Raising and Making Money

Private sector or social sector, most innovations don’t start with money. They start instead with passion, a big problem, and a good hunch, and then they apply a lot of elbow grease. But once the project has legs, a critical factor for any startup is how to bring in money to finance growth and achieve sustainability.

Growth capital for innovation can take many forms. In the for-profit sector, the typical model is investment by individuals or institutions, and here businesses have two advantages over the social sector. First, they can offer a return on investment secured by ownership of stock or company assets. Second, they can raise funds based on human and intellectual capital. For companies like Coca-Cola these so-called “intangibles”—their brands, their people, their recipes—can constitute as much as 80 percent of their value. Even marketing disasters, like the New Coke fiasco of 1985, can eventually raise the company’s value. Lessons learned, for better or for worse, are a form of capital in the private sector.

By contrast, consider Redefining Progress, the think-tank I ran in the 2000s. We had a website garnering 4 to 6 million hits a day and a trademarked brand (the Ecological Footprint) spread on more than 120,000 websites, but we had no way to borrow or raise investment directly against those assets. It’s much harder, if not impossible, to capitalize intellectual property and human resources in the social sector.

Social sector organizations have far fewer ways to raise financial capital, so they must be even more efficient than for-profit organizations in using that capital, and lean techniques can be a major asset in doing so. But it’s also important that social sector investors understand the value of failure in building that human and intellectual capital.

Funders of early-stage social innovation usually have no expectation of a return on their investment. The primary sources of such capital for nonprofit and government innovators are grants or gifts from individuals and/or charitable or government sources. The ability to raise significant funding that, like grants, incurs no obligation to pay it back could be seen as an advantage, except for the fact that the vast majority of social sector efforts will require external capital not just to grow but to operate for their duration.

Another issue is Vince’s original question: “How do we make money?” Beyond the startup investment, many successful, mature social sector innovations simply do not make money in the long run and must rely on gifts and grants to a large extent for their ongoing operation. Beyond the “customers” they serve, innovative programs, as they mature, must treat their funders as a form of customer as well to ensure ongoing support. For government programs, those funders are often budget offices, legislators, and, ultimately, the public. For nonprofit organizations, the funders are individuals, members, foundations, and government agencies.

Because social sector outcomes are so diverse, their work across the board has often been plagued with inappropriate performance metrics. The most pervasive metric is probably that of overhead, or how much of a nonprofit or government agency’s overall spending goes to administration versus delivering services. Rather than measuring the overall impact of products or services, nonprofit rating agencies (like GuideStar and Charity-Watch) have, until recently, evaluated how much of a program’s budget is spent on fundraising, administrative, and management tasks.

The focus on overhead is appropriate in a startup’s early stages. Spending needs to be focused first and foremost on finding the right product or service and demonstrating impact. But once a repeatable business model has been found, the relationship of overhead to overall spending is relatively unimportant compared to what it takes to run the model successfully—for maximum impact.

The importance of social sector funding models cannot be overstated in the lean startup process. A few points therefore stand out for lean startup practitioners:

• Funders of nonprofits and government agencies running on lean principles must explicitly recognize that each failure generates vital learning (intellectual capital). How does the funding build in a way to preserve and transmit that learning to the field? How does it preserve and grow the human capital generated in those failures as well?

• Lean startup practitioners need funders who understand that you will be measuring outcomes but also your impact on the funders themselves, since they too are a client in the social sector.

• Some forms of private sector innovation are hard to link to near-term revenue (network effects models—“if we build it they will come”—for example), and the same is true in the social sector. Social sector investors may be skittish about investing where the outcomes are too distant from the day-to-day activity. Think-tanks are a great example of this category, where hard outcome measurement is challenging. The most generously funded think-tanks are often those linked to direct returns to their donors. For example, those devoted to lowering taxes on the wealthy have proven returns to the wealthy who contribute to them, and those devoted to influencing foreign policy deliver results to governments or private interests who fund them.

• Overhead measurement for its own sake is meaningless. Overhead is just another part of the operating model, and it is the impact level and overall success of that operating model that is the vital metric.

• Since funders are critical customers, open communication about the operating models being tested is critical, as well as how agnostic the funder is willing to be about how its money is being spent. A socially conservative funder may reasonably be unwilling to fund needle exchange programs even if they are proven more effective at stemming diseases than spiritual counseling.

• A focus on overhead is appropriate in the early stages. Staying lean and hiring only those employees you need is vital at this stage.