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Encouraging Unrestricted ‘Growth Capital’ Funding

(Sept. 15, 2008) Strategic investing may be the buzz, but few donors and foundations are actually putting it into action. A new article in the Fall 2008 issue of the Stanford Social Innovation Review (SSIR) examines what donors and charities can do to encourage such gifts.

The author, William Foster, a partner at the Bridgespan Group who advises nonprofits and foundations and leads research on social sector funding, finds that most contributions and grants focus too much on current programs and activities and don’t provide “growth capital” to help charities increase their capacity.

He points out that the grants made by the 100 largest U.S. foundations in 2005 averaged about $200,000, while outside of gifts to universities, hospitals and foundations, donors made fewer than 150 gifts of $5 million or more. In contrast, during that same year, U.S. venture capitalists alone made 3,100 investments averaging $7.2 million each. In addition, less than 20 percent of U.S. grants were either unrestricted or for general support.

 “Only a handful of funders are making grants that function like investments to growth oriented nonprofits,” says Harvard Business School professor Allen Grossman in the article. “I doubt that the total amount nationwide exceeds $100 million per year.”

Foster calls on funders, both individual and organizational, to provide more “growth capital”—large, usually unrestricted, gifts that allow charities to grow their operations as a whole. These donors are looking for an organization that can sustain itself after the initial investment has been made to enlarge its overall capacity.

Who Needs “Growth Capital”

Not all organizations are the right fit for growth capital, such as small, upstart nonprofits that have not proven their ability to adapt to significant growth. Foster has developed seven criteria and characteristics of charities that donors of “growth capital” should use to find appropriate organizations where a large strategic investment would be most effective. These criteria are:

  • 1) The organization addresses a critical need
  • 2) The organization has strong leadership
  • 3) The organization has strategic clarity
  • 4) The organization’s programs are demonstrated successes
  • 5) The organization’s programs are cost-effective
  • 6) The organization has grown successfully
  • 7) The organization has a sustainable funding model.

As yet, this kind of transformational investment is not widespread, the article notes, but the trend is likely to grow. “As entrepreneurs turn into philanthropists, they want to have the same outsized impact with their giving as they did with their business ventures,” SSIR states. “At the same time, institutional foundations want to leverage their dollars to do the most good.”

More Responsibility on Donors

Foster states that turning to a “growth capital” model will place more responsibilities on donors, such as spending more time and attention to identifying appropriate organizations. He notes that private equity investors sometimes spend as much as two years looking at companies before investing, and that nonprofit investors and donors should also be careful and choosey. They must also be willing to say “no” more often than they are now.

“Growth capital” should also involve more donors co-investing with each other, whereby they invest in the same group at the same time, on the same terms, using the same reporting and sharing credit for the impact. Donors need to co-invest, according to Foster, because the amount of funding that many charities need often exceeds what any one funder is able to provide.

Finally, funders must be sure that the influx of money does not change or distort the organization’s ongoing funding model. The unaccustomed influx of large amounts of money can weaken an organization’s financial discipline and undermine part of what made the nonprofit attractive in the first place. Even with a well-developed funding model, core ongoing support may be able to grow only at a certain rate.

At the same time, nonprofit growth investors have to eschew many common traditional common practices, such as restricting dollars, focusing on only short-term funding or demanding specialized reporting. The whole point of growth capital is to support the leaders of the highest-potential nonprofits—leaders and nonprofits who are chosen precisely because they can be trusted.

As yet this kind of transformational investment is not widespread, the article notes, but the trend is likely to grow. “As entrepreneurs turn into philanthropists, they want to have the same outsized impact with their giving as they did with their business ventures,” Foster states. “At the same time, institutional foundations want to leverage their dollars to do the most good.”

The full article “Money to Grow On” is available on the SSIR website.

AFP and SSIR are co-sponsoring the third annual Nonprofit Management Institute Sept. 23-25. Click for more details on this educational program geared to nonprofit leaders.

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