Balancing the Mission Checkbook

The State of Vermont recently adopted legislation creating a new type of entity, a Low-profit Limited Liability Corporation. The L3C, as it is called, is sort of a hybrid of for-profit and nonprofit created as a way to attract both private and philanthropic capital to build businesses with a social benefit. The leading advocate for this new structure has been Americans for Community Development and the Mannweiler Foundation.

The idea behind this hybrid, from an excellent overview of the L3C written by Americans for Community Development, is to “access the vast pools of market driven wealth to make socially responsible investments in so called nonprofit areas.”

From what I understand, the L3C is formed as a Limited Liability Corporation, a well established and flexible business form. The members, or shareholders, of an LLC are entitled to receive a profit or return on their investment. The nonprofit-like aspect comes in the “low-profit” name. The Vermont legislation requires that the L3C must also meet these requirements:

• “Significantly furthers the accomplishment of one or more charitable or educational purposes”
• “No significant purpose of the company is the production of income or the appreciation of property”
• “No purpose of the company is to accomplish one or more political or legislative purposes”
• The name of the company “shall contain the abbreviation L3C or l3c”

This language was carefully developed to qualify these new entities to receive investments from foundations through Program Related Investments. I’ve written before about PRIs as an interesting and unique source of capital funds for nonprofits.

“The key insight of the L3C is that it is not a two-part world but a three part world and that many worthy causes are capable of being self sufficient; they simply do not offer enough of a return in order to attract for profit investors - particularly at their inception,” (Americans for Community Development). So the idea is to create businesses that can attract some private capital, bolster that with more patient philanthropic or socially motivated investment, and result in value to the community (jobs, housing, local revitalization) and a below-market return to investors. This structure is not a fit for every nonprofit, or even for every social enterprise. The L3C is all about raising capital, and when the need for capital is significant, this is worth considering. While the legal form currently exists only in Vermont, several other states are considering adopting the enabling legislation. Meanwhile, an L3C formed in Vermont can operate in any state.

For more information about the forces that are driving the demand for an alternative structure, and some arguments that a new form are unnecessary, The Aspen Institute published a report last year by Thomas Billitteri, Mixing Mission and Business: Does Social Enterprise Need a New Legal Approach?

I have shared some of my thoughts and opinions about the field of social enterprise in this blog, including the question of whether the hubbub about creating business ventures is just a new name for a long-standing practice (see Is Social Enterprise Really New or Different). However, I have to extend my congratulations and admiration to the Animal Humane Society (AHS) for their plans to open a premier pet boarding facility at the Minneapolis-St. Paul airport. This plan sounds like a real winner that merges the assets of the nonprofit with a real market demand. I have high hopes that the return to the AHS will not only be financial, but will also increase their visibility, community support and donations, and reputation. The plans are described in a press release issued on March 10th.

When I lead discussions with nonprofits interested in finding a social enterprise idea to pursue, I encourage them to resist the temptation to replicate what looks like a good idea that they read about in an article or heard at a conference. The best enterprises are grounded in both the mission and the assets of the organization. The most successful enterprises support the mission beyond a projected financial return. They also take advantage of one or more assets, such as knowledge and expertise, location, understanding of a community, and reputation. To be financially viable, an enterprise must also find a market – a bona fide market that is willing, and wants, to buy the service or product.

The pet boarding facility looks like a good idea on all of these fronts. It’s a mission fit, takes advantage of organizational assets including understanding of how people relate to and care for their pets, and the reputation of the organization. The market demand is demonstrated every time you talk to a colleague who has to take a half day off before a vacation to drive across town to drop off and then pick up their pet. There are risks, of course. The facility is expensive ($4.25 million) and the AHS is investing $750,000 of their own designated funds to launch the venture. The goal is to return financial dividends to the nonprofit to support other programs, and the pet boarding facility is structured as a for-profit subsidiary of AHS.

