Adventures in philanthropy

Put off by traditional philanthropy, Wall Streeters and entrepreneurs are setting up businesslike charities that pursue social returns as aggressively as their firms do profits.

Roxanne Hood Lyons, a former schoolteacher in Washington State, had succeeded too quickly. New Futures, a charity she founded in 1991 in one of Seattle’s poorest and most violent neighborhoods, was attracting so many donations that she could barely manage the budget. Needy families flocked to New Futures’ offices in a run-down apartment building for after-school tutoring and child-rearing classes, but sewage leaked from the walls and cockroaches darted out of the cupboards. Then there were the finances.

“Our accounting was a mess. I would sit at night at my dining table, trying to figure out where this money was coming from,” recalls the 47-year-old Hood Lyons, who initially managed New Futures on a $250,000 budget, with six employees serving about 100 families at three different sites.

“It was easy to get money,” she says. But for help in her squabbles with landlords over rent and safety concerns, she couldn’t count on her donors -- government bodies such as the Highline School District -- or the accountants they offered. “What I needed was a whole other professional level of challenge and partnership.”

In early 1998, when she was desperately searching for new counseling space, Hood Lyons got wind of Social Venture Partners, a local fund that was taking a new approach to charitable giving, more akin to a venture capital firm than a traditional nonprofit. Launched in 1997 with $50,000 from desktop-publishing pioneer and Aldus Corp. founder Paul Brainerd and managed by Paul Shoemaker, former group head of worldwide operations for Microsoft Corp., SVP represented a new direction among philanthropists who were frustrated by the lack of transparency and accountability at traditional charities and eager to apply a dose of clear-eyed calculation to the usual idealism.

The concept -- variously known as venture philanthropy, performance philanthropy or high-engagement grant making -- is simple: Once a fund identifies an organization worth backing, it performs extensive due diligence to assess risks and growth potential. If the business model shows promise, the fund makes an initial grant, promising to stay involved for several years if certain goals are met. Unlike traditional philanthropists, high-engagement grant makers follow the principles of venture capitalism by supplementing their financial support with managerial assistance.

Hood Lyons approached Shoemaker after hearing about SVP from a friend, hoping that “these high-powered Microsofties” would meet with her landlord, flash a PowerPoint presentation and induce him to make repairs and provide additional space. She asked for a new accounting system and help with business planning.

After three months and 500 hours of due diligence, SVP and New Futures came up with a business plan that resulted in an initial grant of $65,000. SVP’s managerial involvement felt “overwhelming at first,” says Hood Lyons, remembering how a fund executive met with her once a week in her apartment to discuss progress and problems. “It’s very unusual in the funding world.”

But the sweat paid off: SVP negotiated with the landlord to secure a new, clean apartment in the housing complex where most of New Futures’ clients lived, and it recruited several CFOs to design a new accounting system pro bono. Over the next five years, SVP disbursed $318,000 in additional grants.

Although Hood Lyons recently left New Futures to raise her own two children, the group’s SVP ties continue to help it grow and attract new money, now adding up to $1 million annually, from such sources as the Bill & Melinda Gates Foundation and the Ronald McDonald House Charities. The charity employs 35 and reaches 2,000 children and 350 parents. How do its hard-nosed donors know that their money is well spent? There are tangible results: Children in New Futures’ after-school programs advanced their reading skills by almost two grade levels in 2003, bringing them up to peer-group standards.

SVP is one of an estimated 50 venture philanthropy organizations nationwide, up from ten in 1997, making grants of anywhere from a few hundred thousand dollars to $50 million a year -- and putting grantees through their paces to ensure transparency, accountability and tangible social returns.

The movement began in the 1980s in the banking and technology communities of the East and West Coasts, led by hedge fund manager Paul Tudor Jones II, founder of New York’s Robin Hood Foundation, and Kohlberg Kravis Roberts & Co. partner George Roberts, who started the Roberts Enterprise Development Fund in San Francisco.

Riches from the 1990s technology boom gave rise to a new, larger group of firms intent on putting their own, more professional stamp on the philanthropy business. These include Acumen Fund, formed three years ago in New York by former Rockefeller Foundation program director Jacqueline Novogratz to channel money from wealthy givers to projects in Asia and Africa; four-year-old Geneva Global in Radnor, Pennsylvania, which resembles a Wall Street research shop, advising donors on specific projects; and MicroVest, started last year by Warburg Pincus partner W. Bowman (Bo) Cutter, which promises a financial return on money it invests in microlending institutions in the developing world (see box).

