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.)
