Innovation is Alive and Well in the Nonprofit Sector

It has been well-documented that America’s unparalleled charitable spending has not led to better outcomes. This has led to calls for donors to be more actively involved with their grants, but those of us who understand the complexities involved in the nonprofit sector know that asking donors to each become educated and implement innovative strategies in each individual grant is unrealistic and frankly a bit unfair (Donors have been financially successful and now want to do their part by funding innovative programs, so the least we can do is find realistic ways to ensure their gifts are utilized well.)  This realism has bred a growing pessimism among those who believed donor action would be the only way forward.

However, there is indeed another way forward, and the good news is that we won’t have to depend on individual interventions to fix the system — or worry about them making things worse if they try. There are already management support organizations (MSO) around the country that can help nonprofits deliver better quality outcomes at a lower cost, which focus on capacity building, and where innovation is alive and well.

Understanding just how they’re accomplishing this could provide us with a blueprint for transforming the rest of the nation’s nonprofit sector.  If you are a donor, represent a nonprofit organization or a foundation, or just are interested in helping improve your local nonprofit sector.  Research your area and find out if there are any MSOs that serve your local nonprofits.  You may be able to volunteer as a professional consultant, or help them raise funds to pay for capacity building.  You may be able to inform others in your local nonprofit sector about the importance of capacity building, and how it can lead to making a difference in the lives of more people.

Foundations and Capacity Building

Any nonprofit executive will tell you their biggest concern is not programs, or board management, or even money; their biggest concern every day is that they will have to send someone away who is really in need of their service.  Today this fear is a reality for many nonprofit executives who have to send people away every day.  The answer to this problem, to the surprise of many people, is NOT more money.  It is better efficiency.  The nonprofit sector is broken… in spite of record donations and millions of hours of volunteer time (a resource the nonprofit sector is uniquely able to utilize), the sector is inefficient and unable to properly serve its local communities.  Which is why the strength and efficiency of nonprofits has become such a common and important topic of study.

While the value of strengthening nonprofits to improve their performance is obvious, how to do this effectively, and who should be responsible for the local implementation, are not.  In the last 10 years experts and interested nonprofit executives have begun to realize that foundations hold the most appropriate position in communities to best effect change in nonprofit performance.  Many foundations have since taken a serious role, resulting in an increase in visibility and frequency of capacity-building activities in philanthropy.  While there are still a majority of foundations not involved in capacity building, the ones involved have provided outcomes proving increased efficiency, outcomes and longevity when combining capacity building strategies in addition to capital infusion.

Capacity building in philanthropy isn't new, but increased activities mean new opportunities to learn and replicate best practices in local communities.  Research done by many foundations over the last 10 years has proven what most nonprofit executives already know – that nonprofit organizations struggle to keep vital infrastructures intact, and in tight times are inclined to piratize whatever modest commitment they may have made to them, rather than cut back further on direct services. Moreover, our current grantmaking practices (which often includes a reluctance to pay for core administrative costs) may contribute to what Mark Kramer, in a Chronicle of Philanthropy editorial, calls the "culture of inadequacy." Nonprofit leaders have come to believe that they will never have the resources to "do things right," so they simply accept that they will always be under-resourced and struggling for survival.  Is this really how we want our most essential service organizations to operate?

For foundations, this “culture of inadaqacy” (due to reluctance in funding capacity building) creates an additional problem: organizational capacity is directly related to whether a new program will survive and prosper once its original funding has ended. Thus foundations which do not fund capacity building activities actually deepen their own "exit problem." If they want to see a program endure, much less replicate and build to scale, investment in nonprofit capacity building is essential.  And isn’t program longevity and scale the very thing our foundations are trying to achieve?  This can never be executed without adding capacity building to the standard of service.

SCOPE OF CAPACITY BUILDING ACTIVITES BY FOUNDATIONS

Capacity-building activities in philanthropy are wide-ranging. Just to give a few examples: a foundation pays for the services of a consultant to help one of its grantees with board development and strategic planning. A nonprofit obtains a grant from a foundation to support purchase of computer software and hardware for improving its financial and client information systems. Another nonprofit is invited by a foundation to participate in a capacity building grant-making initiative, through which it receives both direct financial support and technical assistance consultation in a number of management areas – with all this help coordinated through an intermediary organization.

Sometimes capacity building focuses on assisting other philanthropies, which in turn fund and serve the nonprofit community. For instance, a community foundation receives support from a private foundation both to build its asset base and improve its management infrastructure. The community foundation then sets up and staffs a local nonprofit MSO to offer capacity building services to nonprofits in its geographical area.

TRENDS IN FOUNDATIONS AND CAPACITY BUILDING

Recent increases in the visibility and frequency of capacity-building activities in philanthropy arise from several trends. First is the considerable attention to venture philanthropy, with its counterpart in the nonprofit world – social entrepreneurism. Although not inherently linked (I don’t personally believe running nonprofits as you would a business would improve their outcomes), capacity-building in practice is supported by many donors because they view it as the “business” approach to nonprofit.

Second is the increasing commitment by foundations to evaluating funded projects and their measurable outcomes. The lack of nonprofit organizational capacity shows up in evident ways when rigorous evaluation is done.

