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If venture capital investors worked like not for profit funders

There is a need for innovation and accountability in the social sector but there are many challenges that get in the way. One of the major impediments is the way not for profit organizations are funded. To illustrate these challenges I will present a scenario where venture capital and angel investors work like not for profit funders.

Firstly, the investors wouldn’t solicit business plans from entrepreneurs as they do now.  Instead they publish a set of requirements of what it is they are looking for in terms of product description, target market and what expenditures funding would cover.  The applications would also have to be in prescribed form so that they can be evaluated easily.  Instead of receiving multiple business concepts from an unlimited number of sources they would only receive concepts that the investors could conceive of.  Most of these would be incremental changes from things that had worked in the past.  There would be no breakthrough ideas that nobody had considered before; the kind that go on to become Google, Paypal or Tesla.  Since they would all have to apply in the same format there isn’t even an opportunity to discuss innovative approaches to the requested business concept.

The investors would lay out exactly what the funding would cover.  There would be funds to hire programmers, acquire any materials needed and other direct product costs.  Marketing and management would be limited to 10% if it was allowed at all.  The applicants could have people working on products but no one to coordinate the business or get the word out to the market.  The applicants will go without any management team or hire at low salary levels resulting in inexperienced people or those that are not a good fit.

Since the funding would not be sufficient from any single investor or would require matching funds there would be a need to go to multiple sources.  But each investor group has a slightly different idea for what the product will entail or who the target market should be.  They will also have different restrictions on spending, application format and reporting requirements. The organization will spend an excessive amount of time filling out multiple applications in different forms and keeping track of results so that they can report individually to each investor in their specific format with their metrics.  There is then the issue of how to manage a strategy for an organization that is now being pulled in multiple directions and none of them leading to the target market.  Remember that the applicant has not been provided with the funding for the people who will be responsible for managing these conflicting demands.

Most early stage companies find that their original path does not work and they need to change directions. Paypal started out as a way to transfer money between phones and then shifted to a secure means to accept payments online.  Happily for their investors.  Under the scenario being presented here these shifts would be impossible without violating the funding agreement.  The company would choose between a path they knew wasn’t working or one that would maintain their funding.

The metrics would be a combination of staying within the spending restrictions and some contrived success numbers such as number of page views, downloads and probably customers acquired.  The company would again need to twists its operations so that they maximized page views and downloads even if they didn’t result in sales.  They would sell at low prices to get customers even is they were not profitable customers.  None of these strategies tends to result in a healthy and successful organization but it will create the illusion of success while maintaining funding.  There is no measure of impact (i.e. whether the organization actually made a difference with the funding they received).  Without impact metrics it is difficult to determine if the organization is providing real value, if they are improving or if there is another organization that can make better use of the funds.  The lack of a requirement for impact metrics is a good things since there was no funding provided to pay for people capable of measuring and reporting on impact or the systems needed to support that.

There will be a need to apply for additional funding next year since there is little chance organizations operated in the way we have described will be sustainable.  As long as they met the reporting requirements they will probably get another round of funding under the same terms as before.  That is unless the investor has run out of funds or decides not to offer another round.  There is no chance a more innovative applicant will be funded instead since the application process doesn’t allow for any innovation to be presented.  This takes us back to the beginning of a process that will repeat itself annually.

The venture capital process is not perfect by any means and there are not for profit funders that don’t fit this design but unfortunately not many.  Part of the attraction of social business is the need to move away from this process to one that more represents private sector funding.  There is also a movement towards self-sustaining models that don’t rely exclusively or at all on these funding sources.  The transition to these models will take time and there will always be challenges that don’t lend themselves to a private business model. If funders want more innovation, accountability and performance then they need to reconsider how they fund not for profits.

 

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