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«Exploring the Continuum of Social and Financial Returns: When Does a Nonprofit Become a Social Enterprise? Kathy O. Brozek G oodwill Industries and ...»

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Community Development INVESTMENT REVIEW 7

Exploring the Continuum of

Social and Financial Returns:

When Does a Nonprofit Become a Social Enterprise?

Kathy O. Brozek

G

oodwill Industries and the YMCA have something in common: by most definitions they each would be considered a “social enterprise,” a relatively new and

increasingly popular term in the United States. Yet both these nonprofit organizations have a history dating back more than 100 years. For Goodwill Industries of San Francisco, which serves three counties in the San Francisco Bay Area, a whopping 89 percent of its $28 million revenue for fiscal year ending June 2008 came from its business enterprises, not from government grants or foundations. By any standard, this is an enviable nonprofit revenue stream. Goodwill provides training, life coaching and jobs for those who possess a track record considered too risky for the private and public sector employment.1 In 2005, 54 percent of all U.S.- based nonprofit revenue, excluding that from hospitals and universities, was generated from the fees for goods and services. (Fees include government payments for services, but are not grants).2 Yet even though fees account for more than one-half of the sector’s total revenue, nonprofits with social enterprise models like Goodwill Industries are not pervasive. Rather, the fee income of most nonprofits is not integral to its operational model and supplements other, more substantial, funding sources.

The differences between a nonprofit with earned income and a social enterprise nonprofit are core to this discussion and go beyond semantics and nuance. I posit that these distinctions lie in organizational structure, funding sources, formation, employees, founders, execution of tactics, and other parameters. I am not advocating one model over the other, but instead will focus on the challenges, opportunities, and trends facing nonprofits and the circumstances in which each model is a better fit. With insight, stakeholders can create the sustainable and innovative nonprofit organizations that this resource-strapped sector so desperately needs.

In general, all nonprofit and for-profit organizations fall along a continuum from social to financial returns. Effecting social change by combining in one organization social and financial returns, also referred to as blended value, is a key component of the evolving social capital market.3 Figure 1 captures the essence, and the inherent ambiguity, of the social enterprise model.

Goodwill Industries of San Francisco, San Mateo and Marin Counties 2007-2008 Annual Report (990 tax return) (San Francisco: Goodwill Industries, 2008).

2 Urban Institute, Nonprofit Almanac 2008 (Washington, DC: Urban Institute Press, 2008), p. 145, figure 5.3.

3 See Jed Emerson and Sheila Bonini, The Blended Value Map: Tracking the Intersects and Opportunities of Economic, Social and Environmental Value Creation (Blendedvalue.org website, February 24, 2004), available at www.blendedvalue.org/publications/.

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Source: Stanford Social Innovation Review, Spring 2008; Jed Emerson cited as a contributor Presently there is no universally accepted definition of “social enterprise” for either a for-profit or nonprofit organization. The Social Enterprise Alliance defines social enterprise as “an organization or venture that achieves its primary social or environmental mission using business methods.” According to the Blended Value organization, a social enterprise is a “nonprofit organization that uses business solutions to accomplish social goals; the social objective is the primary driver.”4 Here, I define social enterprise as a nonprofit organization with a sustainable, scalable revenue stream generated from activities related to its social mission; it has an entrepreneurial operating model and leadership team.

Another example of a social enterprise is the entrepreneurial and financially sustainable Delancey Street Foundation, a 501(c)(3) nonprofit. Despite many naysayers, in 1971 a few visionaries decided to help the unemployable--former drug addicts, people living on the street, and ex-felons—to turn their lives around through vocational training and entrepreneurial endeavors by “empowering the people with the problem to become the solution.” To this day, they continue to use this self-help model to run twelve social enterprises in five locations across the country, all without any government funding.

Where a nonprofit lands on the continuum of social and financial returns is determined by the vision of the leadership, its executive director and/or the board. However, this decision is, or should be, a dynamic process, as depicted in Figure 2. The vision is influenced by a core belief about how to address a social issue and a pragmatic assessment of how best to achieve the mission. For a nonprofit social enterprise, the question is whether the social mission can be integrated into a scalable, profitable, fee-based model with ongoing financial sustainability. The answers are not always clear-cut, and the risks often hard to quantify.

Ideally, it would be an iterative decision process with a due diligence rigor similar to what a company would undertake in its early stages.

4 Social Enterprise Alliance is at www.se-alliance.org; E. Bibb, M. Fishberg, J. Harold, and E. Layburn, “Blended Value Glossary” (Blended Value, July 2004), available at www.blendedvalue.org/publications/.





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The first question in locating an organization’s place on the continuum is whether a fee revenue model of any type is embedded in the operations; is it likely, in other words, to generate a timely, profitable cash flow? Questions to ask include: Is the infrastructure (staff, accounting, IT systems, building space, etc.) in place or does it need to be acquired? Will the revenue model detract from accomplishing the organization’s mission? Does staff have the necessary business acumen? Are the financial projections realistic?

If the answers point to relying strictly on outside funding, the organization lands far

left on the continuum. Otherwise, whether it is a small, contained revenue stream or a fullfledged nonprofit social enterprise depends on the following criteria (see also Figure 2):

• A social mission integrated into a revenue model: Will this better serve the constituents? Does the operations model involve a workforce development strategy? If necessary, is the market willing to pay a price premium for a “socially responsible” service or product? What are the tax implications of not having the social mission integrated in the model?5 • Scalability: Is there capacity to increase revenues each year? Can the business model be easily replicated? Is growing the model feasible on the basis of funding, marketplace, staff, systems, etc.?

