Venture Philanthropy

The Skoll Centre for Social Entrepreneurship (Oxford University, Said School of Business) has published a working paper by researcher Rob John titled Venture Philanthropy: The evolution of high engagement philanthropy in Europe (June 2006). It does not seem to be available online (which is strange). The Media Development Loan Fund (MDLF), from whose board meeting I am now returning home, is one of the case studies featured in the paper.

The paper defines venture philanthropy as providing a “blend of performance based development finance and professional services to social purpose organizations … analogous to the practices of venture capital in building the commercial value of companies.” That definition seems pretty good to me. The movement toward venture philanthropy arises largely in the United States and in particular from venture capitalists seeking to apply not only their fortunes but their methods into philanthropy and charitable organizations.

One important issue in venture philanthropy is whether it seeks to apply these methods of venture capital merely by analogy or in fact. Meaning, when venture philanthropists fund an organization, do they seek to apply venture capital methods of assessing return to calculate a “social return” on investment that is analogous to private equity’s return on investment, or do they intend to invest in that (relatively narrow) range of charitable activities that can actually generate a genuine return, to then be recycled – as in microfinance sometimes, though not very often – back into the charitable activity?

There are some areas of charitable activity that actually generate revenues, of course. Education, higher education especially, is one. Health care, eg nonprofit hospitals, is another. These are two leading areas in which fees by users of the nonprofit services are expected ordinarily to cover costs of doing business. Microfinance sometimes, though not very often, can generate a return on investment – and in a wider range of cases if one excludes from inclusion in recovery of costs foreign organizations that provide set-up funds and background services, in order to focus on the recycling of funds. There are some other areas, such as community economic development, where real estate developments and small business development can generate revenues that – again, often using a deliberately narrowed definition of costs to be recovered – can generate a return on investment. (You can either include all the background costs in the amount to be recovered as capital investment against revenues, in which case your rate of return is actually a rate of loss, but you can still measure how small the rate of loss is as against other things. Alternatively you can exclude certain costs from the amounts to be recovered and have a positive rate of return, although not one that captures the full implicit subsidy.)

MDLF invests in private media businesses in the developing world, with the social and charitable mission of promoting independent media around the world that provides populations with access to objective news and information. It invests in newspapers, radio, TV, and new media such as internet, and ancillary businesses such as printing presses. It is a paradigmatic case of venture philanthropy actually seeking a real rate of return, not simply trying to measure social return. Because it undertakes regular commercial investment in private businesses, it seeks to recycle its funds and increase its actual commercial portfolio. This is the consequence of a very special charitable mission – the propositions that editorial independence of independent, objective, news-providing is an important feature of a liberal democratic society, and that the best way to achieve that editorial independence is by financial independence of the media company. (Something similar operates in community economic development – a condition of a socially healthy neighborhood is small business ownership and the investment of local individuals in local housing, real estate, etc., thus justifying the investment of charitable organization funds into commercial businesses as a charitable end in itself.)

As a consequence of investing in commercial ventures that have the possibility of generating a return on charitable investment, however, the relationship of MDLF to sources of capital is potentially different. It is able to mobilize a special source of funds within the so-called “non profit capital market” of donor, foundation, philanthropic funds – loaned funds, so-called (originally in the tax law but now a widely used term) “program related investments” in which a foundation lends sizable funds to MDLF, expecting repayment and (below market) interest. MDLF then on-lends those funds – also technically program-related investments. (MDLF, it turns out, is the largest maker of program related investments among all US charities, which astonished me, but apparently this has been true for years.)

Is it also able to mobilize, on account of its ability to generate returns, funds from genuinely commercial sources – the real capital markets, in other words? Well, yes and no. The difficulty is that MDLF’s rate of return on its investments in its clients – all told, all costs in, including the costs of capital, administration, and monitoring of its portfolio – does not fully cover its costs. The interest rates it charges are themselves below local market, and insufficient to cover MDLF’s own costs fully. So in that sense, without access to grant funds from the nonprofit capital market to subsidize its operations and administration, if it sought all its funds in the commercial markets, it would eventually go out of business because its all-in cost of funds would be below the all-in rate of return on its portfolio.

On the other hand, MDLF has made landmark entry into the commercial capital markets. It has entered the US commercial markets through the “socially responsible investor” market – offering, through the SRI Calvert Fund, “press freedom notes.” Here. Essentially, investors can buy the press freedom notes and accept a lower than market return on them. So far MDLF has not sold a vast amount of these notes, which typically are marketed toward the middle income investor in the US who is willing to forgo a certain amount of return that might be had on a purely commercial note.

But MDLF has also done this year a first-ever deal in Switzerland. MDLF is, I am pretty sure, the first nonprofit to have issued a derivative security that is publicly traded on the Zurich stock exchange. You can read more about it here and watch its trading history on the market. The derivative is a genuine landmark in nonprofit finance – and owes much to MDLF’s own (quite remarkable) staff – working with a new and highly, highly innovative SRI organization in Europe, ResponsAbilite. They partnered with a leading Geneva private bank, Vontobel, to create the derivative. Eventually, the Swiss government development agency joined the effort, offering a guarantee on a part of the security. But of course a good question is why a nonprofit would seek commercial market access if the cost of capital would turn out to be higher than its rate of return. Well, two answers. One is that the cost of capital on these instruments is still within the SRI model – commercial in one sense but still subsidized in another, including the Swiss government guarantee and a SRI cost of funds (one percent) to MDLF. The other, however, is that circumstances could arise in which commercial funds might be attractive for particular projects where investment requirements simply outstrip available funds in the nonprofit market. (Much of MDLF’s loan pool comes from European aid agencies, such as SIDA.)

But this is all, well, finance finance. It is about real money and real returns. There is a portion of the nonprofit world for which that can make sense, and in fact it is wider than often appreciated. There are certainly ways in which, for example, investment in vaccine development – malaria, AIDS, etc. – can be about real rates of return because if someone can develop it, governments will provide a market ready to pay for it. The concept of venture philanthropy, however, is most interestingly and controversially applied in areas where it is necessarily by analogy – the concept of the “social return.” How do you measure that elusive thing? You can’t look on the Zurich stock market and track the price of your very cool, very innovative derivative security. The theory is very persuasive in the abstract. The problems of application make you wonder, though, how useful the concept can be at the microlevel. Can the theory generate a usable model?

The train is arriving in DC… so I will leave this here. Our board meeting dealt with issues of mission – what kind of media organizations should be supported with our limited funds, limited staff? Should an organization like ours adopt a global approach or should it seek to specialize in regions? And also real, live money issues, returns on investments, performance of our portfolio. Lots and lots and lots of numbers this weekend. Going closely over our audited financial statements. Going over reports by the finance director on portfolio performance. Discussions of financing mechanisms for new and old clients. M&A. Many of my students, I notice, who tell me they are interested in nonprofits and saving the world, somehow lose interest when it comes to numbers. Anyone who has worked very long in the nonprofit world will tell you, however, that numbers are critical for, well, everything. Likewise some minimum knowledge of accounting and finance. And as venture capital concepts take hold in the nonprofit world, those ways of thinking about the traditional charitable mission of saving the world become ever more important.