Matthew Yglesias has persistently noted that investment strategies can’t outperform the economy as a whole over the long run and fund managers of alternative asset classes (private equity, hedge funds, etc.) tend to make out better than their investors. Apparently, venture capital is no better according to a new report from the Kauffman Foundation. On hedge funds, Yglesias opines that,
Insofar as hedge fund managers are just running a scam where one class of rich people rips off another class of rich people, I’m not sure there’s anything systematically problematic about this. But a large share of the money invested in hedge funds seems to come from foundation endowments and pension funds. That in turn makes me wonder to what extent some of the dysfunctional aspects of the financial system can be traced back to dysfunctional governance of those institutions.
I’m not going to quibble with Yglesias’s assertion that the “dysfunctional governance” of foundation endowments and pension funds has some relationship to the nefarious aspects of our financial economy–in fact, the new Kauffman report urges investment committees to conduct greater due diligence of their venture capital investments–but perhaps “news” that private equity, hedge funds and venture capital firms perform no better than any other actively managed stock funds will encourage foundations to reallocate their wealth to impact investing. The Cordes Foundation, for example, has shifted two-fifths of its endowment into impact investments after its initial twenty percent investment outperformed everything else in its portfolio.
The key is for foundations (and wealthy philanthropists) to see impact investing as a choice between or complement to private equity, venture capital and other investments made in the interest of managing wealth and endowment perpetuity, not as a flat out replacement to traditional grantmaking.
To that point, here is an excellent presentation on impact investing by Fran Seegull, Managing Director of Investments at ImpactAssets:
Why Social Innovators Need Government
There’s been an interesting dialogue between The Bridgespan Group’s Daniel Stid and Social Solutions’ Patrick Lester following Stid’s thought-provoking Washington Post essay, “Dismantling the Social Services Industrial Complex.”
The major point of contention is whether or not social services organizations have the power or desire to impede social innovation. Lester contends that while a self-interested “social services industrial complex” exists, it’s less powerful than Stid claims. I agree, which is why Robert Egger’s work advancing CForward and the recent merger between the National Council of Nonprofits and the Center for Lobbying in the Public Interest has been so fascinating. After all, social nonprofits scrape together government funding year after year and social services organizations certainly aren’t willful deterrents of social innovation. If government were to stop funding ineffective social services program, would the money be reinvested into innovative, high-performing ones? And how would those programs be identified?
But where Lester really hits the nail on the head is his observation that too many in the social innovation community have ignored the need for innovation and advocacy. Lester’s perspective echoes that of Living Cities CEO Ben Hecht who favors mainstreaming social innovation through the public sector. Lester writes,
Simply put: if you want to see more good ideas taken to scale, then you need government funding, and for that you need to fund solid policy analysis and advocacy. This is a role that foundations and/or wealthy high-tech philanthropists need to fill.
Unfortunately, for the most part, they have not. Both seem uninterested — foundations because they have traditionally shied away from it, and high tech philanthropists probably because they made their money in the private sector and seem allergic to government.
For the sake of our children’s future, this needs to change. Foundations and philanthropists need to step forward and fund not just innovation, but advocacy too. Only then will our best ideas be taken to scale.
As management consultant and impact investor Thien Nguyen-Trung argues, the role of social innovators is to “introduce a disruptive, innovative way of achieving social impact in the most sustainable way possible.” Social innovators should view themselves as entrepreneurs looking for a successful exit–and government as the buyer or “impact offtaker” that can take their innovation to scale, and have permanent, lasting impact.
If truly motivated to achieve impact and scale, funders of social innovation must overcome their aversion to government and support innovation advocacy, because even the largest, most efficient social enterprise is unequipped to achieve significant scale. Social innovators, foundations and philanthropists need to help government change the way it does business.
Prisons: Desperate for Innovation
Living Cities CEO Ben Hecht argues that in order for there to be large-scale social change, there needs to be more public sector-led social innovation. I wholeheartedly agree. And outside of education, is there any public institution in more desperate need of social innovation strategies than prison?
