What will be the impact of ‘impact investing’?
By Steven Overly,
The philanthropic organizations and foundations that make up Washington’s massive nonprofit sector are borrowing lessons from the business plans of their for-profit counterparts as they look to fulfill social missions and achieve financial sustainability. ¶ Those dual objectives may have once seemed contradictory. Nonprofits have long been characterized as the bleeding hearts of the economy, forgoing the benefits of big profits, or any profits at all, for the sake of helping society’s less fortunate. ¶ But now some grant-making institutions have begun to experiment with financial mechanisms such as loans and equity investments that require nonprofits or socially minded businesses to repay the money over time through returns. ¶
The practice, called impact investing, necessitates that those organizations generate revenue — and yes, turn a profit — without losing sight of the altruism that has long been their key differentiator and the impetus for nonprofits’ tax-exempt status.
“I would say the entire nonprofit community is moving beyond a frame of charity,” said Chuck Bean, executive director of The Nonprofit Roundtable of Greater Washington, who while supporting the idea sees potential obstacles. “When nonprofits talk to their funders, they need to make the case for investment not just because it pulls on the heartstrings, but because there’s a social return on investment.”
Financial impactAccion International is a nonprofit that makes equity investments in for-profits through District-based Venture Lab. The fund was formed in April to dole out $10 million to upstarts in developing countries that help the poor gain access to financial services.
Paul Breloff, the fund’s managing director, said that’s a tactic that has come with some controversy. But the decision to invest in for-profits, rather than other nonprofits, does not reflect a judgment that one model is more effective than another, he said.
“We invest entirely because we believe in the social mission [of the companies] and we believe this is the most efficient way to grow these initiatives and grow the outreach into these underserved populations,” Breloff said.
So far that’s proven effective. The $10 million that Breloff has been given to invest was actually reaped from prior investments in socially minded companies that have gone on to find success, he said.
Some organizations are taking a similar approach to nonprofits using loans.
The Bethesda-based Calvert Foundation extended its first loans to capital-seeking nonprofit organizations and community groups in 1995, often offering lower interest rates, longer repayment time lines or other terms more favorable than a private bank.
The group’s funding comes in part from a community investment note that individuals and corporations can purchase as part of their investment portfolio, meaning the nonprofit must scrutinize deals to find those that all but guarantee tangible returns, said Lisa Hall, president.
“In the early days of Calvert Foundation, we used to get criticized [that we’re] cherry-picking the best deals. My response to that is, ‘Yea, that’s the point. We’re investing in deals that are going to raise money’,” Hall said.
“That is one of the challenges in our work of impact investing, to make sure you’re investing in things where there is a clear earned revenue model and where there is a track record,” Hall said.
The Calvert Foundation typically invests in groups that have evidence of good operating performance, at least $5 million in total assets and experience repaying debt capital, among other criteria.
But skeptics contend that emphasis on financial return renders some organizations, and perhaps entire social causes, ineligible for impact investments because the communities they serve may not have the purchasing power to yield profits.
“In my mind [impact investing] presumes that usually the user can have some ability to pay for the service, otherwise I’m not sure where the scalability comes from,” said Bean, who worries impact investing may not be accessible for all organizations. “I’m not sure if impact investing could solve chronic homelessness or could be employed in juvenile justice to reduce recidivism.”
Business of nonprofits
Business of nonprofitsLast summer it seemed that District-based Groundswell was hitting its philanthropic stride. The nonprofit, which negotiates on behalf of neighborhoods and community groups for lower rates on renewable energy, was brokering its second deal.
But its funding had run aground. Several grants and a performance contract that the fledgling nonprofit had previously lined up fell through as the granting institutions encountered their own financial hardship.
“We were growing, but your financial stability doesn’t grow with it as a nonprofit,” Executive Director Will Byrne said. “They’re almost separate.”
The organization is now looking to slowly wean its dependence on outside investors by exploring earned revenue models, including the collection of a small fee for its work. The revenue to date does not offset the organization’s total expenses, Byrne said, but it’s a start.
That deviates from the business-as-usual model in which nonprofits compete, often without end, for a finite pool of money provided by individual donors, grant-making foundations, corporations and government agencies.
While that model removes many of the burdens that come with generating revenue, it also leaves nonprofit organizations in perpetual limbo because their services depend on that next elusive check.
Those shortcomings came into sharp focus during the economic downturn as many organizations saw their stream of donations slow to a trickle at a time when demand for their services was on the rise.
“The keyword coming out of the downturn for nonprofits has been diversification,” Bean said. “So diversifying from local government support to corporate support to foundation support and to individual support.”
Bean said organizations looking to produce revenue “need to be cognizant of the need for competencies and a business plan, because for a social enterprise to succeed, they often need to beat the market.”
D.C. Central Kitchen faced that challenge in 1997 when the provider of meals to low-income city residents formed a catering business staffed by the convicts and recovering addicts who participate in its culinary training programs.
“We could be the greatest guys in the world ... but if we’re not putting out a high-quality product [that] competes with our for-profit competitors, we’re not going to get that business and nor should we,” said Mike Curtin, the nonprofit’s chief executive.
Fresh Start Catering, as well as contracts to provide healthy meals for schools and temporary housing facilities, returned $5.5 million for D.C. Central Kitchen last year, more than half of its annual budget. Outside donations made up the rest.
“To be a high-functioning, productive social enterprise, you have to be driven by the mission first,” Curtin said. “When we bring some money to the bottom line, it makes it even better.”
But “if you go too far,” Curtin cautioned, “you’re just another business.”
An identity conflict
An identity conflictTherein lies the philosophical conflict: Does a nonprofit that makes money violate the essence of philanthropy? And is it so distinct from a socially conscious business?
Perhaps the most notable distinction is that nonprofits don’t pocket the money they earn. It’s recycled back into the organization so that it can provide more services or reach more people.
That core mission is what binds the nonprofit sector regardless of how an organization or social enterprise receives its financial support, said Hall at Calvert Foundation.
“They’re trying to address some need that the market isn’t addressing for whatever reason,” she said. “Some of those needs require philanthropy to make them work. And a lot of them can be financed in a way the market hasn’t realized yet.”
The District-based Case Foundation funds organizations through a mix of grants and loans, but co-founders Steve and Jean Case also make impact investments through the couples’ personal fund.
“What it’s likely going to take [to legitimize impact investing] is leaders ... jumping in and making the case by actually actioning it and then being transparent in what their experiences have been,” Jean Case said. “We’re trying something new and it all hasn’t been figured out yet.”
Advocates will need to win over skeptics. Talk of nonprofits operating more like a business or funneling foundation dollars into for-profit enterprises can spook some of the sector’s more traditional philanthropists.
Even still, some say the shift toward revenue-based philanthropy and impact investing is already well on its way.
“We do believe this is the future of what a strong nonprofit looks like,” said Curtin at D.C. Central Kitchen. “That nonprofit will have some sort of revenue generating capacity.”
“We so badly need in our country now for people to understand the nonprofit community isn’t about charity, it’s about economic development on so many levels,” he said.