Charities Need More Investment Capital

Most people think of charities as fundamentally labor-intensive organizations that have little need for investment capital, the resource required to finance facilities, acquire equipment, and do long-range planning.

Universities, hospitals, and large cultural institutions have long recognized the inaccuracy of this perception. But now the conventional wisdom is changing as well for a much broader group of organizations, as demands for new technology, expanded facilities, and such “soft capital” items as strategic planning and program development come crashing in on charities with just as much force as they have on business and government.

Charities are at a distinct disadvantage in meeting these new demands for investment capital, and the tools that have so far been created to help them are nowhere near sufficient to meet the need. For one thing, because of their relatively small size, which translates into high loan costs per dollar of investment, charities are not attractive investments for investors.

At least as important, however, is that when charities achieve a surplus, their nonprofit status means that the money must go back into the organization itself and cannot go to investors, which makes it impossible for charities to gain access to the “equity” markets by issuing stock.

As a consequence, nonprofit groups confront enormous challenges in expanding to reach their full potential and have been losing their share of the market in fields such as home health care and day care to for-profit companies, often leaving vulnerable people at risk when market conditions change and businesses decide it doesn’t make sense to keep operating in particular fields or communities.

That is the message that emerges from a just- completed survey of the capital needs of charities that focus on children and families, the elderly, community development, and arts and culture (particularly museums and theaters). The survey was conducted through the Johns Hopkins University’s nonprofit Listening Post Project, an effort my organization conducts to monitor how charities are coping with a range of key economic and policy trends.

What this survey revealed is that the overwhelming majority of charities experienced significant capital needs over the past two years, with capital for new technology and for program development leading the list. But far fewer than half of those organizations reported meeting these needs, and that was as true of larger organizations as of small ones.

One reason, it appears, is the limited range of capital sources available to charities and the apparent inaccessibility to charities of the major pools of investment capital in the American economy, such as pension funds and insurance companies, which prefer to deal with larger institutions because of the transaction costs involved.

Fortunately, some states have responded to this nonprofit capital gap with inventive bond-financing programs. In addition, institutions like the Nonprofit Finance Fund, the Illinois Facilities Fund, and a handful of special nonprofit investment funds have recently been moving into the void, offering advice and assembling financial resources that can help meet nonprofit investment-capital needs.

But the scale of those operations is barely sufficient, leaving large numbers of small and midsize charities with little help. To close the nonprofit capital gap more fully, additional steps are needed. Among the most promising solutions:

• Charities must become more investment-capital savvy. Nonprofit groups have had their hands full in recent years just coping with their operating revenue needs. But now they and the management-consulting groups that advise them must learn how to cope with escalating investment capital needs and with the often unfamiliar capital markets that control them. That will require training and management assistance of a far different sort.

• New institutions must be created, or expanded, to package the investment capital needs of individual charities and present them to large-scale institutional investors, thereby linking charities more effectively to the major sources of investment capital.

  The Enterprise Foundation and the Local Initiatives Support Corporation pioneered this role in the low-cost housing field, channeling hundreds of millions of dollars of new private capital into nonprofit housing corporations. Similar institutions are needed for a much broader array of nonprofit groups.

• Foundations must find ways to play a far more active role in helping charities meet their investment-capital needs.

  To do so, however, they will have to move beyond making grants — a 19th-century approach for using their assets — and begin thinking of themselves as philanthropic banks that offer charities a menu of loans, loan guarantees, interest subsidies, and related financial tools that use foundation assets to attract other private investment capital, as government and businesses have done.

  For foundations to take this approach, they will need to collaborate with major investment houses and with organizations formed to link charities to institutional investors. The result will be to multiply the impact of foundation resources by using them to attract other public and private resources, producing more bang for each foundation buck.

• Government must transform the tax credit it now offers to investors in low-cost housing into a broader tax credit available to investors to cover a larger set of nonprofit activities. The housing tax credit has been enormously effective in channeling private capital into low-cost housing.

  A similar tax credit made available to help finance the capital needs of small and midsize charities could open important new sources of investment capital for the nation’s charitable institutions and put them on more of a level playing field in competing with for-profit companies.

The days when charities could focus primarily on generating operating revenue are long gone. Increasingly, charities need significant amounts of investment capital as well — to acquire technology, build and equip facilities, and formulate new approaches and programs in response to rapidly changing demands.

Regrettably, however, charities’ need for investment capital seems to be far outdistancing their access to it, with results that are already producing challenges to their ability to maintain effective services and to survive in increasingly competitive markets.

It is time for foundations, government, and charities themselves to take note of this new challenge and fashion a more aggressive response.

Lester M. Salamon is a professor at the Johns Hopkins University and director of the Johns Hopkins Center for Civil Society Studies.