As my friend and fellow writer Michael Corbin brilliantly points out, America’s prison system is an abject failure unencumbered by cost-benefit analysis. We allocate billions of tax payers dollars annually to support an incarceration epidemic that resembles a revolving door where more than four in ten offenders nationwide return to state prison within three years of their release. We can no longer afford our prison culture nor should we want to with that sort of anemic return on investment.
While government is busy experimenting with innovative financing vehicles like social impact bonds (more commonly referred to as “pay-for-success” bonds here in the States) to back improved “offender reentry” outcomes, forward-thinking organizations like Safe and Sound Campaign have already figured out a way to reduce prison spending and increase outcomes.
If this innovation proves successful, hopefully it will quickly displace the old (failed) way that government has funded and operated public safety and corrections.
Funding Nonprofits for Failure
Before I continue with arguments I made in yesterday’s post, I thought some additional context would be beneficial. While preparing my talk for the BmoreFail conference, I gathered perspectives on risk taking, failure and innovation from several nonprofit professionals. Here’s a sampling:
From a nonprofit executive director,
Revenue is hard to come by for nonprofits and we are under intense pressure to have “wins” and put up good numbers. A nonprofit has to feel pretty secure to take risks. It’s awfully hard to go back year after year and explain your outcomes for comprehensive bills that go nowhere or relatively low numbers when [you're] serving residents with the most significant barriers.
From a community leader who serves on numerous nonprofit board of directors,
Based on my experience with nonprofits in Baltimore, I think they are willing or even eager to innovate to achieve their mission, and they expect to take reasonable risks to achieve their goals. Nonprofits are usually created to solve a problem, often a long-standing problem. They need to be smart, ingenious, innovative, and willing to take the risk of trying something new since the status quo has likely created the problem and is not effectively solving it [...] But I’ve heard foundation folks say it is sometimes hard to find good programs to support, and the several times I have read grant requests for United Way and [Baltimore Community Foundation] I’ve often had to try to make sense out of fuzzy, poorly-written proposals. Effective fundraising means having a project that is well thought-out and has the potential to do good. The fundraiser needs to be totally honest and needs to see the process as educating the potential funder about the problem and the proposed solution. The fundraiser also must match the project to the priorities of the funder. It’s not easy.
And, finally, perspective from a former foundation staffer,
[F]oundations/funders are market creators who are not inspired by market demand or to fill a gap but by legacy and institutional values. As long as funders fund to their interests and not to the needs of population or place, then we will have a rift. Funders are becoming even more introspective and niche in their investing. They are creating distinct and very narrow funding silos that limit service providers/grantees [ability] to address the emerging needs of their population/place. In [the] private sector, investors are not market creators…entrepreneurs are. In the social sector, investors set markets and the field reacts at the detriment to people and place. And lest not even begin to discuss power dynamics….
Each perspective is compelling, honest and insightful. The first two points speak directly and indirectly to the nonprofit starvation cycle that leaves nonprofits “so hungry for decent infrastructure that they can barely function as organizations.” How can a nonprofit consider taking risks when it expends so much effort just to keep the proverbial doors open? And how can a fundraiser develop into the rockstar she needs to be when her employer has little money to invest in her development?
Bridgespan Group consultants Ann Goggins Gregory and Don Howard note that while organizations with robust infrastructure are more likely to succeed, most nonprofits don’t spend enough on overhead and compare nonprofit overhead spending with that of the for-profit sector. For example, overhead rates across for-profit industries average about 25 percent of total expenses, while government agencies and foundations average permitted indirect cost allowances are between 10 percent to 15 percent of each grant.
The final point, funders as “market creators,” is an extremely important one, and also speaks to the starvation cycle–though less directly. Foundation leader Paul Brest and philanthropy advisor Sean Stannard-Stockton have debated the merits of “problem-solving philanthropy” and “philanthropic buying and investment” for a few years. The philanthropic landscape is diverse–though not nearly enough–but only philanthropic investment is organically sympathetic to overhead spending, capacity building and systems, and there aren’t enough Venture Philanthropy Partners or Mulago Foundations to go around.