• Sources of funding: Is it a multiyear funding commitment or series of one-year grants and ongoing fundraising? Do the funders provide a collaborative coaching process? Without a fee-generating revenue stream, are other sources of funding available?

• Sustainability: To what extent will the fee revenue add to the future sustainability of the nonprofit? What is the ongoing risk of losing money? Will it detract from the social mission over time?6 5 Anthony Mancuso, How to Form a Nonprofit Corporation (Berkeley, CA: Nolo, July 2007), pp. 80-81.

6 Alex Nichols, ed., Social Entrepreneurship: New Models of Sustainable Change (New York: Oxford University Press, 2008), pp. 205-206.

FEDERAL RESERVE BANK OF SAN FRANCISCO

Community Development INVESTMENT REVIEW New Door Ventures, a nonprofit social enterprise based in San Francisco (www.ggci.org), is a good illustration of the concepts just described. Its revenue-generating model includes a social mission to provide assistance to at-risk youth aged 14 to 21. It offers hands-on training, internships, community support, and jobs programs at its small business ventures. In 2007, its business operations generated nearly 60 percent of its revenue. Its ventures include Pedal Revolution, a bicycle retail, repair, and custom-design shop, and Ashbury Images, a graphic arts production business. They continually seek new ventures. New Door Ventures was part of the REDF venture philanthropy portfolio from 1991 through 2005, receiving funding, coaching, and other benefits. The New Door Ventures social enterprise model works, not by accident, but because of its clear vision, operational efficiency, and innovation, which it has maintained throughout its lifecycle with the help of its initial funder, REDF.

Exploring the distinguishing characteristics between the two models—a nonprofit that generates some income and a social enterprise—highlights the influences that position nonprofits on the continuum and whether the revenue model evolved from an organic process or as a defensive reaction to a challenging environment. Certain features, by definition, describe a nonprofit social enterprise but appear less frequently in nonprofits with earned income. These features include an entrepreneurial vision of the executive director and/or board; a social mission integrated into the fee revenue model; a fee revenue model at the nonprofit’s inception; a scalable operational model; and alliances and resources that are uniquely combined to create value. Additional features include close collaboration and coaching with major funders, a multiyear funding financial commitment, and a workforce development program embedded in the operational model.

Which model is best also depends on the situation. If the operational, financial, and human resources needed for a social enterprise are absent and raising the funds to acquire them is difficult, then a nonprofit with some earned income, even if not scalable, is the prudent choice. A fee revenue stream of any type can enhance the prospect of receiving funding. A Harvard Business Review article offered an example of a model that, in the end, was dysfunctional and stands in contrast to the New Door Ventures story. The author cites an unnamed nonprofit that built an industrial-sized kitchen to earn income through its catering and wholesale operations while providing job training to an underserved market. The kitchen was experiencing yearly losses exceeding $250,000 and few were getting jobs, but the grantmaking foundations were excited about the concept; it served as a reliable fundraising tool so the operations were maintained.7 This may be an extreme example of a funding system gone awry, but in the rush to generate more income, nonprofits are often pushed to eke out revenues however they can.

It also underscores the question that arises in this process of how to assess the ability to raise 7 William Foster and Jeffrey Bradach, “Should Nonprofits Seek Profits?” Harvard Business Review vol 83 (2) (February 2005): 92-100.

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external funding. If a nonprofit possesses marketing savvy when seeking outside funding but bypasses the necessary due diligence to build a profitable model with good leadership, it could turn into an inefficient, money-losing venture. Or, it could mistakenly be perceived as successful because of incorrect accounting methods. The Harvard Business Review article mentioned above challenged the results of research studies conducted by two reputable organizations that indicated a fairly high rate of profitability among nonprofits with earned income. The authors substantiated their claim by sharing research findings from their own, presumably less biased, study. I will not attempt to refute the authors’ analysis, but it is noteworthy as it highlights the complexities of defining and measuring success on the “blended value” continuum, which in turn, may muddle the decision process.

Moving right on the continuum in Figure 1, for-profit entrepreneurs that have incorporated a social mission into their model often face a trade-off between social and financial returns. Figure 2 still applies but the driver is the desire for a higher return which, at least in theory, means lower social returns. Increasingly, indications are that this gap may be shrinking, albeit slowly. Consider Revolution Foods (www.revfoods.com), a start-up company that provides nutritionally healthy and mostly organic food for public schools in California and also sells its products retail. Their objective is to generate market returns while tackling the issues of childhood obesity and healthful food in public schools.

One of the changes that is helping to close the gap between the social and financial return are new investors such as DBL Investors, that invested in Revolution Foods. DBL is a venture capital firm with a mission to assist its portfolio companies in implementing a “double bottom line” strategy. The Community Reinvestment Act (CRA) is also influencing the funding on the for-profit end of the blended value continuum. Banks are able to fulfill their CRA requirements by providing loans to businesses in underserved markets, and more recently, by investing in social-mission-driven venture capital firms such as DBL Investors.

Finally, other individual investors are starting to seek out social-mission-driven businesses with the expectation that they produce full market returns. The blended value continuum in Figure 1 will realign over time if public policy continues to incent private investment in social-mission-driven businesses.

Nonprofit Sector: Market Size and Funding Sources The efficacy of the nonprofit sector funding process has been a topic filled with some consternation. Bill Drayton, the founder of Ashoka, stated, “What a social entrepreneur needs and what a foundation provides is an almost perfect mismatch.”8 George Overholser, founder of NFF Capital Partners, has argued that the dearth of “builder” capital, which helps to sustain growth by investing in infrastructure, has a negative effect on the nonprofit sector. In contrast, “buyer” funding, which in effect purchases services for more recipients, is 8 Nichols, Social Entrepreneurship, p. 309.

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