Category Archives: Funding

For-profit, social benefit: oxymoron or smart choice?

Ten-dollar bill obverse/reverse

Profit and social benefit can go together.

Several years ago, a friend of mine came up with a very innovative way to motivate low-income kids to work hard on improving their vocabulary. Sounds like a great non-profit, right?

But here’s the surprise: he very intentionally formed his company as a for-profit. There are no deep pocketed donors, no fundraising drives. Rather the company is supported by government funding that goes to provide low-income kids with supplemental tutoring. Furthermore in many areas, his company gets paid for actual improvement of reading scores—results—rather than just delivery of service.

Taking a step back, if the societal goal is “raising highly literate kids”, beautiful things happen when a market is set up to pay for outcomes. That’s when entrepreneurs bring their creativity, talent, and energy to effectively meeting that need. And structuring as a for-profit gives him many advantages in serving this market.

Let’s consider the potential advantages of being a for-profit here, rather than a not-for-profit:

  • A for-profit can pay its staff competitive market rates, rather than the lower “nonprofit salaries” that are considered “appropriate.”
  • A for-profit can afford to hire a highly talented CEO with experience scaling services nationally, rather than someone less experienced.
  • A for-profit can avoid the criticism and scrutiny of the non-profit “overhead police” who don’t understand the connection between expenses and impact.
  • A for-profit is accountable to the market—in this case the kids and their reading scores—rather than simply needing to please donors to keep getting funding.
  • A for-profit doesn’t have to spend time on fundraising, and has much more control over future income.

I have to admit that when I first heard about my friend’s company, I just couldn’t understand why he turned away from the benefits of being a non-profit. But the more I learn about the field, and read books like Dan Pallotta’s Uncharitable, the more I see that there are real trade-offs to be had in structuring a social benefit organization.

One last thing: it’s worth noting that my friend is extremely committed to the cause of education. He’s not in it for the money. For many years he has put all of his earnings back into the growing company, so that he can reach more kids. For years, in spite of running a company that employs hundreds, he hasn’t owned a car. Clearly his motive is impact, not personal profit—which makes his choice of a for-profit structure all the more fascinating. Cases like this lead me to wonder if the assumptions behind “non-profit” are in fact a hindrance.

Why are so many non-profit salaries so low?

Homeless person, with shopping cart

a nonprofit mobile office?

Dan Pallotta’s book Uncharitable continues to move me; it is changing my views of where the nonprofit sector needs to go. In the first portion of the book, Pallotta delves into the origins of strongly held American beliefs about the nonprofit pay. He writes:

“In Puritan times, people gave directly to the needy, without using brokers. This is no longer possible on any meaningful scale. Charity is no longer an exchange between the non-needy and the needy. It is an exchange between the non-needy (donors) and the non-needy (the charity workforce) to provide services to the needy. Is an exchange between equals to help the needy. It is no different than the exchange between those who buy cars and those who make them. A law that was meant to provide an economic discount to the needy in face-to-face transactions is now improperly exploited to expect nonprofit sector workers to provide wage discounts to wealthy donors who are in essence buying a service from them, which they use their labor to provide. The donating public expects the nonprofit workforce to extend to it the law of mercy. But it was never intended that such a law be applied in this way.”

This is a big aha for me—over time two distinct dynamics have become confused as one. The first dynamic is the wealthy giving charity to the needy. The second dynamic is nonprofit employees (the non-needy but non-wealthy) working at below market rates, thus also giving charity to the needy. But in doing so, the nonprofit employees are in a way also giving charity to the *wealthy* as well, in the form of their under-priced labor. And this practice of low nonprofit wages is not just common, it’s widely considered to be the only acceptable situation.

I’ll never forget attending a mixer of the San Francisco chapter of YNPN and overhearing several discussions of nonprofit employees who have no health insurance. They were talking about where to go in the city to find free health clinics! These are smart, young, energetic people who could easily find work in the for-profit arena. They are living lives of poverty in order to work for nonprofits. It just doesn’t seem right to me, it doesn’t seem sustainable, and I absolutely can’t see this being good for the field. It doesn’t take much imagination to see many of these young people going and finding “real jobs” and only doing social benefit work on weekends. What a loss for the field.

So what’s going on here? My guess is that there are two factors in play.

One factor is that there are a few markets for the kinds of social benefit that nonprofits generate. These are organizations that are creating real value to society, but which society isn’t currently willing to pay for, at least not proactively. It’s a lot easier to get money to build prisons than it is to build programs that prevent the need for more prisons. I hope that over time as the underlying math and science of how societies work is better understood, the value of the right types of social investments will become obvious and uncontroversial.