And third, there are profound changes in the nonprofit world that both promote and demand increased strength of these institutions. They include more demands for service in the face of government cutbacks, fewer resources, privatization of services (which puts fragile nonprofits more at risk – their revenues may increase, but so does their financial risk under tightly-defined service contracts offered by public agencies), increasingly professional management, and the growth of university-based nonprofit management training programs.

Ultimately, foundation interest in capacity building comes from the desire for leverage – for increasing the impact of philanthropic resources invested in nonprofits. A recent article in Harvard Business Review by Michael Porter and Mark Kramer sets this larger context persuasively,identifying four special assets of foundations: financial resources, expertise, independence, and a long time horizon. How can these assets be leveraged?  Porter and Kramer suggest four strategies that are used by most foundations today:

1 – selecting the best grantees (each of which is made stronger by capacity building)

2 – signaling other funders about how to conduct their work more effectively (promoting capacity building)

3 – improving the performance of grant recipients (capacity building)

4 – advancing the overall state of knowledge and practice (advocacy)

FOUNDATIONS & CAPACITY BUILDING IMPLEMENTATION

In order to effectively achieve their mission to increase the impact of philanthropic resources invested in nonprofits, they must leverage more than dollars.  In an article in Harvard Business Review, authors Michael Porter and Mark Kramer assert: "Foundations can create still more value if they move from the role of capital provider to the role of engaged partner, thereby improving the grantee's effectiveness as an organization. The value created in this way extends beyond the impact of one grant. It raises the social impact of the grantee in all that it does and, to the extent that grantees are willing to learn from one another, it can increase the effectiveness of other organizations as well."  It essentially takes the nonprofits currently being “fed” and teaches them to fish, thereby significantly improving local nonprofits strength and longevity (perpetuity being a major piece of the mission of foundations).

Once foundations accept that capacity building is essential to the success of the sector, and that they are best positioned to implement capacity building consistently and effectively, they still must determine how to implement such a large-scale change.  There are essentially three ways this can be done (and each has been used and is still in practice somewhere):

  1. The foundation can oversee capacity building itself, by hiring professionals and implementing it directly with their own staff.  The biggest challenge with this evolves in large part around the inherent imbalances of power between foundations and nonprofits. These power balance concerns manifest in many technical ways: for instance, community foundations that also operate capacity building programs must be careful to build appropriate "firewalls" between their grant-making and capacity-building functions. Otherwise there may be not only ethical problems, but also a practical reluctance of nonprofits to use the foundation's capacity-building service, which typically requires them to be candid about their operating problems and organizational shortcomings. This reluctance by nonprofits can lead to "the assurance of a mediocre approach."    In addition, foundations that handle capacity building in-house have higher operating expenses that are passed on to the donor.  Community foundations must keep their fees as low as possible in order to compete with the for-profit National Advised Funds (NDAF) such as Schwab, Fidelity and others.
  2. The foundation can build relationships with local professionals whom they then hire to train and consult nonprofits.  This, however, takes significant oversight which will mean higher overhead and higher donor fees, and does not create a sufficient “firewall” to allow nonprofits the comfort to provide information about their weaknesses and get the most out of their capacity building activities.
  3. The foundation can partner with one or more management support organizations (MSOs) who handle the capacity building audits, trainings and consultations requested by the foundation, while still maintaining a separate status.  MSOs can be for-profit or non-profit, and are the most common vehicle for capacity building activities.  The MSO would apply for grant money to implement capacity building, so the foundation could keep overhead costs down and maintain a healthy distance allowing nonprofits to fully open up to the MSO ensuring the best possible outcomes.

All three of the options above are currently being used by foundations around the country.  Most, however, have found that option 3 (partnering with an MSO) seems to have the least number of challenges and allows foundations to concentrate on their other activities.

ADDITIONAL MOTIVATIONS FOR FOUNDATIONS TO USE CAPACITY BUILDING

Foundations have taken on capacity-building activities for various reasons. For instance, at the David & Lucile Packard Foundation, which has had a major capacity building program since 1983, these activities reflect the donor's commitment to applying business principles to nonprofits. The Boston Foundation's efforts starting in 1987 grew out of the observation that many of the homeless and battered women's shelters they were funding in Massachusetts were "crashing and burning" in their first five years of operation.

Intertwining themes of values and necessity tend to re-occur as the most common inspirations for capacity-building efforts; but the fact is that theory-driven, model-based capacity building with good evaluation behind it simply has the best chance for success.

Some additional reasons for capacity building, specific to foundations, include:

1.  Foundations, in their typical role of supporting nonprofits and communities through grant making and other mechanisms, have a vested interest in strengthening nonprofits. Paul C. Light in Sustaining Innovation demonstrates empirically what's already well known intuitively – that strong, healthy nonprofits are more able to be innovative. "Give me food, and I eat for today. Teach me to fish and I will eat forever" is a maxim that applies to nonprofit innovation as well as to the overall operation of the nonprofit organization. Since much foundation grantmaking is oriented to funding innovative programs, capacity building can increase the number of "innovative ideas and applications".

2.  Readiness of nonprofits for new funding is an important issue that can be easily addressed through capacity building assessments.  It is difficult for nonprofits to resist applying for funding, even though they may be ill-equipped to engage in the changes the funded project will require. For instance, a nonprofit may be overwhelmed with change from turbulent life in the community, or even from other funded change initiatives they are already involved with. In the latter situation, "hyperinnovation" can result, to use a term from Madeline Landau at the University of California, Berkeley. Finite energies of nonprofits and community leaders can be dissipated if spread too thinly over too many initiatives.

