From Stanford Social Innovation Review; Fall 2008
By: William Foster
Over the past decade, the nonprofit sector has been increasingly abuzz with talk of strategic philanthropy, venture philanthropy, growth capital, and other forms of nonprofit investing. Among the Web sites of the 100 largest U.S. foundations, for example, 77 tout that they are involved in some type of "investment," "leverage," or "venture activity." As entrepreneurs turn into philanthropists, they want to have the same outsized impact with their giving as they did with their business ventures. At the same time, institutional foundations want to leverage their dollars to do the most good.
Although many nonprofit donors are talking about strategic investing, few are actually putting these ideas into practice. Most make grants that are too small to have a big impact. In 2005, for example, the 100 largest U.S. foundations made (usually multiyear) grants whose average was approximately $200,000. These same foundations' assets, meanwhile, average some $2 billion.1
In addition, outside of gifts to universities, hospitals, and foundations, all U.S. individual donors and foundations made fewer than 150 grants of $5 million or more to the nonprofit sector in 2005. Only 25 of these went to human service organizations.2 By contrast, in 2005, U.S. venture capitalists alone made 3,100 investments averaging $7.2 million each.3
What's more, most philanthropic donors restrict their gifts to specific programs, so grantees cannot use the money to grow their organizations as a whole. In 2006, only 19 percent of U.S. grants were either unrestricted or for general support.4 The rest of the grants-81 percent-could be spent only on designated activities, such as tutoring services for youth in a particular high school or for the construction of a particular building. By contrast, most venture capital investments are not restricted to a specific product, department, or program. Instead, companies can use the money to grow-for example, opening offices in new locations, expanding the company's information technology system, and hiring sales and marketing staff.
"Only a handful of funders are making grants that function like investments to growth oriented nonprofits," says Harvard Business School professor Allen Grossman. "I doubt that the total amount nationwide exceeds $100 million per year."
This handful is worth watching-and emulating. These funders are awarding grants that are becoming known as "growth capital"-large investments that are used to increase the size of an organization's operations and that are not needed to sustain the organization once it has gotten larger. The recipients are themselves trailblazers, using the funds to increase their impact dramatically.
Growth capital is for nonprofits that have demonstrated that their programs work and that have identified a steady source of funds that can support their ongoing efforts. It is not for small, innovative, but still untested nonprofits or for organizations that do not have a sustainable funding model. (See "When Should a Nonprofit Seek Growth Capital?" on p. 53.) If one were to draw an analogy to venture capital funding, nonprofit growth capital would be the equivalent of later stage funding, not early stage funding.
There's great potential in nonprofit growth capital investing. To realize this potential, however, funders and nonprofit leaders alike need to understand the differences between growth capital and grants for ongoing operations-in essence, the difference between investment and revenue. They must also develop the ability to identify the limited number of nonprofits that can benefit from growth capital.
Over the last several years, the Bridgespan Group has worked with and studied both funders that provide growth capital and nonprofits that receive it. We have helped two of the most promising candidates for growth capital develop their business plans-Youth Villages, a Memphis-based organization that helps emotionally and behaviorally troubled youth and their families, and Alexandria, Va.-based Communities in Schools, which helps students stay in school. We have also helped one of the largest providers of growth capital, the Edna McConnell Clark Foundation (EMCF), develop its strategy, identify potential grantees, and assist its grantees with business planning. And we were part of the business planning for a particularly promising new growth capital intermediary, SeaChange Capital Partners, whose founding donor is the Goldman Sachs Group Inc.
Through these experiences, we have honed due diligence processes that funders can use to identify promising nonprofits that can effectively use growth capital to go to scale (and those that cannot). The common deal breaker? A sustainable funding model. Nonprofits can likewise use this process to figure out whether and how they can attract growth capital.
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