The second factor is that there are huge discrepancies in the nonprofit world when it comes to pay—people at some organizations get paid extremely well, even if the impact isn’t clear. My guess is that this links to the relative lack of market mechanisms in the nonprofit world, where pay and impact can be worlds apart.

I wonder: if we can better understand and measure impact, and if we can create markets for that impact, can we find ways to fairly compensate talented individuals for the positive social impacts that they drive?

Donations, overhead, and the “feel good” factor

Do we really want to compete for donors on the basis of low overhead?

I had the good fortune at SOCAP 10 to meet Barty Jan Skorupa of Groundwork Opportunities. In the course of our conversation, he shared with me that when he does a fundraiser, 100% of proceeds go directly to programming. A few years ago I would have said “great!” but after hearing Dan Pallotta give a rousing “social benefit folks deserve to get paid, too” talk at the 2010 SEA Summit in San Francisco, I’ve started to actively wonder how nonprofit leaders can pay the rent when calls of “no overhead” carry the day.

What I took away from Dan’s talk is that overhead ratios are a poor measure of impact. And it makes sense, when you think about it: a smart for-profit company that is going to launch a critical new venture understands the value of investing properly and “doing it right,” and thus they raise big money in order to be as successful. Guess what—a lot of that money goes into infrastructure building and paying competitive wages to smart people, in other words to “overhead.”

But for-profit’s get it—they swing the big bats to get the big results. Dan made the point that the non-profit world often has a meek “spend as little as possible” attitude, based on the belief that “less is best” when it comes to overhead.

Now back to Barty. Here’s a smart guy who could be making good money as a consultant to for-profit companies, who runs this social benefit org “just because.” And I couldn’t help but ask him, “so how do you pay your rent?” because it just seemed unfair that he should have to scrape by. Fortunately for Barty he’s started to attract some grants and institutional money, but it’s still early, and even paying the rent is tight.

Then it occurred to me the next day: the question of whether or not 100% of all “event proceeds” go to programming is really a question for accountants. Let me explain.

Consider two $1M a year social benefit organizations that are totally equivalent in over way, except for this:

  • Org A says “20% of all money we take in, from funders and from events, goes to overhead. The other 80% goes to programs.” So that’s $200K a year to overhead, $800K to programs.
  • Org B says “100% of the money we take in from events goes to programs. And 100% of money we take in from funders goes to overhead.” Let’s say the funders are chipping in $200K a year, and the events raise $800K a year.

Now we have two equivalent organizations, right? Well, not really. Why? The psychological factor.

Here’s my take: Barty is playing it smart by saying “we have no overhead” because the typical individual donor thinks that’s a good thing, and likes the idea of all of their money going “directly to the cause,” even if people who run these organizations in fact need to eat, get medical car, and have a place to live. The casual donor doesn’t really care–from a psychological standpoint, they want the emotional gain from the “direct impact” they are having.

Thus by using the rallying cry of “all funds raised at the event go straight to programming” he can unlock funds that otherwise might not be donated if they went, even in part, to “overhead.” As much as I agree with Dan that social benefits folks also deserve to get paid, unfortunately I doubt we’ll see human nature change such that the average donor cares about infrastructure.

Having said that, I realize that whenever a friend brags about how their charity of choice “has less than 1% overhead” I engage them in a conversation about whether that’s true, and if so, what that would actually mean for the quality of the organization. I’m trying to do my part to get the people around me to think a bit deeper about these issues.

Nonetheless, consider—do you care how about how much overhead Starbucks has, or do you want a good coffee at a good price in a nice shop? If, when it comes to donors, social benefit organizations are at least partly in the business of delivering “feel good,” in return for donations, then a “100% goes to programs” strategy can be a good thing.

Note: since writing this article I finally sat down and read through Dan Pallota’s thought provoking book Uncharitable in which he goes into more detail on this phenomenon of overhead ratios and accounting tricks. He also describes the unsettling case where non-profits that don’t engage in these tricks can lose their funding because they appear to be “inefficient” when in fact the whole “minimize the overhead” frame is what’s actually at fault. It’s time to get out of the overhead game and focus on impact.

Talented leadership drives great social enterprises, but how to afford it in the developing world?

GDP (PPP) Per Capita based on 2008 estimates h...

GDP bites back

It is fantastic to see “first world” entrepreneurs bringing social enterprise to new fields in the “developing world,” especially fields that are complex, global and competitive. Assuming that such a social enterprise can find it’s place in the market, the employees are sure to receive world-class skills and training that will give them fantastic career options. But there’s an inherent challenge to leading such an enterprise from an expensive “first world” country.

