• Social Enterprises Linked to Poor Performance in Nonprofits (Nonprofit Quarterly)
• Study Questions Efficiency of Charity Business Activities (Chronicle of Philanthropy)
• Report Faults Nonprofits on Service (Wall Street Journal)

Looking for the scandal, I read the stories and then read the report behind them. Nothing terrible happened, but a hot button certainly was pushed. I wonder what it is about social enterprise or other earned income ventures at nonprofits that engender such a strong overreaction.

Here’s a summary: Rebecca Tekula, PhD, from Pace University released a research study, Social Enterprise: Innovation or Mission Distraction? The study reviewed IRS 990 data for large human service nonprofits in New York with analysis of the correlation between unrelated business income, program expense ratio, and the asset to liability ratio. Based on the data and analysis, Dr. Tekula concludes that there are negative relationships between social enterprise activities and value of programmatic output as well as between social enterprise activities and financial distress.

The report, and subsequent coverage, raise some big questions for me.

My first concerns are with the data used in the report, which are premised on some assumptions and definitions. Social enterprise activity is represented by unrelated business income, which is a small component of earned income activities at nonprofits. Programmatic output is represented by the program expense ratio, notorious for being inconsistently reported. Financial distress is measured by the asset to liability ratio, which is a better measure of the nonprofit’s need for and use of leverage and commonly needed for any real estate asset.

I also take issue with the conclusions in the report. They are based purely on the statistical analysis, which Dr. Tekula acknowledges. Research reports are always built on a hypothesis and methodology. However, I think that her conclusions are overly broad. The press release about the report summarizes:

In other words, as income from side businesses went up, the share of a contributed dollar that went to actual services went down. Why? Tekula speculates that many organizations with unrelated businesses were not really investing profits in their mission-related services. Instead, profits were reinvested in the business, and losses were subsidized with funds that might have gone to clients.

There is no evidence at all, though, that the nonprofits included in the study were providing substandard or ineffective services to clients.  And there was no data included to indicate that the business operate at a loss.  So speculating that “losses were subsidized with funds that might have gone to clients” is a pretty big jump from statistical correlation based on a narrowly defined ratio.

I have an even bigger question about the sensational tone of the headlines listed above. The heading for the press release from Pace University was Study Finds Nonprofits May Bleed Their Services by Trying to Earn Money. The editors at the Nonprofit Quarterly, Social Enterprises Linked to Poor Performance in Nonprofits, and Chronicle of Philanthropy, Study Questions Efficiency of Charity Business Activities, really went for the bait with this one. There is nothing in the report data or conclusions that support the notion that the nonprofits included in the data are bleeding their services, performing poorly, or are inefficient.

What is it about social enterprise that invites this response?

I was glad to be asked to fill Kate Barr’s blog shoes while she is on sabbatical. I often write pithy blogs, if only in my mind. This assignment forced me to round up some of those loose ideas and put pen to paper; or rather, fingers to keys.

It’s Time to Innovate

Social innovation is on the tip of a lot of tongues these days. Most of us in the nonprofit sector are facing the fact that financial resources will remain tight for several years. Many of us have tried to do “more with less.” We’re now awakening to the fact that it is time to do things differently. In other words, it is time to innovate.

So what is social innovation? I especially like the definition used by Andrew Wolk of Root Cause in a recent speech he gave to the Texas Governor’s Nonprofit Leadership Conference:

Social innovation is the process of developing, testing, honing, and spreading transformative approaches to pressing social issues. It is finding ways to do things better and utilize resources more wisely.

Just as important is what social innovation is not! It is not only the purview of those who are leaders of social enterprises. It’s not just for Ashoka Fellows; though they are a remarkably innovative group. In fact, innovation is a discipline that each and every nonprofit and institution needs to incorporate in its work.

Getting Started

Where do we start?

We start by nurturing the seeds of discontent most of us share that we’re not making the progress we want to make on the issues facing our communities and our world.

Next, we arm ourselves with information about innovative processes. I highly recommend two books: The Medici Effect and Blue Ocean Strategy. Then add a daily Google Alert on social innovation or on the innovations in your particular field. It is okay to copy other nonprofits’ innovations in your own organization. Take a look at www.ideaencore.com – an online marketplace of other nonprofit organization’s best practices and resources.