Best wishes to the AHS on this venture – and thanks for the great case study for us all to observe.

I’ve been mulling the question of what makes a nonprofit organization distinctly different from a for-profit business. Thinking about this is percolating because of an article in The New York Times about a week ago, A Capitalist Jolt for Charity, about the nonprofit In2Books, the related for-profit business ePals, Inc, and the enthusiasm of venture capital entrepreneurs to use their money and talents to do good. According to the article, by morphing the nonprofit into a for-profit with access to angel capital and business practices, the combined organization is better than it could have been as a single nonprofit. They are “making use of some of capitalism’s virtues.” Really? I’m all for any trend that gets smart people from business, and their capital, focused on doing good work, but I am put off by the implication that (a) “regular” nonprofits don’t employ growth strategies already, and (b) there is not a real difference between a for-profit business and a nonprofit, as long as the business owners are working towards a community good.

Some of the phrases used in the Times article include “encourage more nonprofits to become self-sustaining” and “make the market work for social goals.” The terms revenue, profit, earned income, investment, and entrepreneur are bandied about as if they have a clear, singular definition that is unique to this topic. This muddy and imprecise use of business terms applied to nonprofit organizations (as if we hadn’t thought about these before) contributes to the confusion.

First of all, I can think of numerous nonprofits (including Nonprofits Assistance Fund) that have demonstrated smart growth, good business and financial practices, and important community impact. Would we have done better work if we had been a for-profit instead? The bigger issue to me is the essence question – what makes a nonprofit different? Is it just tax status, or is there a more essential distinction? I would love to participate in a broad discussion about this, starting with two fundamentals.

1. Business model differences – nonprofits almost always require some form and amount of subsidy to make the income, expense, and asset model work. Subsidy can take the form of direct financial contributions or grants to pay for some or all expenses, but volunteers, donated inventory and services, sponsorships, and low cost or free physical and financial capital are also forms of subsidy. In the case of ePals, described in the Times article, Intel is including the ePals icon on the Classmate laptop computers. This is a type of subsidy, since a traditional business partner would surely have to pay for this access. I also think that the investors who are willing to purchase shares in a social business without expectation of a market rate return on investment are effectively providing another form of subsidy. All this leads me to suggest that the idea that business practices will help nonprofits become “self-sustaining” and “make the market work” is trickier than it looks on a spreadsheet.

2. Structural differences – nonprofits and for-profit businesses have very different sources of accountability. The shareholders of a business can certainly decide to have a social mission. But the board of directors of ePals, Inc, even with its social mission and good intentions, has the option of changing their mind at a later date and reorganizing to return maximum profit. A nonprofit organization is accountable to the mission and community forever. The workings of boards of directors and staff can certainly be messy, confusing, and inefficient, but the measure will always be a true double bottom line, as it always has been.

What do you think – does this hit a nerve for you, or do you think I’m way off base?

I teach a graduate class in Financial Management for Nonprofit Organizations at Hamline University in Saint Paul. This week’s class topic was social enterprise, nonprofit business start-up, and earned income strategies. One of the hurdles the class faced was with the terminology and definitions used in the “field” of social enterprise. The question that came up again and again is this: what’s the difference between “social enterprise” and ordinary, everyday program activities that have a fee for service or a price attached? I stumble over this question myself. On the one hand, we could say that it doesn’t really matter what terms we use to describe the different earned income streams for a nonprofit, but I think that the continual banging of the “social enterprise” drum make it important to face this question. Case in point: theaters generate earned income by selling tickets to audience members. When the same theater sets up a little business renting out the dark theater during the day for corporate events, they are suddenly recognized as a “social enterprise.” What about all those ticket sales?

