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Aug 25, 2011

Making Profitable Investments in Nonprofits: Comments on Social Entrepreneurship

For the August edition of my Business First column, I decided to write about the social entrepreneurship movement.  This is a relatively new development that is becoming very popular.  It basically supports for-profit investments in areas that benefit society.

Some national companies are using this concept for public relations purposes. They invest in LEED-certified buildings as a way to be “green.” Or they enhance the nutritional content of foods they manufacture. You will see articles and announcements regularly.

Another dimension of this is to “invest” in nonprofit businesses. The investment expects a positive financial return but it is “social” because the investment is in a nonprofit. This can be a very positive development if it brings capital to the capital-starved nonprofit sector.

But as with all things, too much can be bad. The bad side of social entrepreneurship is this:  if all investments are made to bring a financial return, then those investments must be in profitable activities. If all investments in nonprofits are for profitable activities, we are creating a strong bias against the very purpose for having nonprofits:  to provide something which the community needs but which the private sector can’t do profitably.

It is certainly true that too many nonprofits have no profitable activities so that they are living on the dream that contributions can offset the deficits of their high mission activities. The worst response I am seeing is the erroneous effort to have all activities in a nonprofit break even.

Think about it. The only way to turn a money-losing activity into one that breaks even is to cut costs or raise revenues.  If cutting costs doesn’t affect quality, fine. But too many nonprofits are at the point where cutting costs does mean cutting quality. Raising revenue means raising prices or finding additional customers that can pay a price that covers costs. This means favoring customers who can pay and walking away from those customers who cannot pay so much. If this is a low-mission activity that may be okay. But if it is a high mission activity, then revenue enhancement means the nonprofit must walk away from the customer/client base that it was created to serve. Both approaches contradict the very purpose for having nonprofits.

In these situations, social entrepreneurship can be a life saver because it invests in profitable activities whose profits can be used to finance the losses of the high mission activities of the nonprofit.

But what to do when a nonprofit can only get investors interested in profitable activities that can pay a return? What happens to the high mission activities that are not profitable and therefore get no investments? This is not a good scenario.

That dilemma guided the concluding paragraphs in my column. Here they are. I welcome your reactions and feedback.

A nonprofit lives in two worlds. The first world runs a business that intends to lose money even if it is efficient and well-run. This is why nonprofits exist because no one has figured out how to run it profitably so the government in the last century created special tax exemptions as an incentive to run businesses that provide specially-defined, money-losing services that the community needs.

The second world is no different from the for-profit world. It runs businesses that are structured to earn profits. They determine prices and select their customers so that the services can be run profitably. Financial viability requires that nonprofits do some things that more than pay for themselves (profitable activities). That is why we see a zoo that has a golf course, a water park, and soon a hotel. And we see a rehabilitation facility that auctions cars, and a botanic garden that hosts expensive weddings.

Ironically, the highest mission for a nonprofit should always be run at a loss. If it is not, then the nonprofit is underserving its community and failing to fully exploit its purpose for existence. This is what I call a nonprofit’s key mission —  something which the community needs but which the private sector can’t do profitably. If all investment in nonprofits is for activities that are profitable, then the key mission of nonprofits will wither. If social entrepreneurship were to become the norm for investment in nonprofits, then the key mission activities that society most needs would be neglected.

The key to success and sustainability for a nonprofit is to find a balance between the two worlds — the number and size of its key mission activities that lose money must be weighed against the nonprofit’s ability to operate sufficient profitable activities to ensure its financial viability. For a hospital this balance means providing trauma centers and charity care that are essential to the community even though they lose money. And it requires cardiac, orthopedic, and oncology services because they make enough money to make the overall organization viable. Social entrepreneurship will invest in the latter, but it will not invest in the former because they cannot yield a positive return on investment.

The appropriateness of social entrepreneurial investments for a particular nonprofit lies in how those investments help or hinder this balance of activities. Many nonprofits are not currently sustainable because they have insufficient profitable activities to bring the financial support necessary to offset the losses of their key mission activities. For those nonprofits, social entrepreneurial investments are a good choice and certainly preferable to a misguided effort to eliminate losses in key mission activities.

On the other hand, if a nonprofit needs to upgrade or enhance its key mission activities and it already has sufficient profitable activities to be financially sustainable, then social investments in profitable activities should be discouraged in favor of investments in its key mission, unprofitable activities.

Nonprofits, donors, and social entrepreneurs need to remind themselves that the key mission activities of a nonprofit should be priced, and its customers chosen, to run at a loss. To neglect this key mission is to miss the purpose of the nonprofit sector. If profitable investments are made in the context of enabling the sustained provision of unprofitable, high mission activities, then the social entrepreneurship movement can be a lifesaver for our communities.