Investors Trust the Companies They Support. Here’s How Grant Makers Can Do the Same.

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As governments flailed during the pandemic, nonprofits became essential workplaces, providing food to struggling families, personal protective equipment for health care workers, and scores of other necessities.

But while nonprofits employ some 12.3 million people, or about 10 percent of the private work force, they often receive far less support during times of economic crisis than their for-profit counterparts. In the first round of pandemic stimulus legislation, for instance, just 2.5 percent of the $521 billion distributed by the Small Business Administration went to nonprofits.

How nonprofits get treated during a crisis opens a window into the funding challenges they face even in the best of times. While most private investors, such as venture capitalists and commercial bankers, understand that businesses have a better shot at success if they can use capital as they see fit, the “capital markets” that serve nonprofits — foundations, donors, government agencies, and corporate philanthropy — rarely take that view.

Instead, nonprofits have to jump through hoops to satisfy the requirements of multiple donors, a practice that fragments their efforts, distracts from their work, and introduces a need for management expertise that philanthropy is often unwilling to fund. The result is a kind of reverse engineering, in which grantees reconstruct their operations and program offerings so they are in line with a grant maker’s requirements — rather than their own missions. In the process, they diminish their impact and long-term financial health.

One of us, Dan Nissenbaum, knows firsthand the costs of reverse engineering nonprofits. He runs the Low Income Investment Fund, or LIIF, a large community-development financial institution that makes loans to projects in neighborhoods that conventional lenders consider too risky. LIIF is successful by any measure. During its 35 years, the organization has deployed more than $2.7 billion in capital, never lost money for an investor, and earned an investment-grade rating from Standard & Poor’s.

But as a nonprofit, LIIF is forced to raise capital in myriad ways, including bank lines of credit, government contracts, loan guarantees, program-related investments, and restricted and unrestricted grants. Each source of funds comes with a set of requirements, including deployment periods, financial reporting, eligibility screens, geographic- and project-specific targeting, legal representations, and impact metrics. LIIF now has literally hundreds of reporting requirements, creating significant accounting expenses, necessitating countless hours of staff time, and diverting resources away from its larger mission.

Unfortunately, such practices remain standard at most foundations despite recent calls for more “trust-based” giving, which aims to address the power imbalance between foundations and nonprofits by providing unrestricted grants and loosening requirements. While donors increasingly say they support this funding approach, many haven’t figured out how to make the transition.

To start the actual work of revamping their grant-making approaches, philanthropy should take a page from the world of private investment: Focus giving on what will help nonprofits enhance their missions and financial resiliency, rather than on what will fulfill the donor’s own priorities. They should also follow the lead of MacKenzie Scott, the philanthropist whose record-breaking, unrestricted giving recognizes that “people with experience with inequities are the ones best equipped to design solutions.”

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A report released last week by one of us, Andrea Levere, lays out three primary principles foundations should follow to ensure their grant making shows they trust nonprofits to make wise choices about how to use philanthropic funds:

Provide more flexible and less restricted “enterprise capital.” This means supporting the entire nonprofit enterprise, rather than limiting funds to a specific program or activity. Putting restrictions on how an organization uses funds increases operating risk and can crowd out opportunities. For example, when a potential LIIF donor limited an antipoverty project to specific geographical areas, the nonprofit was unable to assemble the amount of funding necessary for effective program delivery. And when another grant maker attached targeted criteria to funding aimed at addressing food deserts, the money became impossible to deploy as market needs shifted.

Instead, foundations should empower nonprofits through multiyear grants that provide enterprise capital (or equity) to invest in what they believe will produce the most value. Antony Bugg-Levine, CEO of the Nonprofit Finance Fund, defines enterprise capital as “a form of grant making in which the purpose is to enable an organization to become stronger and more sustainable, as opposed to a lot of other grants whose purpose is to enable an organization to deliver social value in the short term.” Enterprise capital increases financial strength and resilience while building the organizational infrastructure, human capital, and financial reserves that allow nonprofits to deliver the greatest impact.

This simplified, unrestricted investment approach is especially critical during the pandemic. With financial survival in the balance for many organizations, and addressing systemic racism now a key component of philanthropic giving, nonprofits need equity on their balance sheets to achieve stability and attract other supporters.

Focus on ways to strengthen financial performance of a nonprofit. Funding should support the development of business and financial expertise within a nonprofit, with the goal of putting the organization on a more sustainable economic path. This could include creating an informal “enterprise capital cabinet” made up of those who understand finance and can demystify it for nonprofit leadership and staff, who often lack expertise in this area. The cabinet could operate as a subcommittee of the board of directors or as an external advisory board.

Such arrangements happen all the time in private enterprises. When a venture-capital firm invests in a start-up company, for instance, someone from the firm typically joins the board to steer the organization to success by providing expertise and key contacts. A foundation can play a similar role by working with the grantee to identify needs and then help find experts who can provide training and other assistance to help the organization build its financial capacity.

Reduce reporting requirements, create common measures, and fund collectively. A standardized set of impact metrics and financial covenants can simplify nonprofits’ compliance management. This process should identify a limited number of measures and ensure that sufficient resources are made available to the grantee to collect and analyze the data. Possibly working with the enterprise capital cabinet, the grantee should also identify metrics applicable to its particular mission, target population, community served, or other factors that can provide a fuller assessment of the organization’s work.

Such an approach has the additional advantage of allowing comparisons across organizations. For instance, the National Community Investment Fund and Global Impact Investing Network have standardized a range of performance measures that can be used by community development investment institutions like LIIF and other social enterprises. These streamlined measures can help donors and lenders more easily analyze their investments while reducing the reporting burden on the nonprofit organizations.

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Similarly, creating common assessment metrics can bolster the establishment of more technology-based grant-making collaboratives that deliver capital in ways that reduce the cost and complexity of fundraising. Groups such as JustFund, for example, use technology to simplify grant management and connect grant makers directly to grassroots organizations.

During a time of unprecedented crisis, how philanthropy structures and invests financial equity is fundamental to the growth and survival of organizations whose critical work matters more than ever. Unlike for-profit enterprises, nonprofits must contend with a double bottom line — financial strength and social impact. To realize their full value, they need the same level of dedicated and customized support as for-profit companies.