But consider this scenario: You’re running a US-based social enterprise that competes for customers globally with for-profit companies. Your main competitors are in India. Although your ground-level folks, who actually do the hands-on work, are in a developing country with similar costs to India, your leadership staff is in the US.

To run this business, you’ll need a great management staff. You’ll need leaders who understand your industry globally, who can guide your investment strategy, and who can land big sales contracts.

In the old days, to do that at a world-class level, you often needed “first world” expats—and the large salaries that went with them. But these days the world is changing. In some fields you can get management talent for $40K in India that would cost you $120K+ in the US. It’s a big advantage for these Indian firms.

Granted, it’s an advantage that’s been many years in the making. India’s education system has done a good job of preparing people in English skills, as well as technology and leadership skills, to compete on the global stage. And that talent pools makes a lot of things possible for Indian companies.

Consider now the global competitive landscape: You’re competing neck and neck with an Indian competitor to land a big contract. The customer knows that there are several viable options, and pushes you hard on price. You lower your price, as does your Indian competitor, until you get to a point where you just can’t go any lower. But they go lower, and they win the contract.

How do they do it? They are able to deliver a comparable service to you, but because their senior management salaries are 1/3rd of yours, their overall costs are quite a bit lower.

So what can you do? One route is to find that much more efficiency from your business because your management staff is that much better. In this case they’d need to find 3x the efficiency—challenging, although not out of the question if you can leverage technology in a way that your competitors can’t. Another route is to go into more complicated, higher-end services that the competitors are unable to provide, thus leaving them unable to compete with you, at least for now.

Whatever the strategy, though, the key point is that through head-to-head competition, if you don’t have a competitive advantage to outweigh the disadvantage of higher management salaries, you’re going to lose.

Those folks in India who have access to this talent, they have a lower cost structure without greatly impacting the quality of work they’re getting. So they will set the pricing for the field. Yes, getting sales is more than just price, but when you have two companies with comparable service, comparable output, then price is a real factor. Those lower cost-basis folks will be able to bid down much lower than you, and still be making a comfortable margin. Furthermore they may have a significantly lower tax rate.

Now if you’re going to compete with them, and have a US based cost structure for management, that’s going to be really challenging. Those more expensive US people need to add that much more value than their less expensive Indian counterparts.

And so this becomes a challenge for a social enterprise that wants to attract great leadership talent to work in the “developing world”. Ideally they’d be able to find local candidates, but those people are in such short supply that they can make a lot more money in the for-profit sector.

On the flip side, a social enterprise can attract expats who will work for local salaries, but they tend to stay for two to three years at most. My instinct says that while getting top-notch expat talent is of great benefit to an organization, the turn-over that is created by low salaries is disruptive to the organization’s success.

So what to do? I think it would be really interesting to see a pool of money from organizations like USAID go to funding high-level management talent—expat or local—for top social enterprises. The goal would be to support the world-class scaling up of such enterprises, while creating a pipeline of local leadership talent to fill those positions.

The challenge is that establishing such a pipeline won’t happen overnight—it’ll best be served by improvements throughout the education process to identify and nurture talented locals and encourage them to pursue social enterprise careers. Thus it would take a coordinated effort, and a patient effort, to build such capabilities locally.

Sustainability for social ventures–is it OK to take grant money?

I was chatting today with a friend who is a very high potential social entrepreneur. She’s had grant funding in the past, but has thought about it as a “hand out.” She told me that she really wants to stop taking grants, and just focus on building revenue streams towards a fully self-sustaining venture.

I think she’s has absolutely the right idea in the long run, but may be several years early in pursuing this path.

My experiences in the conventional business world tells me about the importance of seed capital and startup funding towards bringing a business to profit. There are few if any businesses that can bootstrap from nothing and quickly develop into substantial enterprises. Although it’s true that there are pitfalls to taking capital, it’s also true that it takes a certain amount of capital to properly set up a business for success. Ultimately, I don’t know that social ventures are any different.

In fact, several of the most interesting social ventures that I’ve researched use a combination of earned income and grants in order to build their enterprise, and develop scale and expertise that brings them closer to financial sustainability.

This notion of financial sustainability is a key point on which the grant discussion hinges. In that way I think my friend is right on the mark. She’s in effect saying “I don’t want my mindset to become one that relies on handouts.” At the other end of the spectrum, if an organization never takes in any grants or other forms of financing, it could artificially limit the growth and impact that would be possible otherwise, with funding.

Thus it seems to me that there is a healthy balance to be struck between a financial self-sufficiency mindset, scaling up, and being smart and selective about taking on grants and other funding *with the goal* of achieving self-sufficiency. This is what I see successful players in the field doing, and I think it’s important for the talented young social entrepreneurs to understand this balance.