Funding the Benefit Sector At the Intersection of the Social (nonprofit), Private (business), or Public (government) Sectors
Funding the Benefit Sector: The Benefit Sector is emerging to fill a gap in the ability of the three traditional sectors to produce balanced benefits for society as a whole1.
Social (nonprofit) Private (business), or Public (government), sectors or a combination, or hybrid of them can all be part of the Benefit Sector. What makes them special is that they have purposes that balance the social-economic interests of more than a single interest group.
The benefit sector of activity has special features that mean that funding the benefit sector has led to the creation of financial services to meet those special needs. Nonetheless, there are ways that the benefit sector can also take advantage of more traditional finance.
The increasingly blurred divide between what is considered for profit, philanthropy and public administration, has resulted in the benefit sector having both direct equity investment, where an incorporated business exists, and virtual equity investment, where there is none.
Funding the benefit sector has demanded creativity from the world of finance. Direct equity investment for funding the benefit sector can be not only in traditionally incorporated companies, but also in Benefit Corporations, Community Development Financial Institutions (CDFIs), co-operatives, employee-owned enterprises, Low Profit Limited Companies (L3Cs—in 30+ states), Social Purpose Corporations (in CA, FL & WA), and the Public Benefit Corporation (MN & TX). An infrequently used form is the Operating Foundation, that has incorporated companies as subsidiaries, and thus will use equity in their businesses, though at least 85 percent of its income must be spent on its charitable purposes.
Sometimes organizations in the benefit sector are described as hybrids because they generate revenue, as they pursue social goals. Other hybrid forms may include constellations of organizations that include for profits, nonprofits and low profits. Funding the benefit sector generally takes place through the available legal structures described above.
There is no perfect organizational structure and they seek to use the advantages of each to pursue their beneficial ends. There is also a nonprofit corporation, which is a business organization that serves some public purpose and therefore enjoys special treatment under the law, and nonprofit corporations, contrary to their name, can make a profit but can’t be designed primarily for profit-making.
There are many other related developments in the benefit sector, such as the growing use of civic or municipal enterprises to deliver public goods, and inevitably involving public equity. Public-private partnerships (PPP, or P3s), sometimes called Special Purpose Vehicles (SPVs) involve long-term contracts between a private enterprise and a government entity, for providing a public asset or service, in which the private party bears significant risk and management responsibility, and remuneration is linked to performance, and generally the asset passes from the private owner to the government partner at the end of the contract period. This kind of arrangement for funding the benefit sector is most typical in road construction, but are also used for IT infrastructure, health and education. To learn more about this kind of way for funding the benefit sector, read this report from Price Waterhouse.
Equity financing is the process of raising capital through the sale of shares (ownership) in an enterprise. It can involve a few thousand dollars raised by an entrepreneur from friends and family, to giant initial public offerings (IPOs) involving billions of dollars. Equity in an enterprise is the difference between the value of the assets and the cost of the liabilities.
The social sector, or the world of nonprofit organizations, is not ordinarily associated with the idea of equity financing, which is generally considered appropriate for the private sector where shareholder interests predominate and financial returns are expected. So, funding the benefit sector is often somewhat complex, since there is not yet a tradition of money raising for such organizations.
Like private companies that are required to report to shareholders (equity investors), the donors must get reports on how the funds are spent, as well as making reports to the IRS. To qualify as charitable, donations can be given to organizations including Federal, state, and local governments and organizations organized and operated only for charitable, religious, educational, scientific, or literary purposes, or for the prevention of cruelty to children or animals.
The public sector, not normally involved with equity finance, has itself a well defined reporting mechanism, though much debated. This is the ballot box and the system of ‘checks and balances’ between the legislative, executive and judicial branches is the cumbersome means by which no one branch or set of interests is supposed to outweigh the other.