“Philanthropic buying” and “problem-solving philanthropy” typify how institutional philanthropy is generally practiced. And while both are necessary, “philanthropic investment” is best positioned to empower nonprofit enterprises to become entrepreneurial “market creators” encouraged to take the sort of risks that might have lasting and profound social impact.
The Trouble With Nonprofit Failure: P1
I had the wonderful opportunity to speak at BmoreFail conference about failure and risk-taking in the nonprofit space, a critically important topic that deserves increased attention and I’m hoping to continue the dialogue.
Having worked in the for-profit and not-for-profit sectors in my varied young professional career, I’ve concluded that both sectors make false assumptions and have misconceptions about the other. When I hear people suggest that nonprofits need to take more risk, I don’t often disagree, but typically these suggestions come from a point of view grounded in the for-profit experience, and it’s extremely difficult to apply even basic for-profit principles to the nonprofit space; the sectors are structured quite differently. With this in mind, I was sensitive to use my talk as an educational opportunity regarding the sometimes stark differences between the sectors.
I titled my talk, “Why Nonprofits Fear Failure.” Catchy title, but do nonprofits actually fear failure? Yes and no. Nonprofit managers are nervous of failure primarily for two reasons: 1) failure has real human consequences, i.e. an untested, new intervention designed to reduce teenage pregnancies actually leads to increases in teenage pregnancies and 2) defunding of programs and services. Funding is a recurring theme for nonprofits; risk-taking and innovation largely go unfunded, so nonprofits are effectively discouraged from pursuing either.
But back to failure — nonprofits might fear it, but the nonprofit sector is rather failure tolerant. Baltimore, the social services city that it is and home to a robust nonprofit sector, has nearly 150,000 residents below the poverty line. Nearly 25 percents of Baltimoreans live in poverty. Now, this certainly isn’t the fault of nonprofits–there’s no shortage of blame to go around for Baltimore’s atrocious poverty figures–but we do know that many nonprofit poverty interventions either fail or have inconsequential impact.
So nonprofits fail. The question then becomes, how do nonprofits quickly assess impending failure and “pivot,” as tech entrepreneur and The Lean Startup author Eric Ries would frame it. But is the nonprofit sector even capable of implementing an idea birthed in the startup, technological community?
Sasha Dichter, chief innovation officer at Acumen Fund, attempts to answer that very question. He looks at Ries’ BUILD-MEASURE-LEARN cycle and retools it for the nonprofit sector, so we go from this:
To this:
Dichter surmises that,
The lightbulb moment for me is that we are structured as a sector to have a BUILD – MEASURE – LEARN cycle that lasts three years (sometimes longer)…the time it takes to get a grant, execute against that grant, write the grant report during and after the grant, and potentially renew. So the underlying problem isn’t about willingness to take risk, the underlying problem is the false premise that long cycle times make sense – when in fact as a sector we need new and better solutions nearly everywhere and need to create engines of innovation to get us there.
And there’s hope. While The Lean Startup was spreading throughout Silicon Valley and beyond, Mario Morino and Venture Philanthropy Partners have been busy evangelizing similar concepts put forth in Leap of Reason: Managing to Outcomes in an Era of Scarcity. It’s no surprise that Morino, a philanthropist who made his fortune as a highly successful software entrepreneur, might share similar principles with Ries. Morino cites a case where the Latin American Youth Center developed a program to discourage domestic violence perpetuated by Latino men. The center, through ongoing analysis and feedback, discovered that the program was actually validating the use of violence for these men. The center redesigned the program, leading to the desired outcomes: BUILD-MEASURE-LEARN and pivot.
My next post will further explore funding and risk-taking in the nonprofit sector.
The Mulago Foundation and impact
I’ve been invited to give a talk focused on failure and the (perceived?) lack of risk-taking in the nonprofit sector at this week’s Bmore Fail Conference. It’s certainly a weighty and contentious topic, and I’m particularly interested in how my talk is received by an audience predominantly made-up of for-profit entrepreneurs and investors. Without giving too much away from my (almost finalized) talk, I’ve highlighted someone from the nonprofit sector who will certainly resonate with this crowd: philanthropist Kevin Starr, managing director of the Mulago Foundation.
