Are you a nongovernmental organization wondering how to benefit from impact investors?
You are not alone. The Nonprofit Finance Fund recently surveyed U.S. nonprofits, and 20 percent of respondents said they will be seeking funding other than grants and contracts — such as loans and other types of investments — within the next year. In addition, 26 percent are considering pursuing an earned income venture as a way to diversify their sources of revenue.
And the timing couldn’t be more perfect. Global investors are expected to commit 19 percent more capital to impact investments this year than they did in 2013, according to a joint study from JP Morgan and the Global Impact Investing Network. A growing percentage of their portfolio is projected to be deployed to sub-Saharan Africa and Asia as well.
It’s safe to assume that impact investing will play an increasingly important role in the funding of organizations involved in making an impact in developing countries.
While the appeal of impact investing is undeniable, nonprofits should know that taking investors on board is a major step, and implies a vast number of changes in the way their organization operates — changes that might conflict with their mission.
When would it make sense, then, to transition to a revenue-generating model and when would it be better to remain a “traditional” nonprofit? This guide will hopefully allow you to get a better sense of what impact investing means for your organization.
From NGO to social enterprise
There are several ways in which investors can participate in the capital of an organization, but in many cases these require a return on investment — through debt repayment or equity shares, for instance. The NGO should be equipped with a steady revenue stream that will allow it to deliver on this return, or at least with a strategy to reach financial sustainability in the foreseeable future.
Revenue-generating activities are likely to be based on the sale of products or services, and as such, represent a big departure from the grants nonprofits traditionally pursue. They require different sets of skills that may lead to hiring new staff and changing the organization’s mission, while keeping the social or environmental impact it seeks to achieve as an end goal. This is essentially social enterprise.
Impact investing for nonprofits
Nonprofits aren’t incompatible with social enterprise — quite the contrary. Many experts believe pursuing financial profit is unrealistic given the fragile context in which these organizations operate, and the fact that they’re serving the bottom of the pyramid.
“Impact investing creates the illusion that traditional business models can solve big problems in places where poor governance and huge market failures are the rule. In our experience, this is simply not the case,” Mulago Foundation Portfolio Director Laura Hattendorf recently wrote in the Stanford Social Innovation Review.
Indeed, some of the most successful social enterprises are nonprofits. One Acre Fund, for instance, operates through a revenue-generating loan scheme for small-scale farmers, and has so far chosen to remain as a nonprofit despite its rapid expansion throughout East Africa.
Nonprofits don’t have access to the whole range of investments available to for-profits, but they’re not closed off the world of impact investing either. They can take on debt to finance an expansion plan that will result in increased revenue.
Many philanthropic investors — such as the Mulago Foundation, Draper Richards Kaplan Foundation and Peery Foundation — also run grants and training programs for early-stage ventures for which nonprofits are eligible. Other organizations, including Rainer Arnhold Fellows and Ashoka, run fellowships for social entrepreneurs that include financial support and a strong training component. Both types of programs bring tremendous support for organizations that want to refine and strengthen their operating models and take their activities to scale.
Read more on impact investing:
● 10 tips to boost impact investing
● 7 impact investing must-reads
● How the US government can help spur impact investing
● 3 insights into the future of impact investing
● How to win funding from impact investors
The big leap toward for-profit
Komaza, a young organization running an agroforestry program in coastal Kenya, started out as a nonprofit to allow itself time to figure out its business model.
“Trying to bootstrap a forestry company requires a lot of money,” said Patricia Griffin, director of operations. “The way that [our founder] could see getting that money is through donations; that was the only option because we don't yet have revenue coming in on a steady basis.”
Although Komaza has plans to transition to a for-profit company, it is currently focusing efforts on growing and refining its operating model.
Transitioning to a for-profit model is a complicated move that many experts would vote against — they say the need to generate profits gets in the way of the core objective of social enterprise, which is to create impact. Others think there is a way to establish a balance between impact and profits. In any case, nonprofits interested in making the move should be warned that running a for-profit isn’t just about changing their business structure — it’s about changing their entire mindset.
“A lot of social enterprises end up building skills that are good at winning them grants, but those skills are not necessarily the same skills that are good at thinking about how to grow and scale businesses,” we learned from Annie Roberts, a founding partner at Open Capital, a consulting firm working with social enterprises and impact investors out of Nairobi, Kenya.
In addition to leading their operations with a very different mindset, for-profits are accountable to investors and shareholders who intend on seeing their investment bearing fruit. Impact investors might be less demanding than traditional investors if they’re willing to wait longer before seeing a return on investment — impact investments are also called “patient capital” — or expect lower returns. But for-profit social enterprises are still very much expected to fulfill their financial obligations, even when the company goes through hard times.
Before engaging in funding partnerships both parties should be clear that social impact should remain a priority even if the company fails to deliver returns at the expected rate, cautioned Alexei Bezborodov, head of operations at Honey Care, a for-profit social enterprise operating in East Africa. Otherwise the business risks falling into that “mission drift” that is so dreaded by social entrepreneurs, according to Bezborodov.
The hybrid model
An increasing number of social enterprises find themselves uncomfortable with having to choose between a nonprofit and a for-profit structure, as even a strong revenue model cannot cover all of the costs associated with reaching their social mission, which may include training beneficiaries or engaging in research and development activities. Many choose to opt for a hybrid structure in which a nonprofit and a for-profit coexist — one can own the other, or both can have a relationship through service agreements.
New legal structures are also emerging to accommodate those companies that want to place social or environmental impact at the heart of their operations, such as the B corporation in the United States or the “company limited by guarantee” in Uganda. But until these become more widespread, organizations will have to make do with a rather black-and-white situation.
“We are an NGO today primarily because there’s no class B social enterprise structure like California has,” Komaza’s Patricia Griffin said.
Join Devex, the largest online community for international development, to network with peers, discover talent and forge new partnerships — it’s free. Then sign up for the Devex Impact newsletter to receive cutting-edge news and analysis every month on the intersection of business and development.