3.  According to Porter and Kramer, "Affecting the overall performance and strength of grant recipients is important because foundation giving represents only about 3% of the nonprofit sector's total income. By helping grantees to improve their own capabilities, foundations can affect the social productivity of more resources than just their slice of the whole." In an ideal world, all philanthropic activity is intended to contribute in some way to nonprofit capacity building, of course, but some strategies have more "leverage value" in this arena than others.

CHALLENGES OF CAPACITY BUILDING

Capacity building is something that many experts believe will significantly improve the presently poor outcomes of the nonprofit sector, but everything has its challenges.

Funding:  There is also both historical and current resistance to the use of philanthropic funds for capacity building. Christine Letts, Allen Grossman & William Ryan, in their book High Performance Nonprofit Organizations, assert that in too many cases funders see "investment in the infrastructure of nonprofit organizations as overhead – the connotation is that these are deadweight costs that take money away from program beneficiaries."

In the capacity-building paper, Finishing the Job, the Edna McConnell Clark Foundation amplifies this statement: "The role of organization builder is not a familiar or comfortable one for many foundations…. Wary of becoming life-support systems for undercapitalized institutions, foundations have tended to concentrate on refining methods and generating ideas more than on funding and building the productivity, versatility and staying-power of the institutions that implement ideas and distribute services." In particular, it is noted, funders (including both foundations and government) have been reluctant to pay for core administrative costs – such as for staff training, information technology and strategic planning.  This has led to the inefficiency and low effectiveness of the nonprofit sector, often due to the fact that nonprofits are beyond lean and are trying to function with little to no overhead.  (A business run this way would be closed in a matter of months, so why would we want to operate our nonprofit sector in a way that doesn’t work?)  What donors must understand is that capacity building is about a nonprofit reaping an increased result, NOT about management for its own sake.

Role conflicts in capacity buildingrefers to the unique "three-way relationship" that exists between foundations as funders of capacity building, nonprofits and their communities, and providers or intermediary organizations. There are bound to be some tensions, especially as capacity building programs grow in scope. These can best be handled if roles are defined clearly from the outset (plus providing simple structures by which role conflicts can be discussed and resolved).  Important questions that should be asked at the onset of capacity building include:

  1. Should a capacity audit be required before nonprofits can apply for a grant?
  2. How much information from a capacity audit should be provided to the foundation?  To the donor?
  3. Will the foundation provide capacity building grants, or only fund capacity building as a part of a program grant?
  4. Should capacity building initiatives offered to grantees be mandatory or voluntary?  What about capacity building initiatives that directly impact the foundation’s grant?
  5. Should donors be required to pay for the capacity building related to their donations?
  6. Should a partner MSO be funded by an annual grant or by project/hour?
  7. Should nonprofits receiving foundation support be required to be a member of the partner MSO (if they are a membership organization).

These, and several other issues (direct or indirect), are among the complex matters funders, nonprofits and providers will need to consider and decide upon together.

 

 

Credit:

STRENGTHENING NONPROFITS: CAPACITY BUILDING AND PHILANTHROPY, by Thomas E. Backer, PhD of the Human Interaction Research Institute, 2010

The Most Powerful Partnerships – Foundations and Nonprofit Intermediary Organizations (IO)

Partnerships have never been "popular", and certainly not common, in the nonprofit sector.  The basic premise for this is that each organization must compete for limited philanthropic dollars.  Not only is this view counter-productive, but actually a hindrance in today's new landscape of more involved and educated donors who seek out effective partnerships and collaborations that improve nonprofit performance.

Raising money from large numbers of small donors will always be one of the best ways to raise money for nonprofits,  especially if your organization is good at keeping those smaller donors engaged (protecting your organization from the "all your eggs in one basket" scenario); but large foundations and educated philanthropists are now a standard part of the fund raising landscape, and they expect collaboration in any healthy, community organization they plan to fund.  And they expect more than just the local Boys and Girls Club to collaborate with tutoring centers or drug prevention organizations; they want to see collaborations that improve organizational capacity and overall program impact.  The irony here is that foundations themselves often forget about collaboration, and the many ways it can improve their own philanthropic mission.

I believe the single most powerful partnership in the nonprofit sector is one between Family, Private or Community Foundations and one ore more nonprofit Intermediary Organizations (IO) with the sole mission of professionally supporting the increased capacity of fellow nonprofits.

Nonprofit IOs are fairly new.  However, there are several lucky states which have this type of organization, and some have been around as long as 20 years or more.  These organizations, which are most often defined as state nonprofit associations, focus on providing networking and collaboration opportunities, professional consultants at a reasonable price (or sometimes free of charge) and advocating to target policy makers, donors and the general public so they understand the positive impact the nonprofit sector has made in their communities.  Overall most nonprofit IOs are still growing their nonprofit memberships and fine tuning their offerings (although I have found several that are excellent examples that every state should emulate), but the impact they could make if they became a fixture in our nonprofit sector is limitless (especially when you consider how difficult it is for nonprofits to raise money to increase their own capacity, when donors are constantly scrutinizing overhead and expecting nonprofits to do more with less).   If a new business was unable to spend any money on professional development or organizational capacity, it would go out of business almost immediately.  So why is it so difficult for people to understand the importance of nonprofit capacity building?

