Tuesday, March 31, 2009

Moving markets

I've been thinking about philanthropic and social capital markets for several years now. (There are dozens of posts on the evolution of these markets on this blog and this was the primary topic – and title - of my 2004 book) We are currently in one of the most dynamic periods in this area that I've seen in almost a decade. To better explain what I'm seeing, let me clarify the analog from commercial financial markets that I use to watch what is going on.

Commercial financial markets, as exemplified by a stock exchange, need three things in order to function - issuers (of the stock. In other words, companies), investors, and intermediaries.* The first two are the sellers and buyers of the stock, the intermediaries are the banks, brokers, and others who make the deals happen. You need something to sell (stock), someone to buy (investors), and someone to make the deal happen. Sometimes this is all done in private (friends and family investments, angel investing, private equity, venture capital all happen privately between the two key parties, buyers and sellers). However, if you want to bring the shares to a public market then you need an exchange. The exchange sets rules for selling (listing requirements) that ensure the whole transaction is well documented, the stock is what it claims to be, and that the deal meets certain standards of transparency and truthfulness.

Social markets already have some, but not all, of these pieces. Most of what exists in the social space is actually the equivalent of private deals. We have enterprises (e.g. organizations or companies) and investors (many of whom are funders making donations, but more and more actual investors). There is a range of activity and structure on both sides – from nonprofit organizations to social businesses on the sell side and donors to investors on the buy side. Put together the full spectrum and you get nonprofits and grants on one end and social businesses and investors at the other end. This spectrum can be laid out along an X axis that denotes the expected financial return to the resource provider – to the left, where grants are made, is a resource donation with an expected -100% financial return (no money back). In the middle might be loans or capital only investments – 100% financial return. To the far right are capital plus returns, in which the resource provider seeks return of their capital plus a few percentage points, sometimes all the way up to what would be pursued in the regular markets. These ranges are fairly easily calculated, after all their simple financial ratios.

Where it gets tricky is in the calculation of the social or environmental return. How to calculate the extent of these impacts is a thorny problem no matter where on the financial spectrum you participate. Figuring out the relationship between those returns and financial returns makes it even more complicated. Does a -100% donation (a grant) guarantee a 100% social/environmental impact? Does return of capital (a no interest loan) correspond to more or less social/environmental impact? Does pursuit of a financial return automatically reduce the possible social/environmental impact?

I don’t have an easy answer to the calculation of social/environmental return question, though I’ve been told there are at least 240 methods for measuring it.** The OECD is hosting a global project to measure social progress, they can point you to another few hundred measures. And how the social impact floats in relation to the financial impact, well, lets just leave that to another blog post.

But back to the market analog – the social markets have two of the three needed pieces of the exchange puzzle – enterprises and investors. These happen to be the two pieces that can operate in private deals. And that’s what we have now – a social market of largely private deals. Each resource allocation, each donation is handled as a 1:1 transaction. Enterprises seek money in endless series of one-off grant proposals or investment negotiations. Funders, donors and investors for the most part, do their own due diligence on the enterprise whether that be a foundation program officer review, or an investment grade analysis done by a family office staff person on behalf of a program related investment.

Now, the market is slowly building up parts of the rest of the puzzle. Sites such as GlobalGiving, Kiva, MyC4, SASIX, Give2Asia, etc. provide a portfolio of projects that donors/lenders can support - choosing within an online marketplace and relying on the sites themselves to have done some degree of due diligence on the organizations or enterprises. These markets organize different parts of the spectrum - GlobalGiving and Give2Asia offer grant opportunities, Kiva facilitates individual lending, SASIX offers social investment opportunities and Myc4 lets the individual choose their rate of return (from -100% to 100%+) and negotiate it with the enterprise.

Each of these example markets does a different kind of due diligence, they provide different degrees and types of information on the organizations, and facilitate a different type of monitoring and feedback. An investor/funder/lender cannot readily compare an offering (enterprise) on one site to that on another because the information is not standardized, the processes for the due diligence are not comparable, and the standards of reporting are not interchangeable.

