Grants, returns and dividends in philanthropy

Are grants the most efficient means to achieve a foundation’s philanthropic mission?  And what is the best strategy when it comes to investing an endowment?  Last week at the European Foundation Centre some practitioners convened as part of a series of peer exchange events around social investment. Participants in the event reflected on the practicalities involved in changing practices in their organisations.

Already many foundations deliberately invest ‘green’, or screen their portfolio to eliminate investments in companies that abuse human rights, or consciously invest in assets that may give a much lower return but contribute towards achieving their foundations philanthropic mission, or all the above.

Also at the programming side practices are changing. However, when it comes to investing financial resources the main transaction type in private philanthropy continues to be the grant.  These days that would be usually a project grant with a duration between 12 month and 3 years, sometimes renewable.  On very rare occasions foundations still give core funding that is not tied to a specific project. The emphasis is on providing resources for salaries, fees, and expendable materials. Philanthropist rarely use funding modalities like loans, guarantees, or equity stakes. And even when private philanthropist invest in capital goods they usually do it through grants and gifts.  For example the first micro-credit schemes in the eighties and nineties of the last century were sponsored with public and private grants, only recently they enjoy the interest of impact investors.

A useful image depicts the range of options that you have between making a grant and investing in tradable assets that give the highest financial return.

SocialFinanceWheels

From:  Making Your Money Work(harder)book, EFC (forthcoming)

Social investment – which, by the way, does not per definition has to be an investment in a social enterprise – would be anything in the green circles at the left of this image: from providing funding for capital goods (in support of operations) expecting no, or only partial pay-back, to investing with the expectation of a minimal financial return.

The arguments for using these alternative funding and investment tools may vary.  Some suggest that charities, NGO’s, social enterprises and civil society organisations have a need for – and can absorb – different kinds of funding. For example, sometimes they may need an advance as workingcapital which they can pay back later from raising funds, grants or other income. Or they may need capital to procure critical pieces of equipment or to invest in infrastructure, saving recurrent expenditures down the line.

Others would argue it is all about unleashing the innovative force of the market into the realm of the public good, and that the social enterprise model – supported through loans and equity – is the best, if not only sustainable way forward.  And yet others believe on a macro scale that financial returns – even minimal – on (social) investments have the potential to attract on a massive scale the private capital we need to solve today’s social problems.

Sometimes I think funders stick to grants as the only tool to promote social change only for the sake of simplicity or tradition. Giving a loan can be administratively and legally quite complicated if you are set-up as a private foundation.  And as a foundation do you want to own a stake in a social enterprise?  You have to know what you are doing. Which is why understanding the various tool can be helpful. Thus concluded the practitioners that met at EFC: by all means, in your programming do not shy away from using other funding tools, but if you are a beginner, keep it simple and small, and stick to your field of (thematic) expertise.  And maybe most of all: learn from your experience!

At the EFC event an interesting discussion evolved as to whether the partnerships between funders and recipients would be different if the transaction was not a grant, but a loan or an investment  in equity. Some suggested the relation between borrower and lender would be stronger, closer and/or more equal than between grantor and grantee.   In my view it is more complicated.  Closeness in a partnership comes from shared goals and ideals, and from shared realities, personal interaction and trust.  Talking about the limitations of grants as a funding tool, someone suggested that funders “use the grant to buy a project outcome”.  I think it is this ‘buyer-seller’ dimension of the relationship – as if it is a utilitarian transaction – that is problematic.  But is that inherent to the grantor-grantee relation? And how does a loan agreement makes the partners more equal?

Find out more about social investment on the site of Social Finance UK and – also drawing on the UK experience – check out this comprehensive study by ClearlySo.  The EU is also busy fostering social investment in Europe.  Additionally, the Center for Global Development has been investigating and promoting the idea of Development Impact Bonds. These novel financial arrangements could connect different partners in a different role in the context of development coöperation, thus generating a stable flow of income for the actors on the ground, security for government institutions that are accountable to taxpayers to get results, while private  – philanthropic – investors assume and share some of the inevitable risks involved. I will get back to that in another blog.