Benefit Sector Equity
Within the Private Sector, socially–responsible investment (SRI) is not new. It also goes by many other names, including values-based, ethical, impact, mission, or sustainable investing. In the last few years, SRI has been growing at an increasingly fast great rate2. SRI involves “investments made into companies, organizations and funds with the intention to generate measurable social and environmental impact alongside a financial return.3” and increasingly pushes private companies to behave in both socially as well as financially responsible ways, because they have to provide evidence of their behavior in their annual reports. Building on the SRI movement, ESG (Environmental, Social and Governance factors in investment processes and decision-making) investing is estimated by Forbes in 2018 at over $20 trillion in AUM (Assets Under Management) or around a quarter of all professionally managed assets around the world.
Thus, this way of funding the benefit sector is growing rapidly. The Morgan Stanley Institute for Sustainable Investing reported (2017) that 75% of investors are interested in SRI.
Social venture capital is also an emerging field. Founded in 2001 with seed capital from the Rockefeller Foundation, Cisco Systems Foundation and three individual philanthropists, the Acumen Fund raises charitable donations to invest in companies, leaders, and ideas that are changing the way the world tackles poverty. Investors’ Circle, founded in 1992, promotes the transition to a sustainable economy by increasing the flow of capital to enterprises that are addressing social and environmental challenges, contributing to the alleviation of poverty, generation of healthy communities, restoration of our ecosystem, and creation of meaningful economic opportunities for all.
Community Development Venture Capital
Community Development Venture Capital is another variant. For example, the Innovate NY Fund is a seed stage business equity fund with up to $47 million to support innovation, job creation, and high growth entrepreneurship throughout the state. The Innovate NY Fund is supported with $37 million in State funds and $10 million from Goldman Sachs, and is expected to leverage over $450 million in additional private investment for small businesses.
Another example is Advantage Capital, founded in 1992 with a dual mission: to bring businesses, technologies and jobs to communities that have historically lacked access to investment capital, while also generating competitive returns for their investors. They consider that a small business isn’t a product, or a building, or even an idea. People are what make a business. Hence, they invest in entrepreneurs and teams with passion and vision.
Nonprofit Ends Through For Profit Means
To confuse matters, this is not only conducted by venture capitalists, but now foundations have entered the field considering that their nonprofit ends can be achieved through for-profit means. The best example is probably the FB Heron Foundation that started as a traditional foundation, but now focuses its investment on enterprises—meaning to them all forms of business in the economy—as the agents of change and impact. It is a philanthropic institution focused on improving economic opportunity and integration of poor people in the US economy, through being a mission investor that also makes grants to nonprofits. Heron invests in public companies, government entities, private for-profit companies, nonprofit enterprises, and cooperatives. Heron consider itself to be “part of a growing movement of impact investors, values investors and others attempting to ensure that their investments maximize social and financial performance together.”
With a $500 million allocation of its assets, the MacArthur Foundation also makes impact investments to advance established and emerging program goals. Totaling more than $500 million since 1986, these loans, bonds, stock, equity, deposits, and guarantees directly meet the capital needs of special-purpose funds, for-profit businesses and nonprofit organizations tackling environmental and social challenges around the world.
Benefit Sector Community Funding
Community-supported business (CSB) or enterprise (CSE) is a growing practice, widely used in Vermont and growing in other, particularly rural, states4. I have been studying and researching this movement for the last three years, during which time the process has become much more sophisticated. The concept of a community supported business derives from community supported agriculture (CSA) where consumers ‘invest’ in food by buying shares, subscriptions, or memberships in a CSA before the growing season so that the farmer has money to use when no income is being received. Now it has evolved in many ways including nonprofits and government agencies becoming directly involved in funding assets used by CSBs.
Another kind of community sourced capital can be raised through Direct Public Offerings (DPOs). A DPO is a term that refers to a public offering of securities by a business or nonprofit to both accredited and non-accredited investors in one or more states. Using a DPO (also known as investment crowdfunding), a business or nonprofit can market and advertise its offering publicly by any means it chooses.
Crowdsourced capital (as opposed to reward and other forms of crowdfunding), on the other hand, has in principle been allowed since May, 2016, when the new Title III (of the JOBS Act) rules were published, but as yet has been little operationalized. This federal exemption that pre-empts state law and allows a company to raise up to $1 million from investors in all states. See the Venture Founders Equity Crowdfunding Directory—USA, for more information.
