What it takes to build dreams – Part 2

March 18, 2013March 18, 2013 ~ Sasha ~ 2 Comments

Paula Goldman, Omidyar Network’s Director of Knowledge & Advocacy and co-author of the excellent “Priming the Pump” blog series made a very helpful and clarifying comment on the last post (emphasis added):

Sasha, excellent post. I agree with you that as a field we need to get a lot smarter about the risk/social impact equation — this will make or break the field. I also agree with you that the path to scale here isn’t just about making this an asset class. Commercial markets are already incredibly good at allocating capital efficiently, including to businesses that generate positive impact and solid financial return. The risk is that by pumping up the industry in this way, there will be nothing incremental or new about investments labeled as impact investing.

I would ask you though to reconsider the use of the term ‘crummy’ economics. While the economics in many cases for impact investing are sometimes different than traditional investing, taking on additional and different types of risk doesn’t necessarily mean lowering financial returns.

This comment shines a light on exactly the distinction I’m trying to make, because, for this conversation, I’d like to take a pass on the whole discussion of what the returns are in “impact investing” (and whether or not they are “crummy”) since I don’t believe you can answer that question without better defining which segment of impact investing you have in mind.

Instead I’d like to ask whether, as I observe anecdotally, there are sectors/project outside of impact investing that attract huge amounts of capital that have “crummy economics.”

To recap the sorts of conversations I’d love to redirect:

Question 1: “What is the risk/return profile for impact investing?”

My current answer: “It really depends on what you mean by ‘impact investing.’ For some (significant) part of what could broadly be defined as impact investing, the financial returns may well compensate an investor and her LP well for the financial risk she is taking. However, there are also big and important parts of impact investing – including those segments where the non-negotiable is impact; and those segments focused on the poorest, hardest-to-reach populations – where the financial returns likely won’t fully compensate the investor or her LPs for the risks they are taking.”

Question 2: “But if the returns aren’t there, doesn’t that mean that the sector will never grow? Doesn’t that mean that capital will never flow in in significant ways, in which case the sector will never scale and reach its potential?”

AHA! THIS is the question I’m aiming to dig in to, not the prior one. This is why I said that I’d observed that “increasingly across sectors I meet more and more people who acknowledge that most of the most important (dare I say the most “impactful”?) work they do has crummy economics.”

Namely, I’m finding the discussion on “what the returns are” to be circular, because it hinges on how you define “impact investing” and what particular niche/sub-segment you are in. The dead-end I’m trying to break through is the one that says “IF the returns aren’t there versus the risks people are taking, then capital won’t flow in.”

My hunch – and the thing I’m looking for data on – is that this statement might be empirically incorrect. My hunch, informed by conversations with people in sectors far away from impact investing, is that the overall NET returns for huge swaths of projects that create public good (and have an underlying long-term economic logic) might be low (aka “crummy”). But these projects and the people backing them find a way to make them happen at scale – whether by layering capital, layering risk, layering returns, bringing in philanthropy….. in such a way that lots of stakeholders and lots of stripes of money get what they want.

And so, my non-empirically-proven hunch is that the fundamental net (total project, total portfolio) return being low doesn’t inherently limit the ability of billions, even trillions of dollars, to find its way to meaningful project that have a blended return. That’s the data I’m looking for.

One reader kindly pointed out the Kauffman Foundation’s recent report that revealed that 78% of their traditional venture capital funds “did not achieve returns sufficient to reward us for patient, expensive, long-term investing.” And yet $22 billion a year still flows into venture capital.

Not exactly what I had in mind, but that seems to be a pretty great data point showing that failing to compensate LPs adequately for the risks they take doesn’t mean that money won’t flow in.

Should foundation program officers be more like venture capitalists? (Part 2 of 2)

February 9, 2009 ~ Sasha ~ 6 Comments

(This post first appeared on the Tactical Philanthropy blog, as part of a conversation Sean Stannard-Stockton kicked off on creating a ‘capital market’ for philanthropy. It is the continuation of my earlier post on whether foundation program officers should be more like venture capitalists.)

One of the big problems we need to solve as a sector is how to find ways to scale highly effective nonprofit organizations. Kudos to Sean for raising this question and also for highlighting the power dynamic that can often exist between funders and grant recipients. (I particularly like George’s reference to the need to be a “chameleon”, which captures the issue very nicely).

At Acumen Fund, about two years ago we realized that we were in a position for a major scale-up of our work, and we also recognized that the best way to do it would be to raise a large pool of unrestricted philanthropic capital that would take us to the next level. We set out to raise $100M over two years in unrestricted capital in May of 2007, and by the end of 2008 we raised $85 million against this goal.

One of my reflections having led up this effort is that individual philanthropists are typically much more prepared than institutions (foundations and corporations) to make large, long term, multi-year, unrestricted gifts. (That said, there are some institutions that are exceptions to this rule, and I do believe that when programmatic goals of a nonprofit align closely with those of a foundation, large gifts with some restrictions can provided needed growth capital that allows for the kind of organizational investment that growing nonprofits need to make.)

