Patient Capital: Financing Nonprofits
Nonprofit organizations face pressures to focus spending on external operations and pull back on central administrative costs, but this emphasis can undermine the ability of the organization to effectively deliver its services. The concept of “patient capital” offers another point of view.Turbulent financial times and increased competition for funding have brought nonprofits’ challenges into sharper focus. Internal investment, for example in the implementation of a new IT system to improve service delivery, is typically overlooked. Expectations regarding the balance between operational and program funding are reflected in the policies of funding sources; there is usually a limit on the portion of a grant allocated to administration, for example. Further, grants are often short-term in nature, restricting a nonprofit’s ability to plan ahead for financial sustainability. The notion of patient capital brings a different perspective to short-term funding and limited support for operations.
Investors deploy patient capital with an expectation that returns will take a long time to materialize, and may be lower than the market average. Patient capital combines aspects of venture capital and philanthropy. Like venture capitalists, providers of patient capital commit to a lengthy period of support for their investees, and they have a higher tolerance than traditional investors for the risk of capital losses. Like philanthropists, patient capitalists have the aim of increasing societal value, sometimes known as a social return, when disbursing funds. The attributes of patient capital therefore make it an investment instrument that is naturally aligned with the missions of nonprofits.
For nonprofits, patient capital may offer a more sustainable alternative to short-term, restrictive funding options. Instead of spending time on the continuous quest for grant funding, which may have to be set aside for specific programs, nonprofits may take on patient capital to build the operational and strategic capability of their organization. This type of funding can help nonprofits plan for the future and develop functional support for front-line programs.
Nonprofits may also benefit from the management support that accompanies the investor’s patient capital. This can be useful for organizations that are operating in challenging markets and providing goods or services to typically underserved customers. Whereas a traditional investor might find such an investment opportunity unattractive (too much risk for too little return), a patient capitalist not only provides the financial investment but also advice on how to improve the operational model and increase chances of success.Patient capital is not a new concept, but it is gaining more attention with the growth of the ”impact investing” industry. Impact investments are, to some extent, the contemporary manifestation of patient capital. They are made in “companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return,” according to the Global Impact Investment Network. In its 2016 survey of the impact investing industry, the network found that 156 respondents managed $77.4 billion in impact-focused assets, and further growth is expected. Where the network was able to use comparative data, it recorded an 18 percent compound annual growth rate in assets under management between 2013 and 2015. The 2016 survey also found that around a third of the impact investors questioned seek below market-rate returns, which demonstrates the important role of patient capital in the industry. An increasing number of commercial and philanthropic institutions are deploying patient capital. Nonprofits seeking this type of funding can submit applications via the websites of investors such as Acumen, Nonprofit Finance Fund, two industry players that are profiled in more detail below, and Bridgeway Capital. Websites such as ImpactBase, ImpactSpace and ImpactAssets showcase a large number of investors, as well as the impact stories of those organizations that have taken on impact investments. These websites are useful starting points for nonprofits looking to understand the sector and identify potential sources of finance. For nonprofits seeking patient capital from foundations, internet searches provide the names of foundations involved in impact and program-related investments.
It may be useful for nonprofits to understand the source of a patient capitalist’s funds. An important distinction is between commercial and philanthropic sources. For example, institutions such as the Rockefeller, FB Heron, Surdna and MacArthur Foundations have allocated a portion of their endowments to patient capital investments. These foundations are stalwarts of the philanthropic and grant-making world, and a nonprofit may realistically expect an investment from them to be more patient in nature than from an investor who is deploying patient capital that is ultimately derived from a commercial source.
On the commercial side of the equation, Goldman Sachs, Bain Capital and BlackRock have entered the impact investing sector. Family offices and high net worth individuals are also playing the role of patient capitalist by founding funds such as Blue Haven Initiative and the Omidyar Network. These funds fit the patient capital mold due to their flexibility to take high risks while still seeking financial return.
