The costs, benefits and consequences of importing venture-capital practices into the social sector

Last week, at the International Crisismappers Conference in Manila, a panel debate about how to ‘scale’ across contexts was cut short for lack of time. A participant asked an innocent question of the Making All Voices Count team onstage about lessons learned in the program about how to scale. In the response, Andrew Schroeder from WeRobotics chimed in with some sharp points about the true value of scale – do we have to scale to succeed? What if you stay small and continue to make clear impact? Why the community’s obsession with scale?

It got me thinking about how the bug of start-up language and culture has bitten the social sector – for good and bad.

Over the past decade, we’ve seen a substantial shift in the language used to describe funding for social-good work, accompanied by shifts in the actual funding methods employed. It has been most pronounced in the technology for social good space. Foundations, funders, and nonprofits today increasingly talk about “investments” rather than grants. “Start-ups” and “ventures” receive “seed funding”, where new organisations once simply secured core funding. Executive Directors are becoming CEOs, and “capacity building” is now “incubation.”

This shift in language and funding mechanisms can be traced directly to the influence of the start-up economy. It stems partly from enthusiasm regarding technology’s potential role in social-change work, and partly from the money and talent increasingly flowing from start-up cultures into the social-good sphere. When technology giants (companies like Google and philanthrocapitalists like Pierre Omidyar, George Soros, Bill Hewlett, Bill Gates) are making very large “investments”, others in the field quite naturally take note.

This evolution in the way we’re talking and working has both positive and negative consequences. In order to understand both sides, I think it’s vital that we talk more openly about what the change means for the social sector. To be clear, I’m focusing here on the shifts in language and the experimentation with new funding methods – not the underlying politics of who is providing the funding.

Before looking at the effects and suitability of transferring the start-up language and approach to the social sector, I’ll start by identifying the main assumptions about how start-up economics is being considered for the social sector.

In my experience, advocates of this approach tend to assume that:

1. Investing significant capital in proven teams and ideas puts start-ups in a position to scale. And scaling is good. This works well when scaling (exponential growth that allows for capture of a market) is possible. This concept is most prevalent in technology sectors where adding each additional user is virtually free; however, it also applies to some brick-and-mortar businesses (think Starbucks).
2. Making it easy for early-stage ideas to access small pots of funding will allow more ideas to be tested. Additionally, the more concepts are funded, the more likely it is that a small number will become smash successes, enabling funders to recoup losses from other failed investments and make money overall.  
3. By using a social-return-on-investment (SROI) model, the benefits of social sector work can be calculated and expressed in economic terms. For example, every $1 spent providing excellent mental health services to homeless communities might save the city $2 as it might arrest and incarcerate fewer homeless people for petty infractions.
4. Implementing social entrepreneurship models (business solutions that solve social problems through new types of products and services) will encourage traditional civil society and social good organisations to develop new and innovative revenue sources. This will increase the social sector’s sustainability and resilience in a post-crisis, austerity-pinched environment.
5. Capitalist incentives create more productive organisations, even in the social good sector.

These assumptions and the subsequent decisions based on them have both good and bad consequences.

The good

• More money is being put into social good work, largely by a new group of funders. This can benefit organic-growth socially-minded businesses that have great ideas, but which have little chance of obtaining funding from traditional business investors that care more about profits than positive impact or traditional funders who struggle to stay at the forefront of innovation. It can also spur successful technical development and innovation that would otherwise go unfunded.
• Organisational growth can be accelerated. Great teams with great ideas can gain access to large injections of growth capital instead of piecing together small grants from old-school foundations or governments. This can happen in the non-profit sector and the not-for-profit business world. Some investment-minded funders have much greater appreciation for operations and human resources capacity in the organisations they fund. Human resources, administration, and HR, are no longer ‘overhead’ they are critical components of a team that can deliver.
• Accountability and transparency can benefit. Under these approaches, funders and organisations sometimes face more pressure to articulate the value of their work. When a grant becomes an investment, there is an implicit shift in thinking. An investment is typically judged on the basis of how much value is created. Hence, “What will you do with this investment?” is already a different conversation from, “What will you do with this grant?”
• Statements of goals and values can be clarified. While this new language may be irritating to some, it can also empower organisations to create clearer, proactive and creative explanations of how they create social value, and help them measure and articulate their own successes.
• Expanding the pool of low-risk pilot projects can increase innovation. As more small amounts of money become available for experimentation, organisations can try out new ideas on a small scale without risking their own futures on giant unproven programs.