These groups apply the venture capital or private equity model in a variety of ways. Some finance start-ups; an example is NewSchools Venture Fund, which invests in charter schools and was co-founded by Silicon Valley venture capital gurus John Doerr and Brook Byers of Kleiner Perkins Caufield & Byers. Others, like Acumen and Geneva Global, focus more broadly on health care or economic development efforts around the world. But all follow a pattern that differentiates them from many traditional foundations: concentrating their assets on a small number of projects, making long-term commitments, actively shaping strategy and letting results dictate how programs should be run.

Although venture philanthropy principles have begun to influence the charitable sector -- established operations from the Rockefeller Foundation on down have put money into high-engagement firms -- the dollars involved remain negligible. The total, less than $100 million, pales next to overall U.S. charitable giving, which added up to $241 billion last year, according to the American Association of Fundraising Counsel.

Acumen Fund has raised all of $20 million over three years and pledged $6 million in loans and grants; NewSchools made headlines last year when it got a $22 million donation from the Bill & Melinda Gates Foundation. By contrast, the $10 billion-in-assets Ford Foundation approved $525 million in grants in the fiscal year ended September 2003.

And, like venture capitalism, venture philanthropy is not without risk, especially when a group puts a big chunk of its funds behind one project.

IN 2001, THE YEAR BEFORE SHE RETIRED AS HEAD of asset management at UBS PaineWebber, veteran money manager Margo Alexander had an epiphany. Generous in her charitable giving but long frustrated by her inability to know where her money was going, Alexander learned of Novogratz’s then-new Acumen Fund. It was a nonprofit that had all the trappings of an institutional investment firm: offices in New York’s financial district; seed capital from the Rockefeller Foundation and the Cisco Systems Foundation; investments in three portfolios (health, water and housing); and executives and portfolio managers who had Citigroup, Credit Suisse Asset Management and the World Bank on their résumés.

“Transparency and accountability were the markers of Acumen,” says Alexander. “I was quite taken by the idea.”

Though Acumen initially made only direct grants, lately it has been pouring its resources into loans to businesses with a social mission. Financial returns are plowed back into the fund. “We’re like a venture capital firm for the poor,” explains Gavin White, Acumen’s spokesman and a former marketing executive at Credit Suisse Asset Management. “Our contributors see philanthropy as an investment, and they’re getting social change back.”

Acumen’s staff of 13 trolls Africa and South Asia for worthy projects and helps to set objectives, draft business plans and monitor performance. Although this can be an expensive way to do business -- of Acumen’s projected $5.7 million in expenses this year, only $3.5 million will go to programs -- the group argues that venture philanthropy depends on managerial expertise, which comes at a price.

“Venture funding is not just grant making,” says White. “It’s much more management-intensive, and the right skills are what’s required to get the job done.”

Underscoring its commitment to the business approach, Acumen provides quarterly reports that read like securities research. In one recent letter portfolio manager Rustom Masalawala updated donors on an Acumen-funded enterprise in Tanzania that is producing mosquito nets for beds to combat malaria. The $250,000 in loans, he said, has resulted in 98,000 bed nets, with the monthly production set to double, to 32,000, after new knitting machines arrive from China. Masalawala tallied how many employees work in the plant and described improvements in the bed nets’ weave that reduced the unit production cost.

The emphasis on such social returns is changing a sector that has not only lacked the kind of management and bottom-line discipline that these firms are trying to introduce but has also been suffering from an image problem. Concerns about mismanagement and fraud at nonprofits grew rampant following allegations that some charities had misrepresented their goals or failed to disburse funds as promised in the aftermath of the September 11, 2001, terrorist attacks.

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Since then there has been a raft of state and federal proposals to tighten regulation, and the Internal Revenue Service has stepped up its audits of nonprofits. In an August consumer poll by the Brookings Institution, 15 percent of 1,417 respondents said they had a great deal of confidence in U.S. charities; that was up from 13 percent in January but well below the 25 percent of December 2001. Conversely, as of August, 35 percent had little or no confidence in charitable organizations (a slight improvement from 38 percent in January).

To that public skepticism, add the misgivings of savvy financial minds like Acumen Fund chairman Alexander, who complains: “You write a check and it kind of goes off into space. You assume it goes to a good end, but most of the time you don’t know exactly where.”