Largely because the SEC had been so slow to publish crowdfunding rules, many states introduced the intrastate direct public offering. This may be the most popular strategy for direct public offerings because it allows a company to raise an unlimited amount of money, as long as all investors are in the same state (along with a few other requirements).
Considered a social venture fund, Underdog Ventures based in Vermont, invests in sectors such as natural and organic food; environment and conservation; socially responsible consumer products; socially responsible investment companies. Their investor for the Underdog Ventures Legacy Fund directed them to develop a community venture fund customized for community wealth building, through which investments were made in companies that built wealth deeply within their company and broadly within their community.
Benefit Venture Capital and Program Related Investment (PRI)
Investment as well as disposable funds are now helping nonprofit and social enterprises grow and leverage capital to meet the needs of underserved people and communities. The concept of program-related investment (PRI) is relatively new and it is a form of funding that is likely to grow, and can be considered a form of nonprofit venture capital, if used to purchase equity.
Final regulations concerning PRIs were published and made effective in April 2016, that provided private foundations with additional varied examples of how they can use PRIs to further their charitable missions. PRIs are a statutorily defined exception in the Internal Revenue Code to the rules prohibiting private foundations from making “jeopardizing investments.” The rules allow PRIs to be used to make equity investments, or loans, bank deposits and guarantees. One interesting consequence is that if a foundation purchases equity in a subsidiary of a drug company to develop a vaccine for the poor in developing countries, that would be allowed. Such a subsidiary might be considered social intrapreneurship.
As well as PRIs, the traditional venture capital industry is witnessing a growing number of firms that are devoted to the benefit sector. A good example is Big Path Capital that assists mission-driven business owners with the full or partial sale of a business, acquisitions, mergers, capital raises, and strategic options. The firm aims to partner with business owners to grow sustainable, profitable businesses that generate solid financial returns without compromising core values and mission.
Social Business Capital
Such a kind of nonprofit venture capital resembles the concept of the social business— a cause-driven business— developed initially by Muhammad Yunnus. In a social business, the investors/owners can gradually recoup the money invested, but cannot take any dividend beyond that point. Another variant of nonprofit venture capital. Yunnus says, “A charity dollar has only one life; a social business dollar can be invested over and over again.”
StartSomeGood, an example, is a crowdfunding platform exclusively for social change initiatives. I make loans through a social business, the microfunding platform called Kiva, but there are many examples and more are being created almost daily. If this route makes sense for you, then take a look at the Venture Founders Directory of Mission Driven Capital, as well as the Equity Crowdfunding Directory—USA.
Mission Related Investment (MRI)
Mission-related investments (MRIs) are those that are made with a clear intention to meaningfully contribute to the accomplishment of the Foundation’s philanthropic mission and the success of our programmatic strategies, and to achieve a financial return commensurate with the risk and the social impact to be achieved. Unlike PRIs, MRIs are not statutorily prescribed and have no consensus definition. The jeopardizing investment rules and other legal requirements, such as state prudent investor rules, do apply to MRIs.
The Packard Foundation, for example, has made over 250 mission investments totaling $750 million to organizations that support the mission of the Foundation and generate both social and environmental returns. Packard acknowledges that, “In an evolving world with complex social and environmental challenges, the nonprofit, public, and private sectors all have important roles to play.”
Social Impact Bonds (SIBs) are an innovative and emerging financial instrument that leverage private investment to support high-impact social programs. An SIB, also known as a Pay for Success Bond or Social Benefit Bond, is a contract with the public sector, in which a commitment is made to pay for improved social outcomes that result in public sector savings.
1. The Benefit Corporation law describes it as, “general public benefit”—defined as a “material positive impact on society and the environment, taken as a whole, as assessed against a third-party standard, from the business and operations of a benefit corporation.”
2. The 2014 Report on US Sustainable, Responsible and Impact Investing Trends, notes that nearly $7 trillion in US-domiciled assets employ at least one SRI strategy. This up 40 percent from $3.74 trillion in 2012. These SRI strategies include: incorporating environmental, social and governance (ESG) factors into investment decision making; shareholder advocacy; direct investing for measurable impact; or some combination.