Two organizations that derive their funding from non-commercial sources, and can be considered seasoned patient capitalists, are Acumen and Nonprofit Finance Fund:
Case Study: Acumen
Founded in 2001, Acumen uses charitable donations to invest in early stage for-profit and nonprofit organizations that are providing goods and services to low-income customers. Acumen frequently uses the term patient capital to describe its debt and equity investments in sectors such as agriculture, education, clean energy and safe drinking water. While Acumen states that it prioritizes social over financial returns, their monetary returns are recycled into new investments.
In its performance summary, Acumen states that for every $1 it has invested, $5 in either co-investment or follow-on capital (raised at a later date) has flowed to the investee companies. From a financial return perspective, $22 million has been recycled back to Acumen from its investments, which amount to $101 million in 92 companies so far. The social returns reported by Acumen include “58,000 jobs created and supported”, and “189 million lives impacted” by the work of the companies in which it has invested.
These numbers certainly tell a positive story, but a provision of $2.3 million for investment losses is included in Acumen’s 2015 financial statements, which is evidence of the risk that some of its investments may not deliver the expected financial return. However, failed investments occur in all parts of the financial sector. Losses are possibly more likely for a fund like Acumen that sets out to “embrace failure,” according to Chief Investment Officer Scahin Rudra, because it tolerates a high level of risk in order to access higher social returns through its investee companies.
Case Study: Nonprofit Finance Fund
In the 37 years since it was established, Nonprofit Finance Fund has disbursed over $620 million in loans and other financing. The fund’s loans are meant to act as an additional source of financing for nonprofits that wish to make an organization- or capacity-building investment for which grant funding may not be accessible or appropriate. For example, these loans may be used to purchase or renovate a building, invest in equipment or technology, or simply manage working capital needs. The fund is a community development finance institution, and the recipients of its financing are U.S. nonprofits or entities that promote the economic, social or cultural development of their communities. In addition to financing, the fund provides strategic advisory services to help its clients with projects such as business planning, collaboration with other entities, and achieving growth or transformation.
An established industry player operating out of five U.S. cities, the fund focuses its activities in arts and culture, child care and youth services, community development, domestic violence, and education and schools. In terms of financial performance, the fund’s 2014 dashboard shows a provision of $4 million for loans that may not be recovered, as compared to loans receivable of $54 million. Assuming the loans receivable figure accounts for all of the fund’s loans, the loan loss reserve to total loans ratio is 7 percent. This far exceeds the long-term average for all U.S. banks of 2 percent, which is probably reflective of the size of the fund’s portfolio and the risk it takes on as a patient capitalist.
In the context of these case studies, and the current size of the impact investing market, is the availability of patient capital substantial enough to provide a true alternative for those seeking to depart from the usual grants-driven approach? An Urban Institute report found that, in 2013, around 500,000 nonprofits reported revenues totalling $2.26 trillion, and assets totalling $5.17 trillion, to the Internal Revenue Service. These figures dwarf the size of the impact investing market, of which patient capital only makes up a segment. It seems likely that grant and philanthropic capital will continue as the dominant funding stream.
Further, the spread of private investment into the nonprofit sector has received criticism from some quarters. The CEO and founder of nonprofit CA Bikes wrote in 2016 about how the demands and expectations of impact investors may pull a nonprofit away from its original mission, in favor of higher financial returns. There is an argument that, even with patient capitalism, if some level of financial return is expected, there is a risk that alignment of investor and nonprofit interests could diverge.
As long as the providers of patient capital can commit to the long-term nature of the investor-investee relationship, and address the shortfalls of grant-style funding, there will be an important place for patient capital in the nonprofit funding mix.
Patient capital has not totally transformed the nonprofit sector nor the challenge presented by limited administrative funding or short-term grants. However, it has occupied an increasingly visible place in the landscape of philanthropy and nonprofit management. Further, there is some evidence that the thinking among funding sources about operational and long-term funding is changing, such as the Ford Foundation’s new thinking about appropriate percentages of administrative funding and the growth of Grantmakers for Effective Organizations.
Any nonprofit organization can benefit from diversified income sources. It will be important to continue to broaden thinking about how to increase the capacity and effectiveness of nonprofits through wider access to capital and technical support.