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Nonprofits and Social Ventures

One morning about 15 years ago, I had a conversation that forever changed the way I think of impact organizations. I met with Jim Koch in his cramped office on the campus of Santa Clara University, a Jesuit school located at the heart of Silicon Valley and the oldest university in California.

He told me about his vision for being able to improve on the traditional model of nonprofit organizations, using Silicon Valley thinking to create a new kind of startup (“social ventures,” he called them) that could harness the power of markets while delivering social impact at scale.

Jim is one of those guys who has the kind of gravitas that makes an entire room go quiet when he speaks. After getting his MBA and PhD from UCLA, he went into corporate management, then moved to the academic world where, as a professor and Dean of the Business School, he helped build Santa Clara University’s MBA program into the nationally-ranked business school that it is today. As if that wasn’t impressive enough, he also spent time as Acting Dean of Santa Clara’s renowned School of Engineering. To have run the School of Business and the School of Engineering at a prestigious private university in Silicon Valley is a pretty rare feat.

As we sat in his office that morning, Jim talked about how the traditional charity model needed to be updated. Nonprofit organizations tend to live on a hamster wheel of pursuing donations to meet the most urgent problems  (or just the ones that donors care about right now). Conventional nonprofit organizations are incentivized to produce fast relief because actual systemic change takes much longer and is much more difficult. 

When there is famine somewhere in the world, for example, charities raise money to send in truckloads of food. Once people are fed, the charities and donors move on to the next humanitarian crisis without having ever addressed the underlying reasons for why the famine had occurred in the first place. “If what we care about is sustainability,” Jim told me, “then we need a new kind of organization. We need to bring entrepreneurial thinking to the impact world, by creating social ventures.”

Although I had never heard the term “social entrepreneur” before I met with Jim Koch that morning, it turns out that a McKinsey consultant named Bill Drayton had been using it for several years as a way of describing individuals who were creating innovative ways to address society’s most pressing social problems (Drayton went on to found Ashoka, an organization dedicated to supporting social entrepreneurs). Unlike traditional nonprofit charities, social entrepreneurs might have a for-profit aspect to their operation, using earned income to create sustainability and drive scale. Riffing on the old proverb that “If you give a man a fish he’ll eat for a day, but if you teach him to fish he’ll eat for a lifetime,” Drayton wrote, “Social entrepreneurs are not content just to give a fish or teach how to fish. They will not rest until they have revolutionized the fishing industry.”

I finished my meeting with Jim Koch that morning and drove back to my office, thinking about all of this. I had been President of two nonprofit organizations (one was a 501(c)(3) foundation supporting my kids’ school, and the other was a educational nonprofit based on Stanford campus), and I had already been musing about the notion that there had to be a better way to deliver impact. The vision that Jim articulated resonated with me.

Two years earlier, Muhammad Yunus had been awarded the Nobel Peace Prize for what the Nobel Committee called “efforts through microcredit to create economic and social development from below.” It started when he lent $27 to a group of poor families so that they could start a business making and selling handicrafts. He was astonished when they paid it all back, plus interest, and went on to build meaningful livelihoods for themselves. 

He then founded Grameen Bank and pioneered the field now known as microfinance, giving loans to people in Bangladesh too poor to qualify for traditional bank loans, mostly used to start simple income-generating businesses. Not only did his bank lift tens of thousands of people out of poverty, it did so profitably. Read that last sentence again, because it sums up the radical concept that an organization can both do good and do well at the same time.

Jim Koch was exactly the right guy to take these lofty thoughts and put them into structured practice, right at the intersection of his experience of running a leading School of Business and a School of Engineering at a Jesuit university dedicated to bettering humanity. So synthesizing the concepts developed by Bill Drayton, Mohammad Yunus, and others, Jim Koch co-founded at Santa Clara University what is today called Miller Center for Social Entrepreneurship. The Center runs the world’s leading startup accelerator program for social ventures, and I’ve served as a volunteer Executive Mentor with the program for more than fifteen years. We’ve had more than 1,300 social entrepreneurs go through our startup accelerator program and our graduates have gone on to raise nearly a billion dollars in capital and deliver social and economic impact all over the world. Working with Miller Center has been one of the great honors of my life. 

What do these social ventures typically look like? Here are four that I’ve worked with at Miller Center, just to give you a flavor:

Nnaemeka Ikegwuonu wanted to help smallholder farmers in his native country of Nigeria. So he established a community radio station called the Smallholders Foundation that would deliver relevant content to them (weather, market information, tutorials on improving agricultural yields) in order to help improve their livelihoods. Earned income comes from selling air time to NGO’s and others who want to reach the same populations.

Diana Sierra is a successful industrial designer who grew up in Colombia (the country) got a Master’s degree from Columbia (the University), and went on to design innovative new products for a variety of global brands. A trip to Africa a few years ago exposed her to a problem that exists all over the world: girls without access to menstrual products often miss a week of school every month, putting them at an acamemic disadvantage from the moment they hit puberty. Diana put her product design skills to work developing product that could solve teh problem, moved to Mozambique, and founded BeGirl, a social venture that has now reached a half-million young women in Africa (see case study in Chapter 9).