Some independent organizations try to fill the information gap. Among them: the Foundation Center, which tracks the activities of private foundations, and GuideStar, a database of nonprofits that lists everything from mission statements to CEO salaries. But these records are incomplete, based on voluntary disclosures and information gleaned from tax filings. Although more than 1 million tax-exempt charities are registered with the IRS -- a number growing at the rate of 100 a day -- only 30 percent of the organizations are nonreligious entities that have at least $25,000 in annual revenues, requiring them to file tax returns.

One firm trying to go beyond tax disclosures is Aidworks, an offshoot of Hoboken, New Jerseybased Investars, which tracks the performance of Wall Street research analysts. Aidworks has spent three years building a system to collect detailed, project-specific data on the international activities of government agencies and private charities, but it’s still a work in progress. “Transparency isn’t really on the uptake,” observes Kei Kianpoor, CEO of Aidworks and Investars. “A lot of these organizations would not thrive in a transparent environment,” he says, because many are reluctant to share data that could expose their inefficiencies.

Eric Thurman, CEO of Geneva Global, sees slow progress. “Until very recently, the kind of analysis you see in the investment world was almost nonexistent in the philanthropic world,” he notes. “There’s all kinds of sophistication in the commercial world, and yet there were no standards of excellence in philanthropy. But now that’s changing.”

THE ROBIN HOOD FOUNDATION PIONEERED VEN-ture philanthropy when it was founded to combat poverty in New York City in 1988. With $143 million in assets, it’s the granddaddy of the field.

“This is not feel-good philanthropy,” David Saltzman, director of Robin Hood, says. “This is hard-nosed stuff.”

How does Saltzman gauge a meaningful social return?

“There are very clearly spelled-out goals for an organization to meet in terms of performance,” he explains. “If we’re funding a job training program, we’d be looking at who it was that was being served, whether or not these people were getting jobs, whether or not they were staying in their jobs, what their salaries were and whether they were able to lift their families out of poverty.”

Saltzman says it’s readily apparent whether an organization is performing well and is worthy of Robin Hood’s continued support. In the case of KIPP Academy, a public charter school in the Bronx, Saltzman had only to look at test scores: While another school in the same building had the lowest reading score in New York City, KIPP boasted one of the highest. Its math and attendance levels were among the best in the city.

Robin Hood, which made $43 million in grants last year, and the Roberts Enterprise Development Fund, which gave about $2 million in grants and in-kind services, represent venture philanthropy’s old guard. A more explicit venture-capital-like approach took intellectual root in a 1997 Harvard Business Review article by Christine Letts, a lecturer at Harvard University’s John F. Kennedy School of Government. Letts argued that the Internet boom would give rise to a new type of humanitarian -- part Andrew Carnegie and part John Doerr, who then personified the high-tech entrepreneurial explosion. “The venture capital model can show foundations how to help nonprofits build strong organizations,” she wrote.

Her article helped give rise to the notions of social returns and charitable investment, which at first did not gain much favor among traditional philanthropies. They considered themselves above crass commercialism, and they were put off by the newbies’ we-can-do-it-better bravado.

But a few charitable institutions were open to some experimentation, and the principles of venture philanthropy have since gained currency. The Rockefeller Foundation put $5 million into Acumen, and the John S. and James L. Knight Foundation, endowed by the Knight Ridder newspapers family, has given $2.5 million to Cambridge, Massachusettsbased New Profit, which manages a portfolio of charities in the manner of a fund of funds. The $26.8 billion-in-assets Bill & Melinda Gates Foundation, the biggest U.S. private foundation, made an exception to its own rule -- it normally doesn’t donate to other foundations -- when it made its pledge last year to Doerr’s NewSchools charter school programs.

One foundation has even dropped its traditional model altogether. The New Yorkbased Edna McConnell Clark Foundation, started in 1969 by an heiress to the Avon cosmetics fortune, decided that its grants were too small and scattered to significantly improve the health and welfare of low-income youth. Now, instead of making more than 100 grants totaling $30 million a year, the foundation spends the money on just eight to ten programs; grant recipients have included Big Brothers Big Sisters of America, Harlem Children’s Zone and the Massachusetts Youth Teenage Unemployment Reduction Network.

“We’re wiping the slate clean,” says spokesman Bruce Trachtenberg. “Our intent all along was to do good, but now we want to be able to say and demonstrate that we’re producing social return on our investments.” The foundation’s $4 million over the past four years has helped Big Brothers Big Sisters double to 220,000 the number of children served annually by its mentoring program.

