strategies for attaining the goal.
The giver (Buyer) assumes that shopping among existing programs will help move the needle the best. “There are good programs out there that lack execution-funding. Let’s make sure these good programs are implemented by purchasing some program execution.”
The philanthropic investor (Builder) assumes that current capacities aren’t able to solve the problem. And so, their strategy is to become a partner in re-shaping what organizations can do. They partner with the management team, the board, and with co-investors around a single coherent re-shaping plan. In the end, their strategy succeeds or fails depending on whether the organization eventually becomes so compelling that other (charitable giver) funders flock to pay for years and years of high-pquality program execution.
Stepping back, you might call this the OPM strategy (Other People’s Money). “If my philanthropic investment works, it will attract other people’s money towards the program I like.” This is analogous to a venture capitalist that helps to build a company that other people (customers) then use to turn money into products and services.
I feel that our greatest opportunity may be for more philanthropic investors to realize that they must work together, and not one after the other, when they support the re-shaping of an organization. This is because it can take years to re-shape an organization. During these years, the organization must stay focused and not be jumping from one funder’s re-shaping agenda to another’s. By being willing to aggregate their capital around a single multi-year strategic plan, the philanthropic investors raise the probability that their investment will be successful.
Edna McConnell Clark’s Growth Capital Aggregation Pilot is a beautiful example of how this can work.
In response to Glen’s concern about importing a for-profit mindset, I share the concern. It would be terrible if our charitable practices, which arise out of altruism, family values, love of community, religious traditions, and so many the other non-financial facets of life, were to become eclipsed by heartless financial calculous.
In my talks about “decriminalizing fundraising”, I often urge folks to remember that we are in the business not only of helping to change beneficiaries lives, but also, through the practice of charitable giving, our own lives. Indeed, as a philanthropic investor (who tends to be very focused on nerdy impact goals), I am nevertheless comfortable backing organizations that emphasize the creation of fulfilling “giving experiences” as a way to attract sustainable revenue towards their programs.
Thanks George. You make two points that I’d like to respond to:
Investments as “shaping money”: I’ll concede that the intent of accepting philanthropic equity is to “change” the enterprise and so it it understandable that you might label all philanthropic investors as “shapers”. But there seems to me to be a different way to think about shaping that fits with my passive/active labels. Some organizations might seek philanthropic equity to launch a new approach to what they’re doing or to “restructure” in some way. This equity is truly changing the enterprise. However, what of the nonprofit that just wants to keep doing what it is doing, but at a larger scale. I guess that’s still change, but for passive Philanthropic Investors, the goal may very well be to find nonprofits that are executing very well and just need additional equity to keep doing the same thing but at a larger scale. To me, it seems confusing to label this equity as “shaping” capital. Regardless, I get your point completely and it is a good one.
The need for “strategy”: When I use the word “strategy” I’m using it in the way it is used in the term Strategic Philanthropy. In that sense, strategy refers to having a theory about how change happens. The Philanthropic Investor whose interest is in improving education may have no strategy to make that happen. They may not believe that they know the right answer. But they may make very smart investments in a portfolio of nonprofits that are working on the issue. A Philanthropic Investor who has an internally generated theory of how to improve education (for instance they believe that longer school hours, higher pay for teachers and more rigorous testing are the key) and then seeks out nonprofits who are working on these issues is in my opinion a Strategic Philanthropist who is making strategic investments in service of the advancing their theory of change.
Paul Brest has said that he will make a general operating support grant to a nonprofit whose theory of change is the same as his (ie. he can further his own theory by making an investment). Whereas Social Venture Partners make a whole range of investments in nonprofit enterprises that are not in service of any internally developed theory of change. SVP, unlike Hewlett, does not first analyze social problems, develop their own theory of how to solve them and then seek out nonprofits to invest in/buy program execution from. This is what I meant when I said that a Philanthropic Investor need not be “strategic”. But of course a Strategic Philanthropist might make strategic investments in service of their theory of change.
(To be fair, any Philanthropic Investor who is active for awhile will find themselves becoming more convinced of certain approaches to solving problems are better than others. I don’t mean to suggest that Philanthropic Investors must remain agnostic to the various solution approaches. I’m being overly “pure” in my definitions in these posts to help clarify them.)
Well said, Sean.
I would argue that even “just scaling” requires a great deal of reshaping the way an organization is run. Significant growth is usually highly destabilizing, particularly since program expansion is often accompanied with a need to reinvent the way sustainable revenues are generated, plus a need to reinvent the way quality is maintained in a far flung organization.
I get your useful distinction about who authors the theory of change, vs. who enacts the theory of change. I wouldn’t want to suggest, though, that charitable givers (buyers) are non-strategic. Their strategy is to leverage theory of change insights that bubble up from practical experience in the social impact marketplace (as opposed to the ivory tower). And their strategy is to gravitate towards organizations that already know how to execute well, thereby sidestepping the inefficiencies of new-concept start-ups. Maybe this is a “meta-strategy” — but it strikes me as an awfully good way to make social progress, particularly since there a many underfunded programs that work out there.
You’ve convinced me that my use of the word “strategic” was confusing. I’ve posted a clarification. Thanks for pushing me George!
Thanks for this series of articles. I wonder if you’ll discuss ideas that would draw more charitable givers and the philanthropic investors to specific charity sectors and/or specific geographic regions where investment and charity are needed.
For example, I point to the Boston Innovation Hub at http://www.bostonindicators.org/Indicators2008/ This site has a pie chart that you can click into and drill down to get more information related to that issue, and ultimately a list of organizations in the Boston area working on that issue. If you go to the web sites of these organizations presumably you’d be able to find enough information to support a decision to be a Philanthropic Investor or Charitable Giver.
If such information hubs were available in more places what might the strategies individual, or collective, organizations might take to attract a large number of donors/investors?