Manoj Sinha  grew up in India, went to IIT, then came to the US to get his Master’s in engineering from the University of Massachusetts Amherst. Wanting to make a difference for people at home, plus help to save the planet, he launched Husk Power Systems to build and deploy micro-grid electricity systems in rural India. It turns out that rural areas all over the world depend on kerosene lanterns and diesel generators for light and electricity, causing all sorts of environmental damage. Husk’s microgrids can save small communities 30% on their electricity costs with 100% renewable power plants. Husk Power is now serving over 50,000 rural households and has expanded from India into Africa. On his LinkedIn profile, Manoj describes himself as “Driven by personal values, integrity and relentless pursuit for excellence”. That’s pretty much all you need to know, right there. 

Charlot Magayi grew up in Kenya, where many families cooked over charcoal – the only affordable way to fire a stove and cook a meal. As a young mother, she experienced her own child getting respiratory tract infections and burns, very common in families doing cooking on charcoal. So she finally saved enough money to start Mukuru Clean Stoves, repurposing locally-sourced waste metal to manufacture improved, efficient, and reliable cookstoves, sold and distributed by local women. They’ve now sold over 250,000 of their stoves, impacting more than 1.2 million lives across the country while dramatically reducing carbon emissions. Charlot’s organization has a sustainable earned income model (selling stoves profitably), plus social impact (getting families off of hazardous charcoal), plus economic development (distribution is all done by self-employed women), plus climate impact (500,000 tons of CO2 reduced). 

While these are four very different ventures addressing very different problems, they are all using entrepreneurial thinking to create social impact in a way that harnesses market forces to give sustainability to their operations.  That’s a powerful thing.

There’s another key aspect to most social ventures: they typically treat base-of-the-pyramid populations as partners rather than just charity cases. Historically, nonprofit charities have arrived, handed out food to poor people, and then left. Social entrepreneurs are more likely to be from a local community or work in long-term proximity with the communities they serve while helping individuals to establish businesses, improve crop yields, and reduce dependency. 

This is what makes successful social enterprises different from other impact-focused organizations: They have an earned-income model that creates systemic change by treating underserved communities as customers and partners. 

Using The Launch Path for social ventures.

So, with regard to The Launch Path, how is building and launching a successful social venture different from a traditional startup? I honestly think it’s probably 85% the same. It begins by identifying a problem worth solving, you’ll still need to get to Product-Market Fit, you still need to understand how your venture fits within the landscape of competitors and alternatives, and you still need an economic model. But here are a few key differences between launching a social ventures and a traditional startup:

A theory of change plus a business model.

Ordinary startups need to have a business model — a rationale by which the organization creates, delivers, and captures value in the form of earned income. Social ventures — if they intend to be sustainable on earned income – need to have the same. But as organizations dedicated to impact, they also need to have an impact model — a theory of change by which they are creating, delivering, and measuring a desired social/environmental improvement. 

Contributed income vs earned income.

Charities and non-profit organizations exist on contributed income (donations and grants), whereas for-profit companies operate on earned income (profit from operations). Many social ventures are launched and operated on a combination of the two — a typical model might be to use contributed income to launch the venture, and then become sustainable by having earned income associated with ongoing operations. So when developing the economic model we discussed in Chapter 5, you’ll want to be distinguishing between earned income and contributed income. 

Measuring Impact.

We have well-established ways of measuring the financial performance of an organization: revenue growth, net profit, debt-to-equity ratio, etc. With a social venture you’ll also need to have quantitative and qualitative ways of measuring your impact.  Social ventures are sometimes called “double bottom line” organizations because they are operated partly for an economic bottom line (profits that provide economic sustainability) and partly for a social bottom line (lives impacted or carbon emissions reduced, for example). 

Defining Personas.

In Chapter 7 we talked about developing personas for your startup, as a way of making sure you understand that the benefits your product delivers to one sort of customer may be a little different than to another. With social ventures the population that you impact may be different from the customer you are selling to. I like to draw a “how the money flows” diagram with social ventures, showing the different personas involved and how they fit into your overall engine of sustainable impact. 

Sources and structures of capital.

In the old-fashioned bifurcated world of non-profit and for-profit organizations, there were no established sources of capital for mission-driven organizations. Social ventures weren’t “non-profit enough” to pitch foundations for grants and they weren’t “for-profit enough” to pitch for venture capital on Sand Hill Road. Fortunately, in the past ten years this has changed dramatically and today there are many different sources and structures of capital for social ventures. I’ll dive deeper into them in the next section below. 

Choosing the right entity type.