While helping nonprofits one at a time is helpful, these nonprofit support organizations could increase the overall impact of our sector much more quickly (thereby starting to fix the long-time problem of low effectiveness and efficiency) if foundations could understand the critical need for increased capacity, and partner with these organizations to either provide professional support or help nonprofits improve in important areas of expertise like accounting, legal, board engagement, fund raising, staff management, leadership training, outcomes reporting, program management, donor relations, public relations, technology, etc.

The most ideal partnership, however, could go far beyond simply educating nonprofit organizations and advocating to potential donors.  Foundation's could utilize the expertise of these unique IOs to 1) provide a capacity audit on all nonprofits the foundation plans to fund, so that the foundation (and the nonprofit) know what areas they can improve on to increase the effectiveness of their programs (so the foundation is confident it will reach as many people as possible) and the efficiency (so the foundation can save money to use for other important programs);  2) provide new board member training and board education, so the foundation is confident any organization it funds has adequate oversight, a supportive and educated board and is very unlikely to provide legal, ethical or public relations problems;  3) provide program oversight to ensure grant compliance (something most foundation's do not have time to complete) and optimum efficiency and effectiveness (all of which can be provided to donors, significantly increasing donor engagement and donor satisfaction);  4) help community foundations determine areas of service duplication and areas of need, so that some local organizations can be encouraged to focus on best practices (as opposed to expansion when it is not necessarily needed) and some can participate in RFPs to provide new services where needed.  These examples only touch on the important work that can be done through foundation and nonprofit IO partnerships.

In return the foundations would provide financial support to these important nonprofit support centers, either in the form of donations, grants or service fees on a per-project basis.  Grants awarded to nonprofits could include funding for personalized support from the partner IO, as well as ongoing membership and/or conference participation. They could also support IO membership by requiring nonprofits seeking funding to become members, thereby encouraging all nonprofits to seek out ways to increase capacity.   But whatever the cost, the savings in increased efficiencies will provide foundations an extremely high ROI (even save them money that can be used for other programs), and the growing effectiveness will make impact limitless.

Leveraged (For-Profit) Mission Investin

When used in an integrated fashion, mission investments enable foundations to achieve impact in ways that grants could not. The most far-reaching impact of all, however, comes when foundations use for-profit market forces to create social change – in what is called leveraged mission investing.

This form of strategic mission investing has been slow to catch on because it requires foundations to think differently about who can impact social change (and thinking differently is not something nonprofit boards are comfortable with). The traditional view is that nonprofits address social problems and businesses make money. Increasingly, however, businesses are coming to see the social dimension of their endeavors as a key competitive factor.7 Publix SuperMarkets, for example, have often noted their charitable works as a significant factor in their ongoing success.

At the same time, foundations are beginning to pay more attention to the interplay between economic forces and social problems. Poverty, housing, healthcare, and many other core social issues that the nonprofit sector addresses are fundamentally failures of market capitalism to deliver desirable social outcomes. These failures often occur because conventional investors weigh the risk and time horizon of an investment against the expected financial returns, without taking into account any accompanying social benefits or detriments.  Consider the alternative result if bankers had considered the potential social problems associated with giving so many large home loans back in 2003?

Foundations, on the other hand, are in the business of spending money to achieve social benefits. Their calculation of risk and reward can and should be different from that of conventional investors. The most powerful use of strategic mission investing is when foundations use their capital to create incentives, reduce risk, and invent new financial instruments in order to leverage for-profit markets to achieve social objectives.

Foundations can leverage their investments to achieve desired social benefits in a variety of creative ways. They can, for example, help stimulate the creation of a new market, like microfinance. When microfinance was just beginning, conventional investors were not interested in funding it because they believed that the risk of lending money to poor people in poor countries was greater than the potential earnings when the loans were paid back. Foundations stepped in and provided the initial capital for microfinance institutions. Now microfinance is attracting billions of dollars from conventional investors – a clear example of how foundation money can help achieve social goals via market-based solutions.

Foundation money can also help create new companies that have strong social goals but modest financial prospects. One example is Waste Concern, a hybrid forprofit/ nonprofit organization based in Dhaka, Bangladesh. The company’s plan was to hire slum dwellers to collect the piles of garbage rotting in the city’s streets, separate out the recyclables, compost the rest, and sell the compost as organic fertilizer. No commercial financing was available for such a speculative concept, but after persistent efforts the founders persuaded the Lions Club to donate land for composting and the United Nations Development Programme to subsidize the costs of building a facility capable of handling 3 tons of garbage per day. Today, Waste Concern is a profitable company employing thousands of people who recycle the garbage created by nearly 1 million residents.8Only a few foundations have used financial leverage in this way. The $300 million F.B. Heron Foundation, based in New York, is one example. Despite its modest size, Heron has achieved an impact far disproportionate to its resources by leveraging 24 percent of its endowment to advance its mission of helping build wealth for low-income families and communities. Seventy percent of its mission investments earn market-rate returns, yet all are aligned with or directly further the foundation’s program goals.

One market-rate investment that Heron has made is in the Yucaipa Corporate Initiatives Fund, a private equity fund that invests in companies that are located in, serve, or employ people from low-income communities. The fund’s goal is to create attractive investment returns while advancing the flow of private equity into underserved communities. In 2004, for example, Yucaipa and another firm acquired Piccadilly Cafeterias, saving it from bankruptcy and preserving close to 6,000 jobs, many of them in low-income communities in the southern United States. Preserving these jobs kept many Piccadilly workers from falling into poverty.