Serious deal screening to find an evergreen with a locked-in mission – venture philanthropists on exits.

When doing research for the GrantCraft guide on Moving On – Ending Programmes and Funding Relationships we found that venture philanthropists are often very deliberate about exits and that they have a wealth of practical experience in this field. Venture philanthropy claims to “match the soul of philanthropy with the spirit of investing” and in the for profit world, venture capital comes-in-to-go-out. Maybe that background makes it more obvious to plan for about exits and ending financial relationships between the funder and the social venture…..

Over the past year, EVPA – the European Venture Philanthropy Association – has been working on a practical guide for exits.  It was very exciting to participate in the EVPA Workshop last week, discussing a draft of that guide and to be invited to contribute and provide comments. EVPA proposes a five step process that takes place simultaneously with the core venture philanthropy process that starts with developing an investment strategy, followed by deal screening, the due diligence process and deal structuring, followed by the Investment management and ending with the exit.

To prepare for an exit, EVPA recommends that during the first step – when you have actually not yet identified who you will possibly partner with (or invest in as they say) – you reflect on some key considerations that will influence your exit. While screening deals, doing due diligence and as part of the deal structuring you actually develop the exit plan. During the investment as part of the process of investment management you monitor and determine exit readiness. The final step of investment coincides with step 4 in the exit process. Post-investment follow-up is formally not part of the investment process.

exit process

In some of the steps all responsibility and decision-making power rests with the funder, for example when it comes to establishing the key exit considerations, or the exit readiness, which ultimately is the decision of the funder. But for example the exit plan has to be developed and “ owned”  jointly and it has to establish who is responsible for what during and after the exit.  The actual cases that were presented and reflected upon at the workshop showed that the five steps make sense. But the experience participants shared also underlines that realities are quite a bit messier than models and SmartArt.

The multiple funding instruments of venture philanthropists (grants, loans, equity and everything in between) provide enormous opportunities to tailor the funding to the needs of the social venture/project. But they can also make exits complicated. When you give a grant and stipulate in the beginning that it will be a one-off grant disbursed over a certain period, the “ ending’  is a sort of built-in. Similar with loans. Making another grants, extending a loan’s grace periods etc. are obviously always an option but when you take an equity share in a venture, you can only exit when you find a buyer – or you can give your share away, i.e. convert it into a grant but that may not square with your investment strategy….. So thinking ahead makes sense!

During the exchange at the EVPA workshop it emerged that, as with ordinary philanthropists, the rationality of talking about exits upfront seems to conflict with the positive feelings involved in starting a relationship. Pre-nuptial arrangements work in business and even in a family context, but in philanthropy they are often felt to be awkward. Yet, we saw from the examples discussed in the workshop that every exit did benefit (or in some cases could have benefited) from some sort of a planning up front!

And there is more. Every good exit plan needs a plan B, the group at the EVPA workshop also rapidly concluded. Such a Plan B (and C to Z for that matter) again benefits from the rich toolbox of the venture philanthropists. The authors of the draft EVPA guide on exits had identified quite a number of possible exit scenarios using a variety of funding instruments and non-financial contributions,  but the group came-up with many more. All drawing on their concrete experiences.

For those of us without the MBA, the venture philanthropy lingo may be a bit of a complicated read and the exit process and the examples in venture philanthropy are very focussed on exits from one-to-one relationship, not from a field of work or a country.  Also, until now, the ultimate beneficiaries are somewhat missing from the entire process, and personally I find it sometimes hard to connect with the whole venture philanthropy narrative…….. yet, if you want to be a responsible funder, do not let any of this dissuade you and learn.  If you follow this blog, I will let you know when the final document is out, which should be in November this year! Or check for yourself at the site of EVPA