A traditional nonprofit in the US is incorporated as a 501(c)3, a special tax-exempt organization that is required to operate within a constrained set of parameters. Social ventures will often be better off incorporating either as a traditional corporation or a B-Corp, a special entity that is recognized by many states. Choosing one of these structures will give you more flexibility with regard to financing the venture. See “A Legal Primer for Entrepreneurs” in the reference section of this book.

The “Exit” .

Many tech entrepreneurs dream of building a startup that will be bought by Google for $500 million, or maybe having a billion dollar IPO. With social ventures, those outcomes are much less likely. So this makes the investor pitch (and capital structure) for social ventures a bit different. You are pitching the impact, of course, but if you are looking for equity capital or debt capital, you’ll need to have a proposition by which the capital makes a round trip (ie, is paid back to the investor with an upside) even if there is no acquisition or IPO in the future.  

With those broad exceptions, launching a successful social venture or nonprofit organization requires the same essential process as any other startup. The steps on The Launch Path, as outlined in this book, all still apply.

Sources and structures of capital for social ventures.

As mentioned above, social ventures are less likely to be a fit for traditional venture capital, since it’s unlikely the equity in a social venture can be sold in the future at a huge multiple over the purchase price (the basic equation that venture capital relies on). But here are some of the financing types that are successfully used to provide capital to social ventures (make sure you read the Chapter 6 section outlining the differences between grants, debt, and equity).

Traditional Grants. 

Many social enterprises are able to raise seed capital from foundations, structured as a grant. A social enterprise developing some new agricultural technology they plan to sell in emerging markets, for example, might be able to get a grant from the Gates Foundation to develop the technology, with the idea that the enterprise will be self-funded on earned income once the product is launched.

Impact Loans. 

These are loans specifically designed for social ventures and other impact-based organiations. These are sometimes called “soft loans” because the terms may be somewhat more friendly than a commercial bank might offer – perhaps the interest rate is below market rate, or maybe the repayment terms are flexible. The lender (might be a government agency, a foundation, or a private organization) gets the benefit of helping to achieve social impact while still having the capital make a “round trip” back to the lender, and the social venture gets the benefit of capital with more favorable terms than they would get from a traditional bank.

Program Related Investments (PRI). 

Because of the odd nature of US tax law, foundations will often only issue grants to 501(c)3 nonprofit organizations, and if they make investments into for-profit entities they may be subject to a special excise tax under Section 4944 (just hang in there with me on this). So a way to invest in a social enterprise is often via a Program Related Investment, which allows them to help fund a social enterprise that aligns with the foundation’s mission, while still hoping for a financial return on their investment.

Demand Dividend.

 This is a structure that blends aspects of debt and equity. Like debt, it goes on the books as a loan. But like equity, it gives the lender a claim to future profits, with an agreement that profits will be paid out as dividends “on demand” in order to pay back the loan. 

Revenue Share Notes. 

This is a very common and simple arrangement by which the investor gives money to the social enterprise in return for a share of revenue capped at a certain amount. For example, I could give $100K to a social venture with the agreement that they will pay me 2% of all future revenue until I receive $150K back. 

Social Impact Bonds (SIB).

Despite the name they aren’t really a bond in the traditional sense. It’s more of a pay-for-performance agreement. Let’s say your startup has an innovative way to address homelessness in a particular city and you’ll need a million dollars to run the program. You draw up a Social Impact Bond in which perhaps a private investor puts up the million dollars and the city agrees to pay down the bond by $250,000 for each x% reduction in homelessness achieved, capped at a million dollars. If all goes well the city is happy that the homelessness rate was reduced, the investor is pleased to have made a difference and also got their capital returned, and your social venture ended up with a million dollars. 

These are just some of the many sources and structures of capital for social ventures in the current landscape. As with any sort of financing, the key is to find a structure where the interests of the investor are aligned with the interests of the organization. With social ventures getting this alignment can be a little more challenging  because the impact component adds another layer and also because the capital isn’t likely to return to the investor in the same way that venture capital comes back (acquisition or IPO). But the good news is that today there are sources and structures available that make sense to align investors and social entrepreneurs. 

Summary

The world faces many challenges today. We have a climate crisis that threatens the planet, we can’t feed all eight billion people we have now (let alone the ten billion we’ll have by 2050), plus we want economic equality for women and social justice for all. These are big hairy problems. 

Traditional charity still has a role to play, as do governments, but social entrepreneurs can bring unique agility, fresh thinking,  and innovation to bear on these problems. The World Economic Forum says we have now entered the 4th Industrial Revolution and that “the speed, breadth and depth of this revolution is forcing us to rethink how countries develop and how organizations create value.” 

They go on to say that while technology is driving this new industrial revolution, “The real opportunity is to look beyond technology, and find ways to give the greatest number of people the ability to positively impact their families, organizations and communities.”

As someone who has spent his life in Silicon Valley, I believe in the power of entrepreneurship to change the world. Social Entrepreneurs all over the globe today are working at the intersection of innovative thinking, a passion for improving the world, and expertise in harnessing the power of markets. I believe they can deliver change that is powerful and sustainable.