Our first “Nonprofit Capital” blog post outlined three key questions that the charitable sector is wrestling with as new forms of capital are explored and expanded to meet the growing demand for financial resources and impact. In this post, we explore one question in depth: Will nonprofits (and philanthropies) need to adapt or change the ways they operate in order to access new types of private capital?
We consider this question through the lens of “investment readiness”, a phrase becoming more common in social investing. Although there has been a steady increase in the supply of investment finance in recent years (see examples here and here), there is a growing concern in the sector about the accessibility of these financing opportunities for every size and level of enterprise. If social finance is to become a significant source of funding in the charitable sector, concerns about systemic barriers to financial inclusion have to be addressed.
New philanthropic initiatives that try to bridge the information gaps and make investment opportunities more accessible are encouraging. Benefit Chicago is a recent example where the impact investment process is demystified and simplified on a website where potential investees can quickly check eligibility and see criteria and examples of funding. This type of transparency is paramount to lowering the barriers to entry for organizations that have limited resources to devote to the real upfront costs of research and analysis necessary to understand what financing opportunities might be available to them.
While these initiatives are useful and important, a lack of understanding of investment readiness can limit organizations’ willingness to seek investment in the first place. And, when organizations are not deemed ready for an investment opportunity, resources to help them build readiness around promising ideas is often lacking. Gaining the capacities required for investment readiness can be a hurdle for many organizations and can cause pipeline issues on the demand side. The sector, and financial systems within it, need to increase understanding and discussion of investment readiness, increase transparency about how investors perceive and assess investment readiness, and provide sector-wide support to develop investment readiness.
What is investment readiness?
Investment readiness is the extent to which an investee is perceived to possess the attributes which make them an investible proposition by an appropriate investor for the finance they are seeking. Investment readiness is a subjective concept and varies across investors based on their priorities, interests, risk perception, risk tolerance, and other factors. (See examples here and here that discuss how specific foundations are approaching their roles as social investors.)
What does it take to be investment ready?
Demonstrating investment readiness is about making sure that the needs and expectations of investors are met. The burden is on the investee to demonstrate that they possess the most important drivers of business success; that they have a robust, validated route to generating financial and social returns; and that they have a deep understanding of the values, interests, and expectations of a potential investment partner.
To do this, organizations must offer a plan that will stand up to investor scrutiny. Investment plans must clearly demonstrate the key milestones the money will enable, the viability and certainty of debt repayments or a return yielded to an equity investor. Organizations need to undertake thorough financial modeling and detailed market research in order to produce a compelling plan.
Even small changes to standard nonprofit accounting practices may help encourage a market for growth capital in the sector and make organizations more investment ready. Traditionally, nonprofit accounting methods do not differentiate between investments and traditional funding-like revenues. If nonprofits began to report traditional revenue streams and growth capital separately (more on this here), investors could better determine the outcomes of their investments. This would also allow nonprofits to more effectively plan to grow sustainable revenues, avoid becoming dependent on investor-type funding, and demonstrate positive investment outcomes. Adjusting traditional nonprofit accounting practice may be a needed step for organizations to become more attractive for growth capital and help such a market materialize.
The potential economic and social impact of funding the right organizations at the right level and the right time makes a compelling case for intervention. To achieve this, the sector needs to be ready to adapt and implement a more holistic and multi-faceted approach to meeting this challenge.
Boosting investment readiness in the charitable sector
How can the sector help organizations of all sizes get the time, support, and financial “runway” they need to get to the next level of investment readiness? First, there should be targeted efforts to bring private capital investment to organizations with a focus on communicating what investment readiness means. There should also be strategic efforts to develop the capacities of organizations to meet the financial, technological, and programmatic expectations of investors so that the sector increases its ability to attract private capital. The sector must also continue to develop performance measurement and evaluation systems so that organizations can articulate not only outcomes, but establish the associated economic value of those outcomes. Consulting practices and universities can also play an important role by increasing the support they offer to organizations in developing investment readiness through direct support to organizations seeking help with business planning, financial tools, investor coordination, and deal structuring assistance.
And, we hope the resources provided in this focus area are an important first step for potential investees who are exploring new sources of capital — the opportunities they may afford, as well as the costs required to be fully able to take advantage of them.
¹ Overholser, George M. “Nonprofit Growth Capital: Defining Measuring and Managing Growth Capital in Nonprofit Enterprises (Part One: Building Is Not Buying).” Nonprofit Finance Fund, 2010. Web.
² Next Street. “BRIDGING THE GAP: Impact Investment Supply and Demand in the Chicago Region.” MacArthur Foundation, 2016, http://www.benefitchi.org/files/bridging_the_gap.pdf.
³ Rothschild, Steve. “The Non Nonprofit: For-Profit Thinking for Nonprofit Success (SSIR).” John Wiley & Sons, Inc., 2012. Web.