Capital Sources, Options, and Structures

At the May meeting of the Social Enterprise Network, the group discussed capital sources, options, and structures, with a focus on PRI's and the emerging L3C model.  Kate Barr of Nonprofits Assistance Fund facilitated this meeting.

Notes from Capital Sources, Options, and Structures

Traditionally, nonprofits needed an operating fund for services and a capital fund for major building projects. Now, bigger, more complex organizations have different needs: cash flow, technology, staff training and development. These organizations need "soft capital" to develop new programs, build a new donor campaign, or undertake any project that requires an initial output of resources and staff time. According to the Listening Post Project survey, soft capital is more difficult to obtain than buildings or technology. 

Traditional Sources of Capital

  • Foundations and corporations may award grant funds to develop programs.
  • Investors - However, unlike in the for-profit world, where capital investors get ownership or a stake in the company, for nonprofits, projecting the return on an investment is not always easy.
  • Internal cash is most often used by nonprofits. New programs are often developed piecemeal, step by step.
  • Sometimes sufficient working capital can be generated by cash flow.

Other Options

  • PRIs (program-related investments)
  • MRIs (mission-related investments)
  • Long-term working capital borrowing
  • Capital campaigns for soft investments
  • Equity investment approach

PRI's

MRI's

  • Some foundations invest in things that reflect or support their charitable purpose (i.e. not in tobacco stock). They sometimes choose to invest in social enterprise, nonprofit, and for profit.
  • Using endowment for social good will have more impact.
  • A long-term investment. Some investors may expect a lower return.
  • This is the future, but will require a leadership shift.

Long-Term Working Capital Borrowing

Capital campaigns for soft investments

  • Describe capital needs as an investment in the organization. A capital campaign for the organization, which will allow the organization to serve more clients or otherwise fulfill its mission.

Equity investment approach

  • Use "equity language," the language of a venture: ROI (return on investment), use of funds, etc.
    • Example: invest $300,000 today to build a "fundraising machine" that will continue generating income in the long-term
  • Must show accountability and produce data to demonstrate progress
  • See a nonprofit investment prospectus from the Social Innovation Forum, a social enterprise of Root Cause
  • Quantify social return

Structures

  • Decide if your social enterprise will be set up as a whole new organization or within an existing organization.
  • Questions to ask:
    • What is your business model?  What kind of supports do your programs require?
      • Do you need working capital or grants and/or donations to subsidize your programs?
      • Different structures are suited for different business models.
    • Can you do what you want to do within existing structure and with existing leadership? Or will you need to create a seperate organization or subsidairy to meet your goals?
    • Remember different structures have different tax requirements
    • Nonprofit or for-profit?
  • Possible structures:
    • Nonprofit social enterprise: if already a nonprofit,
    • For-profit subsidiary
    • New nonprofit organization
    • New for-profit business
  • "If the Shoe Fits" article from REDF (free registration required) includes an 8-page assessment (mission, prospectus, etc.)

Example: Institute for Agriculture and Trade Policy (IATP) is a nonprofit with a for-profit subsidiary, Peace Coffee.

  • Peace Coffee began in IATP's basement, moved to the Green Institute building in 1999, and is still growing
  • To get the benefits of treating a social enterprise as separate legal entity, they must be separate. This requires clear processes and procedures to keep all related organizations friendly, but at arms length.
    • Separate governance and accounting.
    • Cannot freely transfer charitable dollars (grant money) from nonprofit to for profit. You can provide bridge funding in the form of a loan or anything with a return that is repaid.
      • The nonprofit can receive profits from the related enterprise as divided income.
    • At first, the for-profit purchased management skills from the nonprofit. Must pay for services shared.

L3C (Low-profit Limited Liability Company)

L3C is a new LLC structure designed specifically for a profitable enterprise that includes a community/charitable purpose. A form of LLC legal in 6 states and the Crow Nation.

  • L3Cs were designed to be eligible for PRIs
  • They are for patient investors wanting to invest in a community where there is a lower expectation of return
    • Most for profit businesses must get the best deal for shareholders, but L3C shareholders understand that their return might be lower
    • Remember that owners have a different role than a nonprofit board
  • There is no legal difference between a LLC and an L3C in Minnesota, but having L3C in your name can make a difference for branding purposes.
  • Decide if this works for you. If you need subsidy from grants, this for-profit model will not work.
  • Remember that L3C is a for profit, with taxable income. Nonprofits pay only UBIT (unrelated business income tax) if the income is from a business that does not further the exempt purpose of the organization.
    • Tax partnership - each owner taxed in proportion to ownership
  • "This should replace the American stock market!" for more thoughtful engagement with society
  • This structure is not available in Minnesota. There is potential in healthcare, newspapers, energy utilities - any organization that requires significant capital.
    • Do we think this is a desirable structure to have in Minnesota?
    • Legislation to incorporate as a nonprofit LLC passed last year. It was difficult to get through state legislature, needed to prove business going to other states.
  • L3C Resources:

Nonprofit LLC (limited liability company) 

A Nonprofit LLC is owned only by nonprofits and subject to one or more state Attorney Generals

Other Resources

About the Host: Nonprofits Assistance Fund

Nonprofits Assistance Fund operates a loan fund with $12 million in capital available to lend to Minnesota nonprofits. It is a self-sustaining enterprise, with loan interest providing 70% of the entire organization's revenue.  As a CDFI (community development financial institution), Nonprofits Assistance Fund is able to access capital from a range of sources, including foundation PRI's and from other financial institutions. These financial institutions do not have the same experience and/or capacity to lend to nonprofits.  Nonprofits Assistance Fund fills this market niche, bringing capital into nonprofit organizations of all fields of service.  To continue to access capital from financial institutions and foundations, Nonprofits Assistance Fund demonstrates knowledge, expertise, and impact in the community. The loan fund has been operating for 28 years and has an exceptional 1% loss rate.