The bad

• Funding is biased toward technological interventions. This isn’t true in every case – but many new types of funding in the social sector favour technology-focused projects. This can create incentives that warp the work of great organisations looking for support. For example, a team may decide to make an app even though this isn’t its core expertise and it’s not clear its community needs it. This bias can also lead to money wasted on technical development by groups that are not rooted in a rich understanding of the relevant issues.
• Scale means something different in the start-up world than in the social sector. Scaling a software technology company is possible because once the infrastructure and service are in place for a single user, the cost of providing the same service to a new user is tiny. Large investments in growing a user base pay off because the software can quickly capture a market. This type of scale is often not possible for the services a social organisation provides, as the cost per ‘user’ or beneficiary does not decrease as dramatically once infrastructure is in place.
• Private-sector revenue models don’t always translate. Not-for-profit and non-profit organisations are serving communities that are not served by for-profit companies, and often this is because the recipients of their services cannot pay the full-cost of the service. This is where philanthropy enters the equation. No matter what scale they reach, most non-profits don’t or can’t monetise their services or work. Forcing civil-society or social-sector organisations to focus on sustainable revenue – selling the equivalent of Girl Scout cookies to keep the lights on – may distract them from their core mission, and mute the passion the social sector thrives on.
• Growing too fast, too soon can be dangerous. Management support, development expertise, and training programs are hard to find in the social sector. Injecting large sums of capital into organisations that haven’t built a strong management capacity could be a recipe for disaster.
• Growth can become a metric for success. Organisations can feel pushed to take on more before they are ready. They can also prioritise growth even when that growth would undermine what’s working for them. When scaling and growth become the target, staying focused on impact is much more difficult.
• Sustainability becomes a major challenge. Once an organisation has scaled, it will need a plan to sustain that size after the initial investment has been expended. Private-sector start-ups can hope to capture a product market or make billions on an IPO, but most social ventures have no such means of monetising large-scale success.
• The consequences of failure are different than in the business sector. The start-up world thrives on mandates like “fail fast, fail often”. Yet failure in the social sector has different consequences – and a different opportunity cost – than does the failure of one more software start-up. Because social funding is limited, and needy populations are rarely supported by multiple competing organisations, the failure of a social service often means that a needed service isn’t provided, or that people aren’t helped by some other effective but not particularly innovative initiative.
• Innovation can become an end in itself. Innovation is an exciting and important concept. And pushing for cycles of continuous learning and adjustment is key to long-term success. But making funding available for innovation and not for social organisation’s whose approach is proven, can undermine the success of the social sector.

This start-up-inspired conceptual framework clearly has plusses and minuses. Many of these points do not apply in all cases, and many are not just about the start-up model – they connect to pressure on civil society to operate more like businesses. Despite its benefits, start-up economy thinking has very real potential drawbacks that can make it an awkward fit for the social sector. Moreover, the stakes – real people’s lives and livelihoods – could be no higher. But this approach also offers great opportunities to social organisations that are capable of successfully adapting to it.   

That’s why it’s critical to have this conversation.

Let’s talk.

Are you from an organisation grappling with the opportunities and challenges in this new funding landscape? Are you a funder working to strengthen the social sector and bolster its sustainability by adapting start-up or business approaches in your philanthropy? I know many thinkers and doers are working tirelessly to ensure these models bear fruit. Tell us what’s working and what isn’t! Drop a comment below or drop me a line here.