Inside our organizations we can form teams that work on “developing, testing, and honing” advancements in our fields. We can charge individuals with responsibility to work on the next improvements in our processes, products, and services. We can start to admire the breakthroughs being achieved in other fields and think through how those breakthroughs might translate to our own challenges.

Innovating won’t be easy. Many organizations have stretched their people thin in an effort to keep delivering services at a pre-recession level despite a decline in resources. It’s not hard to predict what will happen if we don’t get around to innovation. Our results will look a lot like they do today. As the great inventor Thomas Edison said, “there is a way to do it better – find it.”

The Low-profit limited-liability company (L3C) structure is attracting attention and commentary about a new way to solve community problems using market-driven practices. The idea of a “new model” is so alluring, though, that I see misunderstanding and lots of hopeful thinking. I like the structure and give lots of credit for innovation and perseverance for its creation and growth to Americans for Community Development. My concern is that the L3C is being discussed by nonprofits and businesses as a single solution to some complex problems. It isn’t.

As described in ACD’s FAQS, the L3C structure is a viable approach to attracting capital with lower than market returns and a social mission. It is not, however, a solution to nonprofit or business entities that have expenses that are higher than revenue (that’s called a deficit in both worlds). It is also not a solution to a business or nonprofit that is losing its market, audience, donors, or other revenue sources.

In this recent article in The Chicago Tribune, for example, one of the cases offered is instructive:

Social entrepreneur Mike Melillo of Watchung, N.J., hopes to secure foundation funds for his social media company by converting the LLC to an L3C. He launched SocialChord, which provides local online communities, with the intention of bringing in investors. Despite two years of trying, Melillo hasn’t nabbed the capital he was counting on. Without the L3C structure to potentially open a new funding stream, Melillo said, “at this point, I’d probably just fold.”

In this case I would want more information about the ongoing business (revenues, expenses, market potentials) before agreeing that the L3C structure brings instant relief.

The allure of the L3C has been problematic for nonprofits as well. Most nonprofits require ingoing contributed funds (individuals, foundations, events) to pay annual expenses to deliver programs and services. These donors generally expect to give to an organization with IRS tax-exempt status. The L3C structure won’t satisfy this requirement – it is developed to attract capital but not tax-deductible, contributed funds. I can think of a few (but only a few) nonprofits that only require low cost, patient capital to support their mission.

Jeff Texler recently questioned whether the L3C structure was really needed by nonprofits in a blog post on JustMeans.

I say all this not to discourage anyone from forming an L3C or advocating for a similar statute in their own state. Rather, my aim is simply to provide a needed reality check. Based on the experience of another standardized social benefit form – the UK’s CIC – the L3C is likely to be no more a magnet for investment and revenue than any other kind of business. In fact, it might even prove to be less successful, since most investors won’t know what it is. Rather than simply dreaming about how the L3C could solve your organization’s money problems, you should also look into what is already possible.

I think his point is important for nonprofits that have fallen in love with the idea of a “new model.” I recently read this online post: “I would like to form an L3C to provide housing and services to various special populations …” First, I’d be interested to know why the 501c3 structure wouldn’t work for this proposed entity. Second, I wonder if the L3C would serve this mission at all. Is this a capital need, or will ongoing support be needed?

Structure should always follow purpose and goals, not lead the way. While the booklet If the Shoe Fits published by REDF was published before the L3C existed, it’s a great primer for the questions to ask before you let the excitement of a new idea outpace the needs of the organization.

Transparency

In December 2007 I wrote about Transparency and Financial Information:

I would strongly suggest that nonprofit organizations make the effort to make usable financial information available on their website. The IRS 990 is already a public document, so it seems like the obvious tool for financial disclosure. However, I think we should go past the 990 to share better information, especially since everyone seems to agree that the current version of the IRS 990 is overly complex, confusing, and very difficult to use. A better solution would be having the audited financial statement easily available on the website.

Guidestar recently published The State of Nonprofit Transparency Report, which included these findings:

A high percentage (93 percent) of nonprofits are embracing the Internet to disclose information about their programs and services.

Only 13 percent posted their audited financial statements on their Web sites. The results of our survey show a reluctance to disclose audited financial statements publicly. Although not all nonprofits obtain audits of their financial statements, our survey sample reflects organizations of the size for which an audit is both prudent and a necessary tool for assessing management’s financial capabilities and the organization’s financial health.

Let’s hear it for more audits online!