In the FAQ section of the Social Enterprise Alliance, social enterprise is defined as “any nonprofit business, venture, activity or strategy conducted for the purpose of generating earned income in support of a social mission.” That definition would seem to include all earned income, from the ongoing theater ticket sales and community clinic’s patient fees to the start-up catering business of a daycare center or corporate events at the theater. If you read the books, articles, and research studies about social enterprise, though, you will see a distinct emphasis on the latter type of revenue – something new and different, rather than something tried and true. The Social Enterprise Alliance also has a nice article on this topic, Social Enterprise: Hype or Reality, which acknowledges that earned income has been a part of the income mix in the nonprofit world for years. The newness of these strategies may be more noticeable in social service agencies than in the arts, health care, or community development. This “new” field might be more about the importance of paying attention to the value of earned – and therefore unrestricted – income, as well as taking steps to generate earned income on purpose and purposefully.

The field of social enterprise, however you define it, is certainly well documented and analyzed. In addition to Social Enterprise Alliance, you will find interesting information and research from REDF and Community Wealth Ventures. If you want an in-depth study with lots of cases, read Community Wealth Venture’s report, Powering Social Change.

What do you think – is social enterprise a distinct and definable movement among nonprofits, or is it a just a new name?

I picked up the December/January issue of Fast Company magazine the other day because the cover story is about their annual Social Capitalist Awards. I know that I’m probably a lot more comfortable talking about capitalists and capital than many of my friends and colleagues in the nonprofit world. Fast Company was regular reading for me for the years when I advised and financed entrepreneurial businesses. I’ve been interested in these awards since the magazine started the annual recognition in 2003, partly because I wondered why a business magazine chooses to venture into the task of evaluating nonprofits. I’ve also been puzzled, frankly, by what the criteria are to be recognized as a social capitalist. There isn’t a clear connection such as earned income ratio, profitability – or surplus as we like to call it.

According to the web site, “From its inception, the Social Capitalist Awards have defined strong performance as a combination of both social impact and organizational effectiveness. This performance is represented by five critical components: Social Impact, Aspiration & Growth, Entrepreneurship, Innovation and Sustainability. The underlying theme through all of our components is the organization’s ability to analyze tough social and organizational challenges and to craft solutions that create significant improvements over the status quo.”

This year the awards went to 43 nonprofits who serve a wide range of communities and needs both in the US and globally. These 43 nonprofits have different income sources, operating systems and service areas. What makes these 43 earn the distinction over any number of other solid, well-run nonprofits?

My understanding of the awards became clearer this year as I read all the articles and expanded information on the web site. The addition of a special category of recognition for partnerships between nonprofits and businesses - with benefits for both – helps to answer the question of why a business magazine sponsors this recognition. The piece I’ve been missing, though, for the last three years is the critical role of metrics for Fast Company and its business readers. All of the awardees are able to provide concrete, quantitative measures of impact for their work. I’ve been making the case for a while that nonprofits need to take responsibility for defining their own measures of success – or else someone else with define them for us. These social capitalists have done that. Whether or not you think that these are the right 43 organizations to be recognized or not, I admire the clarity of the information about their mission, activities, and their impact. The 43 organizations are all great nonprofits, but I am disappointed that the same names appear on this list year after year. I think that about 75% of this year’s awardees have been recognized previously, and 10 or more have been on the list all four years. Get your metrics figured out and watch out for the call for nominations next year!

A second point of clarity for me is the distinction between what Fast Company calls “social capitalists” and the questions I hear about starting a social venture - nonprofits starting an earned income venture. Social capitalists may or may not generate much (or any) earned income from sales of goods or services. Bill Drayton at Ashoka that social entrepreneurship is about innovation and impact, not income. Read more about innovation to solve community problems in an article by Gregory Dees at Duke University.

Though I do not subscribe to the theme that nonprofits universally need to “act more like business,” in one area I do think that the business world has a lot to teach – the sources and uses of capital. Use the word “capital” in a discussion about nonprofit finances and the majority of the participants will assume that the topic is buildings and a “capital campaign.” Business leaders know that they need capital for a range of distinct and important purposes including short-term working capital, permanent working capital, and long-term asset creation. (more…)