Heron has also pioneered the Community Investment Index, a positively screened investment fund that selects publicly held companies that do an outstanding job of supporting low-income communities through workforce development, wealth creation, and corporate philanthropy. Working with Innovest Strategic Value Advisors and State Street Global Advisors, Heron has committed its own capital to test the index and, after its positive initial performance (a 15 percent return in 2006), hopes to attract other institutional investors to this new fund.

Heron also developed a deliberate practice of cross-fertilization between its investment and program staff, so that investment staff gained an understanding of the foundation’s program strategies and impact, while program staff received training in financial analysis and underwriting. Not all of the original program staff felt comfortable with this new way of working, and some left the foundation. Today, program and finance staff work together on mission investments, with program officers often suggesting potential investments, and investment staff lending expertise to the assessment and structuring of the transactions.

FSG’s study found numerous other examples of foundations that have, on occasion, used their capital to offset risk, experiment with new financial instruments, and leverage forprofit enterprises to achieve social change. Very few, however, have built leveraged mission investments into their institutional structure as deeply as Heron has.

 

1 Mark R. Kramer and Sarah Cooch. “Strategic Mission Investing.” Stanford Social Innovation Review, Fall 2010. 7 Michael E. Porter and Mark R. Kramer. “Strategy & Society: The Link Between Competitive Advantage and Corporate Social Responsibility.” Harvard Business Review, December 2006; Mark R. Kramer and John Kania. “Creating Game- Changing CSR.” Stanford Social Innovation Review, Spring 2006. 8 See http://www.wasteconcern.org for more information. 9 Based on Foundation Center data for 50 largest U.S. foundations, March 2007.

 

Integrated Mission Investing

There are two facets to strategic mission investing. First is integrated mission investing, and second is leveraged mission investing.  The distinguishing characteristic of integrated mission investing is that foundations treat mission investments as a substantial and inseparable part of their program strategy from the very beginning of the program initiatives. They make frequent mission investments and dedicate significant funds to their mission investment portfolios. They have designated one or more foundation staff members to manage these investments, although they may still depend on outside consultants to negotiate and structure individual deals. And the staff person charged with managing mission investing works closely with the foundation’s investment staff and with each program area to identify opportunities where investments might be paired with or substituted for grants.

One foundation that has adopted integrated mission investing is Meyer Memorial Trust, a $650 million private foundation based in Portland, Ore. The foundation’s mission is to “invest in people, ideas, and efforts that deliver significant social benefit” to the region. Meyer Trust had made a number of mission investments in the past, but it had not done so in a consistent or planned fashion. Beginning in late 2005, the foundation began to increase the volume and sophistication of its PRI program, and in 2006, the foundation determined that its mission investing should be fully integrated into its overall program strategy. The foundation also decided to increase the amount of money it commits to mission investments. More than 20 percent of its 2007 grantmaking budget is allocated to PRIs – a larger amount than the foundation invested in its first 20 years of existence. In addition, the foundation is in the early stages of investing in market-rate mission investments, committing $10 million to several deals in the past six months.2

Meyer Trust decided that it would concentrate its mission investments on two initiatives: affordable housing and restoration of the Willamette River Basin. To help create more affordable housing, Meyer Trust lent $375,000 to the Portland Housing Center to fund a down payment assistance program. In so doing, the foundation accepted higher levels of risk and lower financial returns than commercial lenders, enabling low-income home buyers to obtain millions of dollars in mortgages for which they would otherwise not have qualified. The foundation is also helping nonprofit housing corporations explore the feasibility of housing sites – such as drawing up construction plans, drafting funding proposals, getting zoning approvals – by making predevelopment loans available through a nonprofit loan fund that Meyer Trust capitalized with a $1 million loan at a 1.5 percent interest rate. Meyer Trust is exploring the concept of capitalizing a statewide housing preservation and acquisition loan fund. The foundation expects to complement these PRIs with technical assistance grants to nonprofits active in affordable housing and community development corporations, especially in rural areas. Meyer Trust will also evaluate opportunities to provide financially sustainable tenant support services through a combination of PRIs and grants.

In its initiative to restore the Willamette River Basin, grantmaking plays a critical role, but PRIs are also integral to Meyer Trust’s strategy. The foundation will use grants to assemble a coalition of funders, policy advisers, and stakeholders to help catalyze a coordinated restoration of the river, which has become too polluted for swimming or fishing. The foundation will use PRIs to lend money to environmental organizations at below-market interest rates for the acquisition of land and water rights. The loans will be repaid from government funding, private contributions, and the subsequent sale of conservation easements. These loans enable the nonprofits to move quickly in acquiring property to protect the basin before they have assembled all of the necessary acquisition funds.

To ensure that its PRIs and grants are aligned, Meyer Trust’s CEO Doug Stamm assigned Ann Lininger, a lawyer and a former program officer, to manage the foundation’s PRI portfolio. She works closely with program staff and also gives periodic reports to CFO Wayne Pierson, who assesses the financial soundness of the investment and determines whether it qualifies as a PRI.

