It would seem that the government could conceivable collect a portion of these financial gains and redistribute these to organizations. The conditions for entering this government-created market would be some study creating a strong statistical connection between the organizations actions and a macroeconomic measure of wealth. For example, nonprofits financing poor students for greater educational attainment could receive money based on the rate of return in net human capital produced. This would effectively internalize some of the benefits produced by the organization back to the organization.

That said, we see our primary role as identifying excellent charities with strong track records and funding them – definitely not as “subcontracting out” our own programs based on our own theories of change. More thoughts on this idea here and here.

In my mind, we advance capital market philanthropy every time we help to steer capital preferentially to nonprofit organizations that are clear about what they’re trying to accomplish and have evidence (qualitative and quantitative) that demonstrates they are making progress toward those goals. We do even more to advance capital market philanthropy when we help nonprofits to clarify their goals and collect evidence of progress?and then make this information widely available to other potential investors. I see a wide and growing array of different grantmakers—from large, established foundations like Hewlett to newer, comparatively small funds like the one I co-founded—taking both of these approaches.

This is a time when we need many experiments. That donor investors care about important societal outcomes and are willing to make enduring commitments to see their efforts through (e.g., Seibel) is a great thing. The field needs an Edna McConnell Clark to illustrate that it is possible to transform a more traditional, established foundation. It needs a Hewlett Foundation to set a standard for the seriousness and strategic way in which philanthropy can be approached. It needs Acumen, New Profit, NFF, SeaChange, GPN, and others to succeed?for each presents a compelling model for others to emulate and adapt. Just as it took a long time to create the continuum of capital-allocation models we now see in the commercial sector (including some models that have clearly done more harm than good), the charitable sector is now engaged in a long process that might outlive most of us. I’d hope we look at these groups (and others yet to emerge) not as the definers of philanthropic capital markets but rather as pilots and demonstration efforts that with their success will stimulate further innovation, effectiveness, and efficiency.

Producing innovative, effective, and efficient capital markets for the nonprofit sector will take many things. For example, it will take results. Sean, you put together a good list of organizations and were kind enough to include Venture Philanthropy Partners on that list. I believe these organizations are allocating capital in thoughtful ways. But perhaps the most important contribution that these groups are making is that they are “nudging the system.” For example, these and other groups have nudged some established foundations to think more in terms of making long-term investments in organizations and their leaders—rather than just making program grants. This mindset—and certainly the terminology—was considered heresy by many as recently as 15 years ago.

Second, philanthropic capital markets require, well, capital. In spite of the many accomplishments of the organizations you cited and the nonprofits they?ve invested in, the sum of the capital they?ve raised remains but a speck within the universe of philanthropic monies. Although I believe these funds will continue to grow, I fear it may be incremental, not quantum or viral.

Third, if we are somehow able to increase the flow of capital, we will need to couple that with an increase in the flow of talent—from entrepreneurial to executive management.

Fourth, we need to be sure that even as we pursue greater efficiency in capital allocation,
we should never try to squeeze out the human element. In contrast with the private sector, there is a great need for the “philanthropic investor” to be engaged, even directly involved, and emotionally affiliated. This phenomenon simply does not exist in the same way in the commercial capital markets. In the private sector, you deliver on or exceed your promised internal rate of return (IRR) and folks love you forever, with or without direct engagement—and with little questioning. The Bernard Madoff case stands as a dramatic confirmation of the detachment of investors in the private sector. On a small scale, I believe the Donors Choose model is highly instructive in that they seem to have found a good balance between “high efficiency” and “high engagement.” They could be looked at as the “high-tech/high-touch” example in philanthropy.

However, while the op-ed calls for an official accounting change. George has already developed the SEGUE accounting system that allows for nonprofits to internally account for investments vs. grants.

A grant with no strings is certainly different from a grant requiring the recipient to execute a specific (possibly new) program, but they’re both grants. An investment into a sector or into a specific non-profit is different if it’s just money or if it is comes with volunteering, consulting, or other forms of stewardship and monitoring.

Metaphor from the public market: buying shares but never going to a shareholder meeting, voting on proxies, or even reading annual reports. One word of “investment” doesn’t cover that spread.

I certainly don’t know what’s good or what’s bad, but if we’re trying to frame the “new philanthropy” issue, then I’m curious what part of post-funding is relevant.

I wholeheartedly agree that one of the big problems we need to solve as a sector is how to find ways to scale highly effective nonprofit organizations, so I applaud you for raising this question and also for highlighting the power dynamic that can often exist between funders and grant recipients. (I particularly like George’s reference to the need to be a “chameleon”, which captures the issue very nicely).

