Venture Capital and Philanthropy: a Bad Fit

An increasing number of foundations like to think of themselves as venture capitalists, investing in new organizations and helping them grow. The comparison is attractive, even romantic in a swashbuckling sort of way. But as I can attest after years in both philanthropy and venture capital, it is seriously misleading. More important, the fallacies of this metaphor illustrate the broader limitations of transplanting successful for-profit models into the very different culture and goals of the not-for-profit world.

The tools of the venture capitalist will not work in philanthropy. The differences are not merely cosmetic, but fundamental to the success of venture-backed companies. Applying a true venture-capital approach to grant making would seriously distort the non-profit world. Merely borrowing the terminology without the methodology will not allow foundations to achieve the success that venture capital has enjoyed.

To fully understand why the metaphor is so problematic, consider the key differences:

Failure rate. For all venture capitalists’ vaunted wisdom and experience, the companies in which they invest fail far more often than they succeed. The rule of thumb is that one out of ten investments will be a home run, two to three others will break even or make a modest profit, and more than half will fail outright, with the entire investment lost.

In the venture-capital world, those dismal odds work because one success can bring such phenomenal results that it compensates for all the failures. For example, $10,000 invested in the Internet search service Yahoo when it began four years ago would be worth $35-million today. Get that one right, and the other nine investments are never even noticed.

Can those odds work in philanthropy? It is difficult to imagine a foundation board that would be pleased if half of its grants went to organizations that failed, and only one out of ten went to organizations that surpassed their goals. In philanthropy, there is no simple way to measure social benefits like monetary returns, no comparable calculus that justifies the waste of rare and precious humanitarian dollars on nine programs that accomplish nothing in the hopes that one will succeed on a substantial scale.

Control. Venture capitalists usually control their portfolio companies, and that is no minor distinction from the way foundations relate to their grantees. Non-profit groups may welcome helpful advice from a donor, but the venture capitalist is careful to back up his advice by being the boss. Difficult decisions are always made by those in control, especially when the right advice is painful medicine. Unless foundations are prepared to exercise full control over charities — an arrangement that might alter their tax status as non-operating foundations — the advice and wisdom that foundation staff members offer grantees may be ignored just when it is needed most.

Board culture. Drawing any analogy between the board participation of venture capitalists and that of charitable donors is about as egregious a comparison as one can make. Non-profit boards are often filled with supporters who are pleased merely to be involved. Goals are rarely clear, and non-profit executives are usually insulated against change as long as they raise sufficient funds to cover their operations. Those may not be virtues, but they are ingrained in the culture of modern philanthropy, and are not easily changed.

A venture capitalist, on the other hand, is single-mindedly committed to the financial success of his company, regardless of the consequences to others. His compensation and reputation depend on it. As a board member, he provides constant outside pressure, driving management to meet its targets on time and on budget. People shout and sweat in those board meetings. Neither board could tolerate the other’s culture for long.

But the differences run even deeper than conflicting cultures. In venture companies, the ultimate measures of performance are clear: Profits, revenue, and market share can all be easily quantified. Determining how well charities serve their social missions is a far trickier business, and makes board leadership much harder.

Changing management. Most often, when a venture company encounters problems, venture capitalists use their board control to impose a change of management and to recruit successors. Many non-profit groups might do better with more-experienced managers at the helm, but it is hard to imagine a foundation forcing the founder out the door and then recruiting a replacement.

Flexibility. Along with changes in management come changes in direction. More often than not, venture-backed companies discover that the key to their success lies elsewhere than originally planned. Tell a venture capitalist that some new business model has a greater profit margin, and you’ll have no argument. But non-profit organizations are rarely able to change direction or to explain such a change to donors. They may change tactics, but they rarely change their goals or mission. Tell a foundation that an organization it financed to provide subsidized housing has decided to provide psychological counseling instead, and the original grant may well be rescinded.

Growth rate. Venture-backed companies can grow at astounding rates. Successful ones can attract hundreds of millions of dollars of capital within a few years, and quickly become independent of their original investors. Venture capitalists can actively advise a large portfolio of companies because, within a few years, the successes no longer need their guidance, and the failures have disappeared.

But social change does not happen this way. Fighting poverty, prejudice, and disease, financing medical research, and educating children all take time. New charities do not sweep the world powered by the invisible hand of free markets. No matter how successful they become, it usually takes many years for charities to become independent of their early supporters. Both the successes and the failures may struggle along for many years, and the workload for foundation executives who want to be actively involved with the organizations to which they give money merely increases with every new grantee.

Expertise. Giving out money seems to make anyone appear to be an expert in almost anything — and this illusion is true of both venture capitalists and philanthropists. Venture capitalists, however, are often experienced entrepreneurs who have built their own businesses, bring specialized knowledge of an industry, or have years of experience guiding new businesses at different stages of development. Foundation executives, by contrast, may not have any training in the fields they support, or in guiding different stages of organizational development. Nor do they investigate grantees with the degree of due diligence that venture firms require before they invest.

Degree of commitment. Venture capitalists use every ounce of leverage they have to make their companies succeed. Other deals are held out as bait, favors are called in, personal connections of investors and directors are called upon, investment banks are pressured, senior managers are recruited, courted, and promised support. For the venture-capital model to work in the non-profit world, a foundation must put be willing to put itself on the line for its grantees. It must use its board members’ influence to assist them, pressure its bankers and investment advisers to help out with contributions and loans, draw on personal connections, and support the charity through major transitions and short-term setbacks. Most foundations do not operate that way — they might be more effective if they did — but to do so they would have to change the nature of their operations and dramatically narrow the breadth of their giving.

Foundation practices can certainly stand improvement, and my purpose is not meant to endorse the status quo. But doing philanthropy well is a difficult and unique endeavor. Its lessons should be learned from those who best understand and practice it, not by borrowing metaphors imported from some other field. And of all the fields to emulate, trying to fit the iron fist of venture capital into the velvet glove of philanthropy is the most dangerous metaphor of all.

Mark R. Kramer is a venture-capital investor, a foundation trustee, a writer and consultant on philanthropy, and the former chairperson of the Jewish Funders Network, a national organization of independent Jewish foundations. His e-mail address is kramercap@aol.com.