Where things get really tricky is when a nonprofit that might be ready for tens of millions of dollars of growth capital (the $10-$30M that George Overholser suggests is a good reference point) finds itself mostly able to raise programmatic grants (often narrowly restricted) in $50,000-$100,000 increments from foundations. Programmatic grants like this can create the two-headed hydra of not having sufficient funding for “overhead” (a.k.a. non-program staff), combined with the communications, relationship and reporting challenge that can come with having 100 individual $50,000-$100,000 grants (an absurd number, but this would get you to $5-$10 million) – the “chameleon” problem.

The irony is that in other lines of work – venture capital; executive search; etc. – being able to find and invest in a world-class team of people is seen as THE differentiator between good and great firms. Yet all too often, foundations seem unwilling to invest in people and organizations, instead seeing nonprofits as a means to a programmatic end.

The problem with a world in which the most proactive, risk-taking philanthropists are individuals (rather than foundations) is that it has the potential to limit severely the types of new nonprofits that will be successful at growing to scale – namely, the winners will be those organizations that are run by individuals who are capable of building strong and deep relationships with ultra high net-worth individuals. Nonprofit CEOs who can do this bring together a unique combination of skills, but if this is only real way for anyone looking to grow a new nonprofit, then we as a society have a problem. (though large scale retail fundraising using Web 2.0 tools is a potentially interesting solution).

The potential I see is to have foundations bring together both know-how about what it takes to solve major social problems AND a risk appetite to put capital behind organizations (and not just programs) that have a real chance at building those solutions.

For now, at least, it seems like we’re coming up short on the appetite for risk and for openness to the idea that investing in great teams and building great institutions will be what brings forth the next wave of groundbreaking nonprofits.

Should foundation program officers be more like venture capitalists? (Part 1 of 2)

February 5, 2009 ~ Sasha ~ 7 Comments

One of the big unanswered questions in the nonprofit space is how new, innovative, effective nonprofits can raise enough capital to grow big and expand their impact. At the core of the conversation is the fact that, unlike in for-profit markets, there’s no clear and established way for nonprofits to raise money around a great idea and a great team.

The ideal proxy, in my opinion, is the venture capital business. Venture investors typically have a specific area of expertise (telecommunications, alternative energy, software platforms) and, within that area of expertise, they find high-caliber people who have assembled teams around a new and innovative idea, and they put up significant amounts of capital to support that team and the idea. The capital is meant to be enough to get the team past a certain threshold, at which point the business will be positioned to raise capital from another source or have an IPO.

Here’s the interesting part: foundation program officers ALSO have, you guessed it…specific areas of expertise and large amounts of capital behind them. At face value, they are positioned to act like venture investors, but they don’t typically act this way.

The analogy to VCs isn’t perfect, but I do think it’s worth considering that foundations as risk-takers and “venture partners” would be a welcome shift for the sector (and yes, there are foundation program officers who act exactly like this, but it’s not the norm).

That said, there are a number of features of the venture investing world that will be very unfamiliar to the nonprofit space, and we would have to figure out how to tackle these if we expect to make progress:

Acceptance of failure. In a typical venture portfolio, 1-2 of 10 firms is a blockbuster success, 3-4 return capital, and the rest lose everything. The venture world has acknowledged that failure is a necessary ingredient in creating innovation; in the nonprofit sector, “failure” is a four-letter word
Betting on people and teams first. This is what VCs do. But more often than not, foundations see nonprofits as implementers of a specific programmatic strategy. Being a delivery vehicle is very different than being trusted to create something new, powerful, imaginative, and groundbreaking.
Clear path to exit. When startup firms are successful, there’s a clear path to the next round of funding. This is arguably absent in the nonprofit world. (Though George Overholser at the Nonprofit Finance Fund has put forth the idea that certain nonprofits with a built-in income generation model can achieve financial self-sufficiency once they reach a certain size, if only they could raise growth capital. I agree, but think the concept might be too restrictive since donations are the revenue model for most nonprofits. So the model might be: Growth → Increased visibility/brand/recognition → Stronger board/donor community → Increased ability to raise funds).
Aligned incentives between the venture investor and the entrepreneur. If the venture-backed entrepreneur is successful, the VC and the entrepreneur get rich. But if a program officer invests in a nonprofit that, through its innovation and ability to listen to its customers, veers off in a radically different direction, in some ways this is necessarily disappointing to a program officer who has a specific (and often somewhat narrowly defined) set of programmatic objectives.
We’re in this together. Venture investors typically play a very active (some entrepreneurs would say too active) role in bringing in resources (people, expertise, board members) to support the success of the enterprise. It is extremely rare that foundations play this kind of active role in supporting the success of their grantees.

So there are lots of barriers, but most of them seem to be of outlook and mindset rather than being structural.