At Acumen Fund, about two years ago we realized that we were in a position for a major scale-up of our work, and we also recognized that the best way to do it would be to raise a large pool of unrestricted philanthropic capital that would take us to the next level. We set out to raise $100M over two years in unrestricted capital in May of 2007, and by the end of 2008 we raised $85 million against this goal.

One of my reflections having led up this effort is that individual philanthropists are typically much more prepared than institutions (foundations and corporations) to make large, long term, multi-year, unrestricted gifts. (That said, there are some institutions that are exceptions to this rule, and I do believe that when programmatic goals of a nonprofit align closely with those of a foundation, large gifts with some restrictions can provided needed growth capital that allows for the kind of organizational investment that growing nonprofits need to make.)

Where things get really tricky is when a nonprofit that might be ready for tens of millions of dollars of growth capital (the $10-$30M that George Overholser suggests is a good reference point) finds itself mostly able to raise programmatic grants (often narrowly restricted) in $50,000-$100,000 increments from foundations. Programmatic grants like this can create the two-headed hydra of not having sufficient funding for “overhead” (a.k.a. non-program staff), combined with the communications, relationship and reporting challenge that can come with having 100 individual $50,000-$100,000 grants (an absurd number, but this would get you to $5-$10 million) – the “chameleon” problem.

The irony is that in other lines of work – venture capital; executive search; etc. – being able to find and invest in a world-class team of people is seen as THE differentiator between good and great firms. Yet all too often, foundations seem unwilling to invest in people and organizations, instead seeing nonprofits as a means to a programmatic end.

The problem with a world in which the most proactive, risk-taking philanthropists are individuals (rather than foundations) is that it has the potential to limit severely the types of new nonprofits that will be successful at growing to scale – namely, the winners will be those organizations that are run by individuals who are capable of building strong and deep relationships with ultra high net-worth individuals. Nonprofit CEOs who can do this bring together a unique combination of skills, but if this is only real way for anyone looking to grow a new nonprofit, then we as a society have a problem. (though large scale retail fundraising using Web 2.0 tools is a potentially interesting solution).

The potential I see is to have foundations bring together both know-how about what it takes to solve major social problems AND a risk appetite to put capital behind organizations (and not just programs) that have a real chance at building those solutions.

For now, at least, it seems like we’re coming up short on the appetite for risk and for openness to the idea that investing in great teams and building great institutions will be what brings forth the next wave of groundbreaking nonprofits.

In our work at SVP, I think the most fundamental philosophy that guides our work with non-profits (human and financial capital) is that the relationship is with and about their ORGANIZATION. We ultimately invest because of a non-profit’s social outcomes, but the most effective way to do that is to help them build a strong organization for the long haul – strong infrastructure, flexible funding, leadership development, clear outcomes, etc.

At SeaChange Capital, we also take an enterprise-centric approach, believing that outstanding entrepreneurs and their boards and management teams deserve and require unrestricted, multi-year philanthropic support in pursuit of significant increases in impact. Certainly this is how great companies are funded, and while acknowledging imperfect mapping between business and social enterprise, we do believe the equity investor’s mindset is applicable to both sectors.

We add to this the conviction that, as the social problems faced by children and youth in our low-income communities are enormous in scale, at least some of the responses need to be of scale as well. This suggests that the funding required from the philanthropic sector, often and ideally in partnership with government, needs to be quite large, larger than any single funder can provide. So we have taken on the assignment of supplementing our own resources with those of a national network of wealthy individuals and families who see the need to act collaboratively, with SeaChange Capital conducting significant due diligence (including utilizing prior research done by others willing to share their insights) and working to arrange the multi-party financings.

Yes, only time will tell if well-capitalized nonprofit enterprises can effect meaningful social change. I would suggest that results from the handful of youth-serving organizations that have achieved financings of this nature (see, for example, Teach for America, College Summit, Year Up, Youth Villages, Citizen Schools) support our thesis.

Thanks for engaging the conversation.

New Profit believes that many solutions to our country’s most entrenched social problems already exist. But many of the social entrepreneurs who have created these innovative solutions lack access to the financial and human resources to grow their enterprises, as well as the connections to policymakers at the city, state, and federal levels that could help them scale their solutions.

What’s the result of this situation? The nonprofit sector today largely consists of “mom and pop shops”—the vast majority (91%) operates with an annual budget under $1 million. And the social problems we face persist.

