Tuesday, September 21, 2010

Growth Capital for Small Nonprofits?

This is a response to a blog post by Nell Edgington of Social Velocity, entitled "Can’t Small Nonprofits Raise Capital Too?" which is available here.

Nell, I wanted to offer some comments on your thoughtful post.  I hear this lament from small nonprofits all the time: how do we grow if we're too small to raise growth capital? It's a fair question to which the nonprofit capital market does not yet provide a satisfactory answer.

For the vast majority of nonprofits, there's only one kind of money, regardless of the particular source:  funding for programs.  That money is secured the old fashioned way, by raising it from donors by (1) building relationships and (2) telling engaging stories about the nonprofit's work.  It's a costly and time-consuming process that never raises enough money for long enough time.  Hence, the nonprofit starvation cycle is the dominant fact of life for small nonprofits.

George Overholser pioneered a new kind of money that he calls "patient capital" or "equity-like capital," and that I call "growth capital" (full disclosure:  George disapproves of the way I use that term).  The basic idea, as you say, is that investors fund the nonprofit's entire business plan for an extended period (say 3-5 years) rather than some or all of particular programs for a finite period of time.  The goal is to enable the nonprofit to permanently grow to a new level of operations that can be sustained by traditional program funding.  George observes that it's simply too costly for small nonprofits to make the case for this kind of funding, and he knows whereof he speaks.  Small nonprofits are no less deserving than larger ones, but only the larger ones can undertake the kinds of planning and demonstrate the capacity to make effective use of funding designed to enable organizations to grow by factors of 2, 3 or more over the course of several years.

However, I believe there is an intermediate kind of funding between program funding and growth capital that small- and medium-sized nonprofits can raise and that is capacity-building funding.  Of course, we all know what capacity-building expenses are -- computers, specialized staffing, professional accounting and fundraising systems, and so on -- and we also that almost no funders, either individuals or foundations, provide this kind of money, which we disparagingly call "overhead" or "administrative" expenses.  The failure of the nonprofit capital market to provide capacity-building funding (and not growth capital) is what keeps small nonprofits locked in the Catch-22 of the nonprofit starvation cycle.

The emergence of growth capital is a recent development in the nonprofit sector and it is still very much in its infancy, even though courageous intermediaries like NFF Capital Partners and EMCF are demonstrating its importance for scaling what works.  But you're completely correct that a similar effort needs to be made for capacity-building funding.  As you might be aware, Ken Berger at Charity Navigator is revising his rating methodology so that effective nonprofits won't be penalized for making reasonable overhead expenditures designed to enhance their organizational capacity and extricate themselves from the starvation cycle.  (Another disclosure:  I consult with CN.) Hopefully, charities that would lose four-star ratings under the current CN rating system will attract greater funding when the new system goes into effect.

Growth capital is aimed at achieving true scale, but capacity-building funding is aimed simply at producing robust nonprofits that aren't held back by the starvation cycle of program-only funding.  Just as small businesses provide most of the jobs in this country, we need the kind of funding that can enable many more small nonprofits to meet the everyday needs of the communities they serve in a reliable and sustainable way.

1 comment:

  1. Steve, I don’t think our arguments are that far off from each other. I absolutely agree with you that capacity capital is an enormous need in the nonprofit sector, and what George is doing for growth capital should be done for capacity capital.

    However, there are a couple of areas where I do disagree with your argument.

    First, I don’t think anyone has yet come up with a final definition for scale. What is “scale”? Does it mean that everyone in a city who could benefit from a nonprofit’s program has access to that program? Or everyone in the county, state, country, world? Or does it mean that the underlying system is changed? Or does it mean that policy has changed? What is true scale? I imagine that it’s probably different for each organization.

    Therefore, if there is a small organization that is providing a powerful and unique solution, shouldn’t they be able to expand that solution, not through incremental growth, which is the nonprofit norm, but by factoral growth, which growth capital allows? Take my example of English at Work that provides a unique solution to English language needs at the workplace. They are currently offering their program only in Austin, TX, but the program could address enormous needs in the state of Texas, or in the Southwest region, or perhaps throughout the country. And honestly, they don’t have a lot of competitors right now. So what’s holding them back from really expanding this program to an ever growing population of immigrants? Growth capital. But English at Work would never catch the eye of the Nonprofit Finance Fund or New Profit or any other venture philanthropy fund or proponent of growth capital. So what English at Work and Social Velocity are doing instead is creating a growth plan and then educating their current and potential funders in their network about the power of growth capital.

    Nonprofits like English at Work and the countless others who have a great solution and a vision for growth don’t have the luxury of sitting around waiting for the nonprofit capital market to evolve to a place where the bottom 80% of nonprofits have access to growth capital.

    Second, creating a growth capital campaign doesn’t have to be prohibitively expensive for smaller nonprofits. Sure they can’t afford the larger fees that Nonprofit Finance Fund might charge, but they also don’t need that kind of money to be able to grow. Heart House is another example. They want to expand their afterschool program for at-risk kids throughout the state of Texas. They’ve put together a comprehesive growth plan to do this and the price tag is just north of $1 million. They have already raised a good chunk of that money, not from venture philanthropy funds, but again from their own circle of donors and friends who they are educating about the power of growth capital.

    I think George, the Nonprofit Finance Fund, Charity Navigator, you and many others are doing a phenomenal job of bringing the ideas of growth capital and capacity capital to the consciousness of funders, regulators, nonprofits, etc. The case studies that NFF has provided are fabulous tools for those on the frontlines of the nonprofit sector wanting to raise growth and capacity capital, but needing help articulating and providing examples to donors, board members and others about what it is and what it can do.

    The good news is that growth and capacity capital are already being raised among smaller nonprofits. So let’s not tell them to wait. Let’s give them more tools and examples to do more. Because the number of problems facing local and regional communities is only getting worse. Those smaller nonprofits that have solutions need all the help they can get to bring those solutions to more people.