Venture Philanthropy Embraces Key Strategies of Venture Capitalists

The problem: Find a way to get more bang for the buck out of charitable donations.

 

The strategy: Adopt techniques that worked well for venture capital firms in the 1990s – mainly, a deeper ongoing interaction between giver and recipient, and an emphasis on measurable results.

 

The upshot: The birth of the movement variously called “venture philanthropy,” “social entrepreneurism,” “strategic philanthropy,” and “e-philanthropy.”

 

But is it all that it’s cracked up to be – a new model for charitable endeavors that even mainstream non-profits should adopt? Or is it a fad? Or is it little more than a renaming of practices that have long been embraced by well-run charities?

 

Not surprisingly, there’s plenty of debate over those questions and, as yet, not much academic research. Rachel T. A. Croson, professor of operations and information management at Wharton, studies charitable organizations and dealt with a number of venture philanthropists during a recent sabbatical in Berkeley. According to her, hundreds of organizations claim to be using venture philanthropy principles.

 

The latest of several annual surveys commissioned by Venture Philanthropy Partners, a Washington, D.C. foundation that supports programs for children, finds that the field is growing but still small, with most American VP firms clustered in the New York and Silicon Valley regions. While there are more than 50,000 charitable foundations in the U.S., the survey found only 42 pure VP organizations, making grants totaling about $50 million in 2001, less than 0.2 percent of all grant-making in the country that year.

 

“A few years ago, the concepts of venture philanthropy and high-engagement grant-making were over-inflated, with airy promises to transform philanthropy as we know it,” the study concluded. “Today we can see their progress toward that promise is real but not yet revolutionary.”

 

The small count of pure VP organizations, however, does not reflect the field’s impact. Croson says venture philanthropy techniques have been adopted by many mainstream foundations, leading to a new approach that “has changed the pitch being made to potential donors. How [does one] convince donors to give money? The way is to show deliverables [measurable results] … In general, charities have become a lot more results-oriented, and are doing a lot more internal metrics on [the question], ‘Have we succeeded – yes or no?’”

 

Beating the S&P 500

Thomas J. Donaldson, professor of legal studies at Wharton who studies ethics in business, says venture philanthropy is part of a broader trend of making social, ethical and other do-good goals part of investment decision making. There has been an explosion of socially conscious mutual funds in the past decade, and many union and academic pension funds now use social criteria to screen stocks for investment. Typically, they avoid stocks in companies with significant interests in tobacco, alcoholic beverages and arms manufacturing, though there are many different social screens. Some, for example, are tailored to specific religious beliefs, others to labor or environmental issues.

 

Much of this is traced to the movement 20 years ago to get American companies to divest themselves of stocks in companies with interests in South Africa. Now, socially conscious investment philosophy has gone mainstream, with one out of every six to nine investment dollars in the U.S. subject to some kind of social or ethical criteria, Donaldson says.

 

Growing size and publicity about past successes have made more people aware of this kind of investing. Also, Donaldson points out, benchmark indexes containing large numbers of stocks in companies that pass social muster have performed well, sometimes beating usual gauges like the Standard & Poor’s 500. Investors thus realize they “don’t take a financial hit” by doing good, he notes.

 

“I think we see a wave of new creativity when it comes to how we spend money and how we invest – all with an eye to the social and ethical dimension,” he adds. “There is a growing sophistication about how being ethically responsible doesn’t just mean not doing unethical things; it means helping our remarkable system of capitalism create the best by playing a role at all points in market transactions.” It is not that there is a surge in morality, Donaldson suggests, but that investors, entrepreneurs and philanthropists see new ways to do good and make competitive returns at the same time. Venture philanthropy is one result.

 

One well-publicized example of this kind of effort is the Hot Fudge Social Venture Fund, a community development venture capital fund created by  Ben Cohen, co-founder of  Ben & Jerry’s Ice Cream, and several directors. The fund provided both capital and management expertise to help launch Los Angeles-based TeamX, Inc., a producer of SweatX brand apparel. The company, according to its website, “is dedicated to the highest standards of workplace dignity,” providing wages “above the Los Angeles livable wage” and good “benefits and working conditions.”

 

Social Return on Investment

Many in the venture philanthropy field say the concept originated with a 1997 Harvard Business Review article, “Virtuous Capital: What Foundations Can Learn from Venture Capital,” by academics Christine Letts, William Dyer and Allen Grossman. They argued that many grant-making foundations gave too little attention to helping non-profits build efficient, self-sustaining infrastructures and increase capacity to deliver services. The failure forced non-profits to spend too much time hunting for new grants, they said.

 

The authors suggested foundations adopt a number of venture-capital techniques, such as better risk management and ways of gauging recipients’ performance. Rather than just giving money and waiting for an eventual report on how it was spent, the foundation should have an ongoing role in helping the non-profit attain its goals. The foundation also should have an “exit strategy” for eventually ending the relationship, just as a venture capital firm bows out – and cashes in – when its incubated company goes public.