Meyer Trust has fully integrated mission investing into its program strategy and internal operations, increasing its impact beyond what grants alone would have accomplished. By relying primarily on low-interest loans to nonprofit organizations, however, Meyer Trust has not harnessed the leverage that comes from applying for-profit market forces to solving social problems. Its recent market-rate investments in private equity funds are the foundation’s first major forays into what we call leveraged mission investing.

 

 

1 Mark R. Kramer and Sarah Cooch. “Strategic Mission Investing.” Stanford Social Innovation Review, Fall 2010. 2 Meyer hired FSG to develop its new strategy. FSG has also consulted for other foundations mentioned in this article, including F.B. Heron and Grand Rapids, on a variety of projects. 

The Experimental Stage of Mission Investing

Many foundations have already begun to do more than simply make grants, and consider social values in their investment decisions through the screening of securities portfolios for undesirable stocks, using shareholder activism to change corporate behaviors, investing in socially responsible businesses, and making loans to promising nonprofits.  While these foundations are successfully challenging the orthodoxy that grant-making is the only tool foundations should use to effect social change, there is still much more that can be done.  Using mission investing effectively, however, requires foundations to change the way they do business.  And that means educating and persuading a great number of community leaders… a complicated task in any context.

Nevertheless, our research clearly shows that more foundations are doing more mission investing than ever before. Despite this activity, the impact of mission investing often falls far short of what it could be. That’s because the majority of foundations that make mission investments are still at the early, experimental stage. (See chart at right for the stages of mission investing.) These foundations may have made mission investments over a period of time, but typically only in small amounts or on an infrequent basis. Though they may seek out individual investments, rather than simply waiting to be asked, they often have not yet revamped their program strategies to incorporate mission investing as a core philanthropic tool. In addition, they often focus only on below-market- rate investments and do not use their endowment assets for mission investing.

Because these foundations are still experimenting with mission investing, they have not yet restructured their operations to support this approach. As is the case in most foundations, their program staff and finance staff remain in two distinct operations that rarely communicate with one another. Mission investments are usually managed by program staff without the full benefit of the finance staff’s expertise and assistance.

Although the foundations in the experimental stage of mission investing are doing more than most foundations, research has found that they are not yet treating mission investing in the same strategic manner as their grantmaking. As a result, their mission investing may increase social impact, but they are not fully exploiting its potential.

One foundation that is in the experimental phase of mission investing is the Grand Rapids Community Foundation, in Grand Rapids, Mich. The foundation’s mission is to “build and manage the community’s permanent endowment and lead the community to strengthen the lives of its people.” The foundation has $225 million in assets, of which only $1.4 million is in outstanding mission investments, all in low-interest loans to nonprofits. The foundation began making mission investments in the early 1980s with a series of small (typically under $25,000), zero-interest “recoverable grant” loans to grantees using program funds. The loans were made in response to requests by grantees rather than as part of a proactive program strategy.

The foundation began making larger mission investments in 1994, guaranteeing a $200,000 loan to Dwelling Place, a local nonprofit community development corporation that builds affordable housing. The foundation knew that Dwelling Place had strong financials and capable management, so it considered guaranteeing the loan to be low risk. The foundation’s board, however, was unfamiliar with mission investments and spent considerable time debating whether to provide the guarantee. In the end, the loan was repaid on time and the guarantee was not called upon.

As the Grand Rapids Community Foundation gained experience with mission investing, it was willing to experiment in bolder ways. In 2004, the foundation made a $1 million loan at 2 percent interest to Lighthouse Communities, a nonprofit community development corporation, to help create a loan fund for home improvements and lead paint removal. This time, the foundation initiated the idea, knowing that some of its donors were interested in neighborhood development. Because of the foundation’s leadership, eight banks provided an additional $2 million to the Lighthouse fund at a low interest rate.

Although these mission investments have met all financial and social expectations, and the Grand Rapids Community Foundation has become more proactive in using this tool, the foundation has not yet developed a strategy for future mission investments, nor has it changed its operations or staffing structure to support an ongoing mission investment program. This foundation’s experience is typical of the large majority of the foundations in FSG’s study: Despite having had a number of successful experiences with mission investing over many years, most foundations have remained in the experimental mode for decades without moving beyond low interest loans to grantees or graduating to a more strategic and integrated approach.

Next step:  Some foundations have advanced beyond experimental mission investing to the next level – strategic mission investing. There are two facets to strategic mission investing. In the first – integrated mission investing – foundations change the way they manage mission investments by fully integrating them into their overall program strategy and internal operations. In the second – leveraged mission investing – foundations change the types of investments they make, adding for-profit businesses to the mix and deliberately leveraging market forces. Although foundations can pursue these two facets of strategic mission investing independently, they achieve their greatest impact when they bring the two together in a unified strategy.

 

 

1 Mark R. Kramer and Sarah Cooch. “Strategic Mission Investing.” Stanford Social Innovation Review, Fall 2010.

Risk vs. Reward Of Mission Investing

Boston-based FSG Social Impact Advisors, recently completed the most comprehensive study to date on mission investments (as opposed to the broader universe of social investments), which they define as investments that proactively further a foundation’s mission.2 Funded by the David and Lucile Packard Foundation, the study analyzed the mission investments of 92 U.S. foundations.

The vast majority of private foundations that make mission investments concentrate on program-related investments (PRIs), whose primary purpose is to further the foundation’s charitable objectives, rather than to earn financial returns. (The IRS allows foundations to count PRIs as part of their required 5 percent annual payout.)  Most PRIs are below-market-rate loans made to foundations’ grantees with interest rates between zero and 3 percent.

