22 Feb 2000  Research & Ideas

Social Capital Markets: Creating Value in the Nonprofit World

Money given away to nonprofit organizations used to be considered "charity." No longer. Donations to nonprofits are increasingly viewed as capital investments of precious resources. HBS faculty members Jed Emerson and Allen Grossman have launched an interdisciplinary effort to study and understand these "Social Capital Markets."

 

The Harvard Business School Initiative on Social Enterprise is embarking ona new intellectual endeavor to understand a fast-changing and fertilearena — the Social Capital Markets.

For years, money given to nonprofits has been thought of as charity, saysJed Emerson, Bloomberg Senior Research Fellow in Philanthropy, who willspearhead the effort along with Allen Grossman, Bloomberg Senior Lecturerin Philanthropy. But a new understanding is emerging: these dollars, whilecharitable, are still capital investments of precious resources."The question then becomes: can we extract bedrock lessons from thefor-profit world and apply them to philanthropy?" Grossman says.

It's a question ripe for research, given the changes sweeping the SocialCapital Markets. For one, a new breed of donor is altering the terrain:Internet moguls, entrepreneurs, and other business leaders who have createdwealth in their lifetime. "They look at how they created value in thefor-profit marketplace and want to take a similar approach withphilanthropy," Emerson says. Joining this group are baby boomers, who will be recipients of an unprecedented intergenerational transfer of wealth over the next 40 years.

"These are people entering their retirement years very engaged,"Emerson says. "They are not going to be happy just writing a check andgoing to the annual dinner." Finally, says Grossman, there's growingpressure from the government and other funders for"outcome-based" funding — a process based on nonprofits achievingcertain goals. "It comes down to people questioning the system inwhich we've invested hundreds of billions of dollars and asking, 'Is itworking in an optimum fashion?'"

photo of Allen Grossman
Allen Grossman

Venture Philanthropy

Grossman asked that question himself during his six years as president andCEO of Outward Bound, plunging him into the Social Capital Markets arena.When Outward Bound received an $8-million grant for a new educationalinitiative, Grossman was determined to grow and sustain the organization.He asked numerous foundations about criteria necessary to receiveadditional funding. "The answers were not always clear," he says."In the business world, if you succeed you will be rewarded withadditional capital. In the nonprofit world, I simply didn't understand thepathway to success."

Grossman's quandary led to hiscoauthoring a groundbreaking 1997 Harvard Business Review article"Virtuous Capital: What Foundations Can Learn from Venture Capitalists." In the article Grossman and coauthors Christine Lettsand William Ryan suggest that foundations can learn from venturecapitalists since both face similar challenges: selecting the mostworthy recipients of funding, relying on young organizations to implementideas, and being accountable to the third party whose funds they areinvesting. They identify relevant venture capital practices — such ashelping management develop and execute strategies, measuring investmentperformance, and maintaining a long-term relationship — that would benefitboth foundations and nonprofits.

The article helped catalyze the thinking of many in the nonprofit field and illuminated and encouraged an evolving approach to philanthropy. A growing number of organizations are engaging in "venture philanthropy," rangingfrom The Entrepreneurs' Foundation in Silicon Valley to New Profit, Inc. inBoston.

"Now we want to go further and ask, 'How can we look atthe Social Capital Markets more systemically to see what kind of changesmight be helpful for philanthropy?'" Grossman says. Drawing on theexpertise of HBS faculty in finance; negotiation, organizations andmarkets; and entrepreneurship, Grossman will examine how the terms andconditions of the distribution of capital have an impact on nonprofitmanagement and organization performance. He will also research how theavailability of capital at various stages of an organization's evolutionaffects growth.

"If we don't start thinking differently there'sa potential for crisis in the nonprofit sector," Grossman says. Withfor-profits rapidly entering nonprofit territory, he explains, nonprofitsneed to be able to compete on a level playing field. "So much of theirability to compete is based upon the availability of capital and how theyacquire it."

photo of Jed Emerson
Jed Emerson

Social Return on Investment

Jed Emerson has also been deeply engrossed in the Social Capital Markets asexecutive director of the Roberts Enterprise Development Fund (REDF) in SanFrancisco. Created by George Roberts, one of the founders of the New Yorkinvestment firm Kohlberg Kravis Roberts & Co., REDF has been a pioneer indeveloping VC-like ways of measuring "social return oninvestment" (SROI).

REDF invests substantially in a small portfolio of local nonprofits, each a market-based enterprise such a Juma Ventures, which recruits high-risk urban youth to work in Ben & Jerry's shops. They closely monitor employees' progress and also try to quantify the costs each represents to society. They then track how that cost structure changes due to the nonprofit's intervention. "If employees go off welfare and start earning wages and paying taxes, there's an inverse relationship. They end up contributing to society," he says. "We are trying to find out what are the investments needed to achieve social value." REDF recently hired a full-time financial analyst, formerlywith J.P. Morgan, to help build models for SROI.

REDF also practices venture philanthropy through efforts such as targeted business analysis and venture committee assistance for investees. "Thesenonprofits are competitive enterprises — Rubicon produces high-qualitycakes, for example — that just happen to employ folksthat the rest of the labor market often won't hire," he says. "Wedon't operate on a charity basis because if you do it's difficult to managea good business."

At HBS, Emerson will be looking at how investors in the Social Capital Markets understand valuation without clear-cut metrics by which they can assess their ROI. "In other words, how do you know you have achieved what it is you said you wanted to?" he says. He will also research how others across the country are trying to develop and advance such metrics.

"For decades people have said there is just no way to measure nonprofit value creation. How can you value a forest or a clean ocean or living in a nonracist society? But I think there are ways we can begin to talk about value in terms that tell us whether or not we are moving in the right direction."

From Social Enterprise, The John C. Whitehead Fund for Not-for-Profit Management, Winter 2000