 

In the years following publication of that article, venture philanthropy has come to be distinguished from traditional philanthropy in the way projects are selected and managed, according to Croson. A traditional foundation publicizes its grant-giving criteria and then waits for applications; a VP foundation actively seeks organizations that can benefit from its funding and expertise. (See related article on corporate philanthropy.)

 

VP foundations also tend to seek philanthropic start-ups rather than established organizations, just as venture capital firms fund business start-ups. A VP foundation tries to improve its overall results by building a portfolio of recipients that complement one another – an AIDS-research organization and an AIDS-education organization, for instance.

 

VP foundations tend to make longer commitments to recipients than do traditional foundations, and there usually is a more intense ongoing relationship, Croson adds. The foundation may put representatives on the recipients’ boards, for example. And the foundation offers professional and technical help.

 

The most controversial aspect of VP, according to Croson, is the focus on measures of performance. Many use the term “social return on investment,” or SROI. There might, for example, be an accounting of the number of jobs created or the number of people given training.

 

The four-year-old Durham, N.C.-based Sustainable Jobs Fund has a $17 million investment fund contributed by six organizations, including the Rockefeller Foundation, the Appalachian Regional Commission and Citibank. The fund is set up as a 10-year limited partnership.

 

All of the fund’s current 14 recipients, or “portfolio companies,” are intended to turn a profit. “We’re trying to use the tools of venture capital to achieve some social benefit,” says managing director Larry Waddell II.

 

One of the portfolio companies, for example, is Salvage Direct, a Titusville, Pa. company that provides an on-line auction for insurance companies to sell wrecked vehicles to salvage companies. Sustainable Jobs Fund initially put about $600,000 into Salvage Direct and holds a minority equity position and one of the six directorships, Waddell says. “We provide guidance and strategic assistance to the CEO.”

 

Salvage Direct is currently profitable, but the goal is to increase annual revenues, now about $3 million, to $30 million, at which point Sustainable Jobs Fund will sell out at a profit. Beyond that, the goal is to create 40 to 45 jobs over five years – the social return on investment.

 

While job creation is one of the performance metrics, the target is not an absolute requirement, Waddell says. But the results “will weigh heavily” on the fund’s decision about whether to provide additional financing.

 

Another VP foundation, NESsT Venture Fund, finances a string of philanthropies in Chile and Central Europe.

 

“The way we approach our work is it’s a very close relationship with the organization,” says co-founder and CEO Lee Davis. “Typically, before we even provide any financial support, we have worked with the organization anywhere from six months to a year. And then when they enter the portfolio there is even more contact.”

 

The goal is to help the organization achieve financial returns that can be used to improve its social returns, according to Davis. In some cases, the profit-making venture is related to the social goals. NESsT, for example, supports a Czech endeavor called P-Centrum that provides treatment and post-treatment help to recovering drug addicts. NESsT helped the organization develop a wood-sculpting business that builds benches and other structures for children’s playgrounds. The goal is to make money and teach skills to P-Centrum clients.

 

In another project, NESsT has helped a Czech organization called Betlem establish a for-profit construction and renovation business. This enterprise was picked because Betlem had a number of staffers with construction skills. But the construction business’s sole purpose is to make money – it has no direct connection to Betlem’s charitable mission of caring for people with disabilities.

 

Davis notes that there is nothing new about a philanthropy looking for ways to raise money aside from seeking donations. Museums have gift shops, and many organizations have long sold items such as coffee mugs and tee shirts. “Now it’s just becoming integrated into how non-profits try to finance their work in addition to traditional fundraising,” he says. “We’re just trying to get away from this one-size-fits-all way of funding nonprofits.”

 

Reinforcing Basic Principles

Some critics argue that venture philanthropy is just a fancy name for practices that well-run charities and foundations have always employed.

 

Writing in the May 2, 2002 edition of The Chronicle of Philanthropy, Mark R. Kramer, founder of the Center for Effective Philanthropy in Cambridge, Mass., characterizes VP as a fad underwritten by venture capitalists who got rich in the stock bubble of the ‘90s and blithely assumed they could transfer their skills to a field in which they had no experience.

 

“Young entrepreneurs became our heroes, and we hailed a new breed of  ‘social entrepreneurs’ to bring the magic of this success to charities and foundations,” he says. As it turned out, it was a market bubble that made these people look good, and few were really the geniuses they appeared to be.

 

While venture capitalists expect to cash out at a profit, charitable work is not in itself profitable and will therefore always depend on donations, he argues.

 

“Interestingly, the three main elements of venture philanthropy – building operating capacity, close engagement between donors and recipients, and clear performance expectations – are not new at all,” he writes. “Many would argue that those have been among the trademarks of effective philanthropists for decades, and that they were well on the rise long before venture philanthropy gained public attention … What seems so new about venture philanthropy may have been the sizzle, not the content.”

 

Still, he acknowledges that venture philanthropies, despite the modest size of the field, have managed to “reinforce a few basic principles of effective philanthropy that were already emerging.”

 

Venture philanthropies have underscored the fact that helping others is not simply a matter of dispersing money but of making a deep, long-term commitment and casting a hard eye on results.

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