CHANGES IN GENERATIONAL ATTITUDES AND demographics are challenging many philanthropic traditions, suggests David Ratcliffe, head of the Merrill Lynch Center for Philanthropy and Nonprofit Management, a unit of the Wall Street giant’s private bank that advises clients on charitable giving. He notes that as wealthy baby boomers approach retirement, they demand financial transparency in, and control over, all decisions that affect their net worth. “We have become a nation of planners,” says Ratcliffe. “We plan our retirements, we plan our children’s education, we plan various components of our financial life. Philanthropy is really the last frontier of planning.”

One of Ratcliffe’s most popular vehicles is the donor-advised fund, which allows investors to set up tax-free investment accounts whose proceeds automatically go to certain charities. But this option doesn’t satisfy donors who want a full tally of how their contributions are spent.

Josh Bekenstein, a 46-year-old buyout specialist at Bain Capital in Boston, says that if he had time on his hands, he would research nonprofit organizations before donating money and then work with them to ascertain that his funds were making the maximum impact. For now, he gives his money to New Profit. Its research team “essentially does for me what I would do if I had more time,” says Bekenstein, who is a board member of the group.

New Profit, founded in 1998 by social entrepreneur Vanessa Kirsch, specializes in children’s education, using scorecards like those common in the corporate world to measure organizational performance. The system evaluates intangibles like customer satisfaction and social impact. Investors receive summary reports describing how many grade levels a certain class advanced and how many children from a given program graduated from high school.

The Knight Foundation donated $500,000 to New Profit between 1999 and 2001 “to learn a bit more about the philosophy and practices of venture philanthropy,” says foundation spokesman Larry Meyer. Once it passed muster, New Profit received $2 million with a mandate to expand one of Knight’s favored causes, Kids Voting USA, which promotes civic education among students. “They’ve got this venture capitalist mentality that helps organizations shore up their weaknesses and improve their practices, so that when you’re ready to make the big leap -- scaling up or launching some new program -- you’re able to do it,” says Meyer.

High-engagement grant makers are as reluctant as any portfolio manager to discuss their losers, but they certainly have them. In one instance, disclosed on condition of anonymity, a foundation joined up with a former heroin addict and drug dealer who had spent time in prison and wanted to set up a neighborhood drug rehabilitation program. Although the grantee lacked management skills and had no background in social work, the fund believed that his experience with addiction and access to the community would prove valuable. But he didn’t take the fund’s advice, and the project failed miserably. Two years and $100,000 were down the drain before the foundation pulled out.

“That’s one of the problems of venture philanthropy,” says the head of the foundation. “Sometimes, because you’re interested in giving someone an opportunity that others might not, you end up funding somebody who’s too high-risk.”

Because of their size and style, performance-focused grantors tend to put their eggs in a few small baskets, which is not only risky but also can skew the power balance in the relationship. In fact, some critics say that new-age grant makers too often cross the line between engagement and control, says Rick Cohen, executive director of the National Committee for Responsive Philanthropy, a Washington, D.C., think tank.

Susan Berresford, president of the Ford Foundation, told the Stanford Social Innovation Review last year that most of the complaints she hears from grantees about venture philanthropists concern their “intrusive and controlling style of interaction and a demand for compelling near-term results.” She added, “These problems occur when aspects of the venture capital model are taken into the nonprofit world without regard to its different culture or characteristics.”

The venture generation’s impatience and aggressiveness -- qualities that can be constructive in the business world -- also did not endear them to the philanthropic establishment. “One of the mistakes we made early on in venture philanthropy, and I was guilty of it, too, is that we came off as too aggressive,” admits Mario Morino, co-founder, chairman and managing partner of Washington, D.C.-based Venture Philanthropy Partners, a five-year-old firm that has raised more than $30 million. “We didn’t give enough credit to people who were already doing similar things.”

The cultural tensions have eased over the past few years. The high-engagement contingent has worked at mending fences with industry veterans, who in turn have adjusted their own strategies. “We saw things that the venture philanthropists were proposing that we thought we could take and modify,” says the Clark Foundation’s Trachtenberg. “And some of the venture philanthropists whose models we used are coming back and using our examples.”

Now the question is whether the high-engagement approach can have a lasting social impact. The big test will come as the baby boom generation bequeaths its wealth: If venture philanthropy draws a tiny fraction of the more than $40 trillion that is believed to be up for grabs, the movement could finally break into the mainstream.

“There’s a lot more to be done,” says Rachel Croson, associate professor of operations and information management at the University of Pennsylvania’s Wharton School and an expert on the nonprofit sector. “We’re going to come to some kind of compromise between the all-the-way venture philanthropy organizations and the old-style ones. So in a sense it’s going to change the community profoundly, but not by winning everybody over to one side.”