I discovered Mr. Starr and the Mulago Foundation a few years ago while reading Sean Stannard-Stockton‘s excellent–and now defunct–Tactical Philanthropy blog. Stannard-Stockton wrote about Mulago’s focus on impact on his blog and in the pages of the Stanford Social Innovation Review, writing,
What if foundations mostly gave unrestricted funding instead of dictating how grantees could spend their grants? What if foundations kept supporting grantees who performed instead of ending funding because the “grant cycle” had ended? What if foundations ditched the whole system of soliciting grant proposals and focused on proactively searching for great grantees? What if foundations expected grant reports to mostly consist of information the nonprofit was collecting anyway rather than specialized requests that sap the grantees resources?
Well, it turns out that sort of foundation already existed and I’ve been an admirer of Mulago Foundation ever since. I became an even bigger admirer after Kevin Starr penned a fantastic essay on impact investing and other forms of blended capital, noting,
In the real world of the poor, real change still means stepping up with money that you don’t expect to get back, while demanding maximum returns in the form of impact. When you find someone who can do that, just give them the money.
A brilliantly simple analysis. And I encourage you to give a listen to his talk on impact:
“Stand your ground,” politics and CForward
I recently came across a talk given by Tom Tresser, a Chicago-based organizer, educator and civic activist, who questions the nonprofit community’s reluctance to effectively engage in political action, citing the National Rifle Association’s influence in national and local policy-making and argues that there needs to be a similarly effective political instrument for the nonprofit community. Tresser notes the work underway by CForward, a nonpartisan, 501(c)4 organization that “champions the economic role of the nonprofit sector and supports candidates who include the sector in their plans to strengthen the economy.” I love what CForward is doing and it’s no surprise that the forward-thinking Robert Egger, founder and CEO of DC Kitchen, is behind it. Tresser really espouses the value of sustained political engagement and is pushing Chicago’s creative community to organize around its seemingly disparate political interests.
Not accidentally, the NRA is among the most dominant political influences in America, along with the Christian right and Grover Norquist’s Americans for Tax Reform. What would the political landscape look like if CForward really became as influential in policy-making as the NRA? The legislative impact of the NRA cannot be understated. Consider “stand your ground” laws which have gained considerable attention in the wake of the tragic death of Trayvon Martin. The NRA and its allies have spread the law to over 30 states (it’s law in 25 states) and gun control advocates like political talk show host Bill Maher admonish the Democratic Party for rolling over on the issue and conceding far too much ground to the NRA. The nonprofit sector on the other hand, particularly social service groups dependent on government funding, lacks sufficient political capital, and is constantly at risk for underfunding or defunding.
Both Tresser and Egger understand that even an imperfect political system weighted heavily toward deep-pocketed business interests can be used to advance their agendas. They’ve acknowledged political campaigning is imperative and efforts like CForward have taken a page from the Republican Party’s winning playbook and use it to optimize the political agenda of the nonprofit sector. Labor unions have come to a similar conclusion; while fully aware that the Citizens United ruling is far more beneficial to corporations, unions are exploiting the ruling to offset corporate money flowing into conservative groups like American Legislative Exchange Council.
More importantly, labor unions are changing how they engage in politics. As A.F.L.-C.I.O. president Richard Trumka told the New York Times,
The way we used to do politics is we’d set up a structure six months before the election, and after Election Day we’d dismantle it… Now we’re going to have a full-time campaign, and that campaign will be able to move, hopefully, from electoral politics to issue advocacy and accountability.
It’s good to see that the nonprofit sector might eventually move in a similar direction.
Rodney Foxworth is an entrepreneur, writer and business strategist focused on nonprofits, new media enterprises and social ventures. He's held positions as a nonprofit manager, sales executive and marketing specialist across multiple industries.
