The New Economy and Venture Philanthropy: Excerpts From a Report

Following are excerpts from “Venture Philanthropy: Landscape and Expectations,” a report prepared by Community Wealth Ventures for the Morino Institute. The full report is available on the institute’s Web site (http://www.youthsocialventures.org).

A sea change in philanthropic giving, an unprecedented creation of wealth in the New Economy,

and an Internet-enabled transformation in organizational effectiveness are converging to create an extraordinary opportunity to work in new and different ways to meet society’s most vexing and long-standing social problems. The convergence of these forces has set the stage for a fundamentally different approach to philanthropy, one that learns from the past while drawing upon the best practices found in firms in today’s New Economy: venture philanthropy. …

[Research shows] that:

* Current methods of funding and supporting non-profits can be improved. Non-profit organizations exist in a culture of dysfunction — limited capacity and modest outcomes pervade critical organizational elements such as strategic planning, staffing, training, management, financing and performance measurement. This dysfunction makes success highly improbable and calls into question the sustainability of organizations unable to adequately capitalize future growth.

* While many non-profits have succeeded in developing solutions to many of the problems facing youth in low-income communities, their efforts have not been broadly disseminated, adopted or brought to scale. What is needed are not new solutions to social problems but new ways to fund and support successful non-profits so they can grow and build on their success.

* New Economy entrepreneurs have different expectations for philanthropic involvement than those active in previous generations. They want their investments in non-profit organizations to have a broad impact, and they want to be able to measure that impact.

* A social venture fund that applies venture capital practices to funding youth-serving organizations offers a promising way to tap the resources of New Economy entrepreneurs and other business people so as to increase the effectiveness of the non-profits it funds.

Venture philanthropy and social venture funding means different things to different people. But at its core, venture philanthropy seeks to obtain greater return from non-profit organizations, whether social, financial, or both. …

Many non-profits struggle with insufficient resources to provide essential human services that were once the role of government. Their work, which once supplemented government efforts, has now in many cases taken the place of government. In fact, they’ve become their community’s principal service provider for many human needs. However, resources have not increased in proportion to their increased responsibility. Though the cornerstone of support for many non-profits is government funding, the rate at which government funding increased between 1992 and 1996 was only 2.9 percent, compared to 8.4 percent between 1987 and 1992.

Non-profits are chronically undercapitalized. For the most part they find themselves limited to just one financial instrument — the charitable donation — and most of what they do is financed on a pay-as-you-go basis. This is in direct contrast to the way virtually everything else of value gets built. …

Non-profits are risk-averse and often unaware of the broader range of financial tools that may be available. Debt and equity financing has not been easily available to early-stage businesses. But in the same way that this financing is being cultivated to fund early-stage start-ups, so should there be more options open for debt and equity-like financing to support innovative non-profits. Because non-profits are chronically undercapitalized, they rarely achieve their objectives, which in turn makes it less likely they will receive the resources they need. And so the cycle continues.

Non-profits have been compassionate and committed service providers but inattentive institution builders, focusing most of their energies and resources externally rather than building and supporting their own capacity. Non-profit organizations often ignore the value added by superior management, usually preferring to be managed by organizational founders rather than experienced managers. They almost always neglect systems of recruitment, training and personnel advancement, generally recognized standards of quality and measurements of productivity. In addition to lacking the resources for capacity building, they also often lack the skills [for capacity building]; such skills are very different than those required to conceive and create a new organization or to implement the services which it is the organization’s mission to provide.

According to Chris Letts, Allen Grossman and William Ryan, co-authors of High Performance Nonprofit Organizations, in the for-profit sector, organizational capacity is valued as the primary means for succeeding in the marketplace. …

The relationship between programs and organizational capacity is strikingly different in the non-profit sector. The two are considered almost as competitors in a zero-sum struggle for limited resources. Money invested in organizations is considered lost to direct service. …

The challenge is not just to create solutions. The challenge is to figure out how to make those solutions affordable, sustainable, replicable, and figure out how to get them to a scale that fulfills their organization’s mission. This challenge requires new strategies and new tools. …

Letts, Ryan, and Grossman, in their seminal Harvard Business Review article [“Virtuous Capital: What Foundations Can Learn from Venture Capitalists,” March-April 1997], identify six points that distinguish venture capital practices in philanthropy from those in more traditional philanthropy.

1. Risk: [Venture capital] firms take risk and are rewarded accordingly. Rather than being avoided, risk is managed. Foundations avoid risk because they are not rewarded one way or the other for taking risk. Accordingly, foundations compromise the likelihood of measurable return.

2. Performance Measures: [Venture capital] firms focus on performance measures that will lead to long-term growth. Foundations focus on short-term program outcomes and avoid the question of long-term consequences.

3. Closeness of Relationship: [Venture capital] firms are comfortable with close working relationships with investees. They are involved in deal flow, CEO selection, strategic planning, etc. Foundations tend to keep their distance in their relationship with grantees. In addition, they tend to be totally uninvolved in operations.

4. Amount of Funding: [Venture-capital] firms fund few deals but they put enough money in chosen deals to make a difference. They will also help with subsequent funding needs. Foundations fund a small part of each deal. They tend to undercapitalize and seldom help with subsequent funding needs.

5. Length of Relationship: [Venture capital] firms will stay involved over a number of years, and this is known to all participants. Foundations seldom stay involved for more than two or three years.

6. Exit Strategy: [Venture capital] firms have an exit strategy identified at the point of entry. Often the exit is made possible by another VC firm. Foundations rarely have an exit strategy.

With that definition in mind, we discovered a venture philanthropy field that resembles the “Wild West.” Individuals, organizations and foundations are experimenting with a variety of techniques …

The pioneers of venture philanthropy come from a new generation of entrepreneurs who, generally, have never been part of the foundation community. Many of the field’s leaders are familiar with venture capital techniques either directly or through technology ventures that succeeded through venture funding, and they are eager to invest philanthropically in a manner that has a successful track record. …

Social venture philanthropy is the product of both our times and of the quest of many of America’s most dedicated citizen and business leaders to share not only their wealth but also the strategies behind their success. In contrast to the philanthropists of old, who established foundations at the twilight of their careers, venture philanthropists are at the height of their professional pursuits. They expect similar returns on their philanthropic investment as they receive in their professional investments, and they are willing to actively get involved to ensure success. …

Although social venture funds are new and still unproven, they are designed to tackle some of the structural issues that have prevented foundations from investing effectively in organizational capacity building. If they succeed in creating a philanthropic marketplace that is more responsive to outcomes, they have the potential to create a powerful vehicle for social investment in an environment where the public sector can no longer be relied upon to take successful pilot programs to a national scale.