This same pattern has long been the case offline as well, it just took the form of individual foundations or family offices doing their own due diligence on nonprofits. In this model every funder did his/her own due diligence, according to his/her own standards, and did not share it with others or try to use it to leverage other funders. Community foundations, which share due diligence across their unrestricted funds, their field-of-interest and donor advised funds, were probably the first to recognize they could use one set of analysis to leverage several sources of funds. There are also a few notable “syndicate deals” that have been done, such as financing for GuideStar, VolunteerMatch, Edna McConnell Clark Foundation’s work on growth capital for nonprofits, and the efforts of the Growth Philanthropy Network, to name a few. The online markets were the next stage in this changing model, as they conducted due diligence on an enterprise and then make it available to anyone who uses their platform to make a gift or a loan.

So these online markets herald an important shift – from 1:1 private deals between donor/nonprofit or investor/enterprise to public spaces, with some shared due diligence and some insight into who else might be providing resources. However, for the most part, the social capital markets still largely rely on private deals, negotiated directly between the two parties.

I think we're on the edge of the next shift in this model. REDF recently launched a key set of tools on coordinating funding at the grant end of the spectrum. The Gates Foundation routinely packages its funding with other public and private funders. The Nonprofit Finance Fund offers expertise in growth capital, and the Omidyar Network and others have played significant roles in scaling microfinance. The aforementioned Growth Philanthropy Network and Edna McConnell Clark Foundation efforts, SeaChange Capital Partners, and some of the work that NewProfit Inc and some venture philanthropy groups also fall into this category.

The next stage is building resources that can set standards for and accelerate these kinds of practices. One effort is the newly launched Global Impact Investing Reporting Standards effort, which has been re-named The Galilio Project. This work is led by my colleagues at B Corporation and builds off the incredible tools they have built (and my company has used).

This May in London New Philanthropy Capital is convening the first ever meeting of nonprofit analysts. These folks - who come from independent consulting firms, some of the online markets, pools of donor advised funds, and independent agencies such as New Philanthropy Capital, will gather to discuss the "tools of their trade." The meeting is specifically geared toward identifying common principles and definitions and building an association of nonprofit analysts. Should the group be successful, one can imagine the emergence of a set of standard criteria, methods, and reporting templates, as well as some professional definitions, guidelines, and (one hopes) ethical parameters. In other words, this association could be one step toward due diligence of nonprofit enterprises that would meet certain standards, provide an agreed upon level of information and transparency, and be conducted according to publicly available methods. These attributes would allow for comparisons of enterprises assessed under different due diligence practices. It would also allow the comparisons of those different due diligence practices. Such comparability would allow for interaction across the different listing platforms, so that a donor or investor could creditably compare an opportunity from one enterprise with that on another platform.

Then, if real comparability is achieved, we will approach the point where the due diligence providers themselves can be assessed and compared. This would accelerate the development of actual intermediaries in a capital market. They would compete – on quality of work, reputation, price, and experience – to identify, assess, package and bring together deals that serve investors and enterprises. Some might be foundation program officers, others might be independent consultants, some might work for banks, others might be investment analysts – the intermediary space in social capital markets will no doubt be as diverse as its counterpart in commercial markets.

With those three pieces – enterprises, investors, and intermediaries – as well as the rapidly expanding universe of social exchanges and online platforms – the social capital market – from grants to market rate investments, from nonprofits to social businesses – will be fully visible. It will have built a public face from its private deal history. Like I said, there are some interesting things happening in social capital markets.

The changes I’ve just described are part of the present, not the future, so I’m already peeking around the next corner to see what’s there. I’d place some bets on the growing role of visualized, integrated online data, the creation of overlapping global networks, the spread of alternative corporate structures, whole new financial product innovation, regulatory overlap, confusion, and expansion, pervasive opportunities for social action, and the deliberate cooperation, possible consolidation, in all segments of the market – issuers, investors, intermediaries, and exchanges. I’ll be sure to report back as I try to make sense of what I’m seeing.

*Thanks to Peter Clifford of WFE for this language.
** New good thinking on this is taking place under the auspices of the Global Impact Investing Network and is informed by this Monitor Institute report, which has some nice visualizations of these concepts.

1 comment:

Anonymous said...

I think what you're seeing is the corporate business model superimposed on philanthropies.