Underlying much of my recent debate with Paul Brest was my view that funders should emphasize investing in building great nonprofit more than working with nonprofits to execute a foundation designed programmatic strategy. One problem with this approach is the lack of understanding around the concept of “philanthropic equity”. To that end I’d like to present an op-ed c0-authored by myself and George Overholser of Nonprofit Finance Fund Capital Partners.
By George Overholser and Sean Stannard-Stockton
It is time for the Financial Accounting Standards Board (FASB) to incorporate the concept of “philanthropic equity” into its standards for nonprofit accounting.
Without equity to shield them, America’s nonprofits are systematically undercapitalized. Since 1970, only 144 of them have grown to surpass $50 million in annual revenues. During the same time period, 46,136 for-profits have broken through the $50 million mark. Even small nonprofits, the backbone of our social purpose sector, are plagued by a chronic hand-to-mouth existence that can only be overcome if equity can find its way to the balance sheet. Achieving scale, gaining the necessary size to tackle systematic social problems, are buzzwords of the social sector. But until nonprofits and philanthropists understand the role of equity in the building of world class organizations, true scale will be a farfetched goal for most nonprofits.
Yet the financial concept of equity is wholly absent from nonprofit accounting, as is the firm-nurturing role of equity stakeholder. We believe that this absence is a major reason why so few high-performing nonprofit firms are able to achieve national prominence and impact, and why so many smaller nonprofits fall on hard times from which they never emerge.
President Barack Obama has called for the creation of a “Social Investment Fund Network that invests in ideas that work, tests their impact, and expands the most successful programs.” The idea, first suggested by the nonpartisan social entrepreneurship advocacy group America Forward, has taken form within the recently proposed Serve America Act, which is sponsored by both John McCain and Barack Obama. An FASB-backed nonprofit equity accounting treatment would go a long way towards helping the Social Investment Fund Network identify scalable social enterprises as well as remain accountable to taxpayers for investment results.
Recognizing the distinction between revenue and equity is critical to building great organizations. Revenue is cash flow delivered to an organization in exchange for execution: delivering goods and services. Equity is cash flow delivered to an organization for the purpose of building the organization. Without the ability to account for philanthropic equity, it is simply not possible to distinguish between donations that keep a nonprofit running and those that are intended to build the organization.
For-profit investors recognize the critical role of equity and judge the performance of firms via measures such as “return on equity” (ROE). Warren Buffett is widely known to emphasize the importance of investing exclusively in firms that have a long history of achieving high levels of ROE. A philanthropic equity treatment would provide social impact metrics analogous to ROE – not just what happened with this year’s budget, but what is accomplished throughout the life-cycle of the nonprofit firm. Without the life-cycle perspective provided by an equity approach, the concept of enterprise-building investments rapidly becomes nonsensical.
A new equity-like methodology, called the Sustainable Enhancement Grant (or SEGUE), has already been deployed successfully among several high performing nonprofits to help bring them the accounting transparency they need to attract equity-like philanthropic donations. It has been well vetted by leading law firms and accounting firms. Now it is time to build SEGUE concepts into FASB guidelines.
Witness VolunteerMatch, a high-growth, high-performing nonprofit that is not yet self-sustaining. Last year, VolunteerMatch facilitated 16.2 million hours of volunteer work. At a $19.50 per hour value of labor, this represents $315 million of social benefit per year that likely would not have taken place, were it not for the existence of VolunteerMatch. They did this on an annual operating budget of just $3.1 million.
VolunteerMatch obtains revenue from three ongoing sources: fees from corporations that use its services to manage their own volunteering programs; fees from nonprofits that pay for premium recruiting; and contributions made by visitors to VolunteerMatch.org. At current scale, these three sources of revenue fall short of covering VolunteerMatch’s annual operating costs.
VolunteerMatch’s executives believe that if they can raise $10 million in up-front “philanthropic equity,” they will be able to grow their organization three-fold over the next four years, to a level where their ongoing sources of revenue begin to generate a surplus.
Similar to a venture capital-backed for-profit, VolunteerMatch would “burn through” $10 million of equity growth capital while erecting a customer-supported business. With equity capital in hand, they would not be forced to begin each year anew, begging their supporters for major donations. Instead, their ability to produce social impact would be in their own hands and their equity investors would see the social return on their investment compound year after year. An equity accounting methodology highlights not only the opportunity for immediate impact at VolunteerMatch, but also provides a framework for donors to track the organization’s progress towards their sustainable growth goals.
If we are to build a high-functioning nonprofit economy capable of achieving significant impact on a large scale we must change nonprofit accounting to make the results (both positive and negative) of philanthropic equity investments apparent to everyone.
Once we have the needed financial tools, the next step will be the use of syndicated capital campaigns similar to those seen in the for-profit private equity field. This sort of equity-like syndicated campaign is already being created by organizations such as SeaChange Capital Partners and the Edna McConnell Clark Foundation. But it will require an official change in nonprofit accounting for this concept to really take off.
There is too much at stake for donors to continue giving more than $300 billion a year without a better understanding of which nonprofits are using their money to build sustainable organizations and which are not.
The need for philanthropic equity accounting has never been so urgent. Regardless of whether you support the idea of a Social Investment Fund Network, it is critical that taxpayer-funded investments be made within a rigorous and accountable framework. With the official recognition of philanthropic equity, we will establish a framework within which a new generation of high-performing, well-capitalized nonprofit institutions can thrive.
George Overholser is founder and managing director of Nonprofit Finance Fund Capital Partners. Sean Stannard-Stockton is a principal at Ensemble Capital Management and the author of the blog Tactical Philanthropy.
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