We see our role as a funder as identifying the best solutions to social problems, then providing these solutions with the financial and strategic support needed to grow their social impact. At New Profit we’ve decided not to become subject matter experts. We don’t subscribe to any one point of view on education reform, healthcare efficiencies, or workforce development strategies. Instead, we believe entrepreneurs hold the insights and are best suited to design and grow their innovations. Like venture capitalists, we look for leaders and innovations with the potential to create fundamental, widespread change. We then provide financial capital (multi-million dollar growth capital grants over four to six years), access to networks (other funding sources, experts in content areas, policymakers), and necessary strategic assistance (management consulting, portfolio managers) to help each entrepreneur grow their solution to new communities and to drive their own strategy for scale through policy, creating markets, or another widespread change strategy.

So where does systemic change come in? We’ve realized that scaling great organizations alone won’t be enough to solve the persistent social problems we all face today. To realize transformative change we’re going to need to improve the environment in which all nonprofits operate. New Profit believes this means building effective social capital markets, and, connecting policymakers at the city, state, and federal levels with solutions to social problems, as well as a range of other strategies. For these reasons, in addition to working with a portfolio of innovative organizations, we’re also working with a coalition (see America Forward), and a broader network of colleagues, to inform policy, improve capital markets for social innovations, and advance a national dialogue about how we can support and grow what works.

I’m not sure I buy the concept of a secondary market. Although Dan Pallotta in his book Uncharitable posited the idea of nonprofits spinning out their fundraising arms which could share profits with stock holders. Not sure I like that either, but maybe there is a twist that makes something work.

But I love the thought puzzle you lay out!

(ALERT, this is going to get technical!)

For those who aren’t familiar, the vast majority of trades that take place in the stock market involve one investor swapping money with another in exchange for shares. None of the money goes to the firm — its just an exchange between shareholders.

It all works because shares have value: shares confer to their owners the right to receive a portion of the firm’s earnings for ever more, they confer certain decision rights and they confer the right to “assign” ownership of the shares to other investors. All of these right are seen to have value and that’s why they can be traded for cash in a secondary market.

What’s interesting is that often, the shareholders actually never receive any earnings (in the form of dividends)and never even expect to. Instead, earnings are retained by the firm.

What’s fascinating (if you are nerdy about such things) is that even though no one expects to receive any earnings, the shares nevertheless can have great value.

This is because shareholders think in terms of how much earnings COULD be distributed in the future, should the shareholders or their representatives in the board choose to start demanding those dividends.

Thus, secondary market shareholders think in terms of the firm’s future ABILITY to distribute earnings, and, even though the distribution never happens, that is enough to place a value on the shares.

I find this intriguing because, financially speaking, a nonprofit bears a strong resemblance to a for-profit that retains all of its earnings.

The nonprofit tax code doesn’t say nonprofits can’t have profits. It says that nonprofits can’t DISTRIBUTE their profits. This is called the non-distribution constraint.

So this is all very tantalizing. YOU DON’T NEED TO EVER DISTRIBUTE EARNINGS TO HAVE A SECONDARY MARKET THAT WORKS.

What you do need to have is a belief on the part of the shareholders that customers will continue to use the firm to change their money into whatever the firm has to offer.

Translating to nonprofitdom, a nonprofit enterprise has value to the extent that it is expected to continue to turn funders money into socially beneficial program execution.

My point here is that when it comes to finance, nonprofits and for-profits may be more similar than meets the eye, and this is something we capital-market makers can maybe take advantage of.

Nevertheless, the big difference is that for-profit shares grant the shareholder two things that nonprofit shares do not. First, they confer the RIGHT to extract dividends. And second, via voting or board representation, they confer the right to influence a bunch of firm-level choices including whether or not earnings will be distributed.

To finally get to an answer to your question, Sean, I believe we may one day be able to use analogous features to get a nonprofit secondary market of some sorts to work.

We couldn’t offer shares that confer a right to receive dividends, but perhaps we could confer a right to brag about being the official Builder-steward of the enterprise. This is kind of a naming right. Instead of having your name on a building, though, it is being named as a steward of record. Not super compelling, perhaps, but who knows? Naming rights for all the bowl games sure have certainly worked well, and are bought and sold regularly in a secondary market.
Perhaps more potent would be to build certain decision rights into nonprofit shares. “In owning this equity share of nonprofit xyz I formally have the right to weigh in on whether or not we will merge and change the mission.”

These are just musings of course – I can see all sorts of things I don’t like about what I’ve described. But its good food for thought, and perhaps, with alteration, there may be something that could work!