Mergers and Strategic Collaborations

In June 2008 I suggested Speed Dating for Nonprofits:

No one would say that mergers are the right answer for every nonprofit, but if you do think that joining forces would make sense and help your organization maintain stable services, where do you find your mate? I think I’ve found the answer – speed dating for nonprofits! Speed dating is an organized event to help singles meet a number of people in one evening with the intent of finding one or two for an actual date.

I’m excited that MAP for Nonprofits and the MACC Alliance for Connected Communities have organized a Speed Dating event on May 20^th to explore strategic partnerships.

Low-profit, Limited Liability Corporation (L3C)

And in May 2008 in Where For-Profit and Nonprofit Meet I was excited about the new hybrid Low-profit, Limited Liability Corporation (L3C) that had been adopted in Vermont.

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.

This post continues to attract readers and questions. The most common confusion is about the fit for nonprofits that need subsidy (i.e. grants and contributions), rather than capital. The L3C is designed for capital but doesn’t offer any incentive for contributions. For more information, the experts on the L3C are Americans for Community Development. We’ll explain this new hybrid form at the May 14^th meeting of the Social Enterprise Network.

Since the post was written several other states have adopted the model, with others in the legislative process. I’m hoping that Minnesota can get on the bandwagon in the next year.

The best part about the event was the positive, upbeat tone of the ideas, questions, and discussion. I’ve been to a lot of pretty downbeat meetings lately that have focused on reductions, cutbacks, and shortfalls. While the social entrepreneurs at the network all recognize the difficult economic realities that we all face, there was an energy that I really needed to renew.

Adding to the positive momentum of the Social Enterprise Network is the possibility of a real commitment from the new administration to nurture innovations for the common good. Featured in President-elect Obama’s Blueprint for Change are a number of ideas to expand service and innovations, including a Social Investment Fund and Social Entrepreneurship Agency for Nonprofits. Government is an important player in the nonprofit sector, as contractor, funder, and policymaker, and a new, more innovative approach could help lead to real change for some big challenges. A recent blog post from Public Innovators describes this rich opportunity.

A final gift at the Social Enterprise Network was hearing Kevin Lynch, President of Rebuild Resources in Saint Paul, that he and Julius Walls, Jr. of Greyston Bakery, just authored Mission, Inc., The Practitioners Guide to Social Enterprise, which was just released and is available for sale online.

Thanks to everyone who came to the first network lunch – I needed the boost of energy and optimism. I can’t wait for the next meeting in February.

Update:

Photos from the event are available on our facebook page.

Social enterprise is defined by Social Enterprise Alliance as “an organization or venture (within an organization) that advances a social mission through entrepreneurial, earned income strategies.” This often reflects a market-based effort to receive earned income in direct exchange for a product or service. Examples of social enterprise from SEA include:

• A substance abuse treatment facility operating a moving company
• An organization promoting college enrollment that provides workshops to educators
• A youth services organization opening a pretzel shop or ice cream shop franchise
• Goodwill thrift stores

Social entrepreneurs are defined by Ashoka as those who “act as the change agents for society, seizing opportunities others miss and improving systems, inventing new approaches, and creating solutions to change society for the better. While a business entrepreneur might create entirely new industries, a social entrepreneur comes up with new solutions to social problems and then implements them on a large scale.” Examples include:

• Jim McCorkell, founder of Admission Possible (an Ashoka Fellow)
• Muhammad Yunus, founder of Grameen Bank

A socially responsible business is defined as a venture (generally for-profit) that seeks to “leverage business for a more just and sustainable world” (Social Venture Network) or “help create a better world by building healthy communities, promoting economic equity, and fostering a clean environment” (Social Investment Forum). In addition to generating a profit for shareholders, these businesses have goals in the areas of economic development, employment, environmental practices, or ethical business practices.

For me, the key distinctions between these terms are the following:

• Social enterprises are defined by revenue source
• Social entrepreneurs are defined by innovative vision and strategy
• Socially responsible businesses are defined by the intention and goals of a for-profit business
  

It may seem to some people that the definitions are just semantics, but I think they’re important if we want to create resources, find capital, and develop a knowledge base. The needs and demands are probably different if your focus is on revenue sources rather than a game changing strategy.What do you think – do these definitions matter? Are the three listed here on the right track, or would you offer some others?

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?

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.

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?

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?