Many foundations assume that such loans are high risk, but FSG’s analysis suggests otherwise. Of the 28 foundations in our sample that collectively made $230 million in loans that matured during the past 40 years, 75 percent experienced no defaults. Furthermore, the overall full repayment rate of principal and interest in this sample set was 96 percent.

Although most foundations concentrate on PRIs, many are starting to make market-rate investments that earn returns comparable to those of conventional investments in the same asset class made without considering social returns. These investments include loans that carry interest rates at or above the prime rate, municipal bonds, and equity investments in real estate development. Foundations are also diversifying the types of mission investments that they make, moving beyond loans and exploring areas such as private equity and venture capital. (Unlike PRIs, which are typically drawn from program funds, market-rate mission investments are often made directly from the foundation’s endowment, or from a segregated pool of endowment assets.)

Endowments and the income that flows from them are foundations’ lifeblood, so it is understandable that most foundations are proceeding cautiously when it comes to putting endowment funds into less conventional investments like mission investing. However, major U.S. foundations haven’t hesitated to shift a significant proportion of their assets into other unconventional investments, such as hedge funds, private equity, natural resources, and international stocks. Foundations have moved into these investments, as risky as they sometimes are, to diversify their portfolios and increase their returns. According to the Commonfund Institute’s study of 279 foundations, unconventional investments (hedge funds, venture capital, etc.) make up 23 percent of foundation holdings, and international investments make up another 20 percent.4Mission investments, in contrast, make up only about 2.4 percent of the assets of the foundations in FSG’s sample, and less than one-twentieth of 1 percent of all U.S. foundation holdings.

There are solid reasons why foundations are not pursuing mission investing with the same degree of vigor and imagination as they are pursuing unconventional investments like hedge funds and private equity (reasons that provide direction on how to inspire more mission investing by foundations). Most foundations do not have staff with the combination of program and financial experience that is necessary for finding and managing mission investments, and the compensation incentives for those who do manage a foundation’s investments are based solely on financial returns, not social returns. Foundations are also hindered by the limited number of mission investment opportunities, the paucity of outside investment advisers who understand mission investing, and the lack of reliable performance data for benchmarking the social and financial returns that mission investments provide. A misunderstanding of fiduciary duty – thinking that it limits a foundation from taking more risk or less return in pursuit of its mission – has also left many foundation boards skeptical of the entire idea. 5

The research, investment results and tools are available for mission investing by foundations.  It is now time for foundations to recognize their organization's full potential and begin using their investments for social change.  To only see grant making as a way to impact communities is shortsighted and irresponsible.  It equates to purchasing a 100-room hotel to house the homeless, but only allowing use of the 10 rooms on the bottom floor.  In other words, we can do MORE.

 

 

1 Mark R. Kramer and Sarah Cooch. “Strategic Mission Investing.” Stanford Social Innovation Review, Fall 2010. 2 The report,Compounding Impact: Mission Investing by U.S. Foundations, may be downloaded without charge athttp://www.fsg-impact.org. 3 Foundations approach the risk of mission investments in different ways. Some view mission investments as true investments, expecting low risk and market-rate returns; others use grant dollars to make risky investments with little due diligence and no attempt to collect on delinquencies. 4 Communfund Institute. “Commonfund Benchmarks Study 2007 Foundations Report,” 13 June 2007. 5 Mark R. Kramer. “Foundation Trustees Need a New Investment Approach.” The Chronicle of Philanthropy, 23 March 2006.

 

Effective Social Change – It’s More Than Just Grant-Making

As a past community foundation CEO, I am a passionate advocate of the power of foundations.  However, I find myself disappointed in the narrow-minded focus of many of these organizations who hold so much potential power in terms of making and inspiring positive social change.  Currently most foundations (especially in Florida) are trying to solve the major social problems of our day – such as poverty, homelessness, global warming, and lack of healthcare – by making grants to nonprofits.  However, grant-making is not why foundations hold so much potential power, because that is not where major change is made.  Large scale social change is made in the capital market, and foundations are in a unique position to create change because they alone control large pools of investment capital that CAN BE dedicated to broad social purposes. They have the power, through their collective financial assets, to craft market-based solutions to social problems.  Market-driven solutions cannot cure all social ills, but they can create positive social change in many areas that nonprofits previously could not influence.

What we are talking about here is not the bland "social investment strategy" most foundations define with a paragraph in their investment policy stating "no investments will be made in companies involved in the production of tobacco, weapons or alcoholic beverages".  Instead, we are talking about a proactive approach to using a foundation's large investment pool to help shape social change.  A practice most often called mission investing, or impact investing.

Mission investing refers to investments in revenue-generating nonprofit and for-profit organizations whose work is consistent with an investor’s charitable purpose and goals.The emphasis is on investments, as opposed to grants.  To be successful, foundations must reach out beyond the nonprofit universe to work with a new set of partners in the commercial sector.  Board members and foundation staff must recognize that for-profit enterprises also contribute to social solutions. They must thoroughly understand not only the nonprofit options for intervention, but also the impact of commercial enterprise on the social issue to be addressed.

Foundations must also realign their organizational structures to bring program expertise to the investment side and investment expertise to the program side. This may require recruiting new staff or hiring consultants who bring this unusual combination of perspectives. Foundations must also coordinate impact evaluation and financial reporting processes to enable tracking of progress toward both program and investment objectives.

