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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.


Social Business Part 1 — The stalled emergence of the social enterprise

The concept of the social enterprise is increasingly found in the news, social media and in the organizations arising to support them.  The social enterprise is expected to provide solutions to social issues while also being sustainable.  This sustainability is accomplished through a hybrid of not-for-profit and for-profit business models.  In my observation these entities start out on the drawing board as hybrids but tend to slide back towards traditional not-for-profits.   As this article will propose, we have not broken free from out-dated thinking that is needed for a new form of social enterprise to emerge.  I will present my thoughts in two separate posts.

The social sector has traditionally been not-for-profit organizations and government.  These groups addressed problems or needs where for-profit organizations were not engaged.  That is, there was no opportunity to make a profit so the private sector was not interested in investing.  The problem with this scenario is that the social problems and the cost of solving them has outstripped the supply of funding available.  On the flip side the funding that runs through the private financial system is building up and seems to be overrunning the investment opportunities in the private sector.  In parallel with these two trends the concept of social business and social finance has emerged.  Unfortunately, unlike the clear private/social poles that existed before, no one really knows how this new hybrid should work.

One thing we know from experience is that money flows quickly like water to where it can earn a return.  People and organizations don’t move at that pace.  They tend towards increment change.  As a result we are seeing social finance organizations emerging ahead of the organizations they need to invest in.  The band is starting to play but no one is on the dance floor.  We are also talking about impact investing before we fully understand what impact is and how we will measure it.  If we don’t solve this problem we will see poorly designed metrics and money chasing poor investment opportunities.  We need to shift our focus towards building sustainable social enterprises that we can invest in and we need them in large number.

For some there seems to be the expectation that existing not-for-profits and governments will tack on some form of impact measure and then carry on as usual.  This might be fine if what we have now is working effectively and efficiently and I don’t believe that is the case.  We have also seen private sector companies using superficial social measures to create the illusion of social impact.  Again most people don’t believe this is true on a wide scale.  The third alternative is the creation of a new set of organizations called social businesses.  They will have the joint social/financial outcomes baked in from the start.  The few that have been created tend to look like either a traditional not-for-profit or private sector company and mostly the former.  Founders tend to use one of these poles as a starting point when creating the business model.  With some exceptions they have not been very effective in creating large scale change or in being sustainable.

We need to break free from the status quo thinking that underlies the two primary business types in order to deal with social issues in a sustainable way.  In my next post I will discuss approaches for breaking away from these old ways of thinking that will enable us to successfully start building true social businesses.

The meaning of impact

We need to move towards a system that assesses social innovation based on impact.  This assessment holds for not-for-profits, government and businesses that profess to have social goals.  Most people agree with this need and we can hold nice conversations around moving from inputs to impact as measurements.  However few people have given much thought to what it means to measure impact.  Too often when someone describes what they have in mind the result is a list of high level statements like, we create jobs or a list of activities like, we deliver food to the elderly.   This response is understandable since effectively measuring impact requires a different way of thinking and a lot of hard work.

I will illustrate impact with an example I have been working on with a not-for-profit group.  We are still in the early stages of developing this metric and still have a lot of work to do.  There are also a lot of complexities around effective metrics that I won’t have room to cover in a blog post.  But my purpose here is to illustrate the difference between measuring inputs versus impact.

Our not-for-profit has been established to help build social ventures and social innovation in our community.  Our expectation is that jobs will be created and social problems will be addressed.  Our plan is to work with all ages ranges to build intergenerational ventures where the experience and knowledge of older generations is combined with the technical capabilities and unique viewpoints of younger generations.  We expect to create jobs for youth as well as seniors and everyone in between.  Some of the roles will be paid and some will be volunteer.  Some of the ventures will also focus on the problems of disadvantaged youth and those faced by an aging population.

The inputs and intermediary measures will be numbers of people mentored, numbers of ventures started and grown, jobs created and investment funds provided.  The measure we want to use for impact is based on the dependency ratio.  That is the number of people dependent on others for support divided by the number of people in the community.  Dependent people are children that are in school and not working, unemployed persons and seniors that are past traditional working age.  Increasing employment and volunteering across all population groups will reduce the number of dependent people.  We can measure our impact by working to keep driving that number lower.  We can also work at a dollar level by making the numerator the cost of dependency including unemployment benefits, healthcare costs, crime, etc. against the total fund flows in a community.  Both of these measures will be difficult to establish and track but it can be done.  Having this measure will enable us to determine the impact of our programs, and those of other organizations, on the prosperity of our community.

So I call upon people looking to make a social impact to start moving past easy conversations and into the hard work of developing true measures of impact.  I also encourage groups to work to together to share ideas and assist each other.  Metrics that can be used across programs to measure community health will align the multiple providers to move in the same direction, reduce duplication of effort and optimize the use of resources.

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