At the same time, the spread of strategic mission investing will also require changes external to foundations. A robust and efficient marketplace of investment options for mission investing does not yet exist. The sector needs new investment intermediaries that offer foundations easy participation with low transaction costs in a wide range of investment vehicles targeted toward specific programmatic objectives. People with financial and business expertise must be recruited into the sector. Nonprofits must develop the financial discipline and appetite for investments as well as grants. And better ways of measuring social performance and benchmarking financial returns must be found.

Neither the internal nor the external changes will happen all at once. Instead, they will evolve. The more foundations create demand for strategic mission investments, the more others will develop a robust roster of investment offerings. This will make mission investing easier, leading more foundations (as well as social-concious individual investors) into the practice. And as mission investing becomes more mainstream, foundations will attract staff and develop the internal processes necessary to support them, as well to benchmark each other.

 

1 Mark R. Kramer and Sarah Cooch. “Strategic Mission Investing.” Stanford Social Innovation Review, Fall 2010. 2 Based on Foundation Center data for 50 largest U.S. foundations, March 2007.

 

Tactical vs. Strategic

Cheshire Cat appearing (detail)Think about your normal work day. How much time do you spend talking with people about building something? Building a website, starting a campaign, writing a grant, whatever. I’ve noticed that most of the questions I ask, and most of the questions asked of me, are all about logistics and tactical decisions: which fundraising event should I do? Should I do a blog? How do you build a budget? And so on. Considering how much time we spend on these sorts of questions (and this may be hard to hear), none of that stuff really matters.

Changing the world is much more important than having a the biggest fundraiser in town. You can have the best event in the world, but if you don’t have a clear vision for what you want to do it for, no one will care. Consider a for profit enterprise. You can have a super-optimized business model, but if no one wants to buy what you’re selling, you don’t have a business. In the nonprofit sector you are selling a mission, and if you don't have a clear vision of what you want to accomplish, no one is going to support it.

You can learn all about tactics as you go along, but you must have a clear STRATEGY from the start. After you have a clear strategy, then you can go back to some of the tactics. Then you can figure out what you’re doing and how to make it better, and you’ll see more of an impact. But starting with the tactics is almost always a mistake.

Another mistake often made in the nonprofit sector is the idea that you can simply find and reproduce successful programs that seem to achieve your similar mission. Often these replicated programs are started by people impressed with original program, and instead of reinventing the wheel they try to emulate the success of another nonprofit. The interesting thing is that they tend to copy the tactics but not the strategy. Too bad for them, because they’ll only see a fraction of the success.

In short, it’s like the Cheshire Cat from Alice in Wonderland said: “If you don’t know where you’re going, any road will get you there.”

More & More State Programs are Being Shifted to the Nonprofit Sector

While the nonprofit sector fights to keep our federal government from drastically cutting the charitable incentive tax credit, a credit thought to drive substantial funds to nonprofit

Governor of New Jersey Chris Christieprograms to the nonprofit sector. In an effort to cut budgets without hurting community support, state governments are turning to the nonprofit sector – the sector often forgotten EXCEPT in times of crisis. This crisis, however, is not the standard hurricane or earthquake. We are now being recruited to help in our country’s financial crisis.

Here is an excerpt from a press release with an example of a New Jersey after-school program shifted to the nonprofit sector: “Having eliminated through a line-item veto all state funding for the nonprofit named New Jersey After 3, Governor Chris Christie announced this month the creation of a private-public partnership to maintain some of the organization’s after-school programs in public schools. Appropriations for the programs run by the nonprofit had declined from $15 million in 2007. The new arrangement revolves around having NJ After 3 assist the state with its “No Child Left Behind” (NCLB) waiver application and work with various governments to support the expansion of high quality expanded learning time programs around the state.  In announcing the partnership, reportedly funded by a political supporter, Governor Christie announced, “This is the model for what we should be doing for these types of programs across the state during difficult fiscal times,” suggesting that more government programs are likely to be shifted to the nonprofit sector in the future.”

While nonprofits are most often happy to assist in helping with programs that serve our communities, it is difficult when financial support for our current programs is hurting. With the current economic climate, the government pushing a “pay-by-results” agenda for future funding, and the charitable tax incentive being reviewed as a way to increase taxes collected… how do we find the funding to pay for these new programs? One way is to reform our nonprofit sector to be more efficient, and make each dollar go further. Large foundations such as the Gates Foundation, as well as growing professional nonprofit associations, are beginning to recognize the need for reform and start funding the necessary research to get started. But in order to protect and expand our current standing, we also need to advocate for the nonprofit sector (or third sector) for better support (financially and otherwise) from our other two sectors: private and government.

The nonprofit sector is often seen as the weak, ugly stepsister of the powerful corporate and government sectors. We are seen as doing the best we can with little money and lower professional standards. We are often forgotten about until a crisis such as a hurricane or terrorist attach occurs, at which time we are expected to “back up” our private and government sectors to make sure the basic human needs are met. But we are not the small, weak, underperforming sector people often expect us to be. We have access to huge amounts of capital, both fiscal capital and (more importantly) people capital. We also have some of the brightest, and most passionate professionals of any sector. We are doing incredible things in our communities, but with the acknowledgement and cooperation of our other sectors, we can do so much more.