Diversify Funding — including through impact investing
Aiming to create funding relationships with a diverse group of funders has several advantages, and may be legally required for nonprofits in some countries. Diversifying sources reduces the risk of any one funder changing strategy and evens out cash flow. Diversifying by instrument can help blend different kinds of capital to achieve different strategic goals.
However, diversification across different kinds of funders, interests, and goals can be costly to cultivate and manage. For example, government funding is usually reliable once in place, but can also come in irregular tranches and cause cash flow problems. New funders may ask the organization to add activities that are not within scope, or actively pursue interests not aligned with those of the organization.
Looking for new, diversified funders is easier if you have new data or success stories to share and a story of momentum. Organizations with strong revenue models can also engage with impact investors to diversify their capital mix.
Lesson 1: Diversify funding to smooth out cash flow
WSUP on the ups and downs of government aid grants. WSUP started with a large unrestricted grant from DFID. While this was critical to its initial success, the distribution schedule was hard to manage — in CEO Neil Jeffery’s words, it was “lumpy,” leading WSUP to have periods where it would have to hold back on plans while the money ran low, and then ramp up quickly to spend the sums that came in. By 2014, DFID funding was 45% of WSUP’s budget, and it decided to diversify to smooth out its cash flow. WSUP pursued bilateral funders, including the US Agency for International Development (USAID) and the Australian Development Agency, as well as grants from large and medium-sized foundations, such as the Bill & Melinda Gates Foundation and Stone Family Foundation, and private companies such as The Coca Cola Company. In 2018, DFID funding — which had not decreased — was 31% of WSUP’s budget. (To learn more about WSUP’s approach to scaling, read their scaling snapshot.)
Lesson 2: Understand funder motivations and avoid mission creep
Educate Girls (EG) on Corporate Social Responsibility (CSR) funding in India. As of 2014, businesses in India with annual revenues of more than 10B rupees ($154M) must give away 2% of their net profit to charity. While this is a significant opportunity to diversify funders, EG reports that working with companies this way has been a mixed bag. It has a few strong CSR partnerships and some disastrous ones. For example, corporates often express interest in having EG expand to areas where these corporates have a presence, but where it doesn’t make strategic sense for EG to enter. EG has also faced circumstances where corporates want to incur favor with governments and request EG to provide new services outside its core program (such as low-cost toilets), requiring EG to actively manage relationships with governments as it declines such partnerships.
Lesson 3: Leverage key moments to diversify, building on momentum
Living Goods on diversifying post-Randomized Control Trial (RCT). Living Goods received very positive results from its first RCT in 2014, showing that its model reduced child mortality by more than 27% in communities in which it worked — at an annual cost of less than $2 per person. LG used those results to inform a new four-year scaling plan that included quadrupling growth. LG went back to its existing funders with its ambitious plan, and the majority of funders responded by doubling or tripling their funding. Based on those commitments, LG was able to interest new funders to fill out the remainder of its needs, ultimately engaging 15 core funders and a handful of small individual donors to support its scaling plan. (To learn more about Living Goods’ approach to scaling, read their scaling snapshot.)
Lesson 4: Use impact investing as a tool to engage new financial stakeholders
Organizations wanting to diversify through impact investment capital have been experimenting in a multitude of structures. We include two examples here, showing a bit more detail on lessons in bringing investment capital into your nonprofit as a new source of external capital, and in spinning out a nonprofit subsidiary to raise debt funds.
Root Capital on the challenges of blending colors of money inside an organization. Root Capital founder Willy Foote realized early on that diversifying their capital base made sense because they had different and distinctive uses and business models within their organization. The loan portfolio could be financed with low- interest loans and the training and field building could be subsidized with grants. He and the team created a “layer cake” of different kinds of funding the organization could leverage for various purposes. Years later, though, he says he “was guilty of not being crisp enough about the different expectations you have to set with the kaleidoscopic stakeholders you have to bring together.” He set expectations for the entire organization around reaching complete self-sufficiency as he experimented with growth on the investing side. Today, he says, “Even though we expect to fully repay all of our loans, we will never set expectations again that we will be fully break even at the organizational level. So, everyone understands now that we are all about impact and additionality.”
Water.org on spinning out a nonprofit impact investment manager, WaterEquity, to meet market demand. A core part of Water.org’s model is to provide technical assistance, along with small grants, to microfinance institutions (MFIs) to reduce the cost and risk to those MFIs to launch and scale water and sanitation-related microloans. This model has been incredibly successful, but Water.org recognized that, with more affordable debt financing, the MFIs could further scale these portfolios to meet increasing demand. In addition, Water.org saw an opportunity to provide more affordable debt financing to enterprises across the water and sanitation supply chain serving the world’s poor. It piloted an $11 million fund, raising equity from accredited impact investors and providing debt financing to seven microfinance institutions. After the successful launch of this Fund, Water.org launched a separate organization, WaterEquity — the world’s first impact investment manager dedicated to investing in local, high- growth enterprises serving the water and sanitation needs of the poor with a focus on Asia, Africa, and Latin America.
Today, WaterEquity raises money from institutional and impact-first investors including forward-thinking corporations, foundations, financial institutions, entrepreneurs, and socially conscious individuals. Structurally, Water.org and WaterEquity — as two nonprofits — are legally independent, though they share a CEO and co- founders (Gary White and Matt Damon) and one board member. In its first year, WaterEquity’s inaugural $11 million Fund helped 225,000 people and is on-track to reach one million people over its seven-year life. As the Fund’s investments continue to perform, it has already returned capital to owners in 2017 with a higher-than-expected annual distribution payment of 3.6 percent.
In April 2017, WaterEquity went to market with a new, $50M Fund. Committed investors include the Overseas Private Investment Corporation, Bank of America, and the Conrad N. Hilton Foundation and Skoll Foundation. WaterEquity estimates the investments will impact the lives of 4.6 million people, generating a 3.5 percent financial return at a near zero philanthropic cost. Executive Vice President of Business Development and Investor Relations, Alix Lebec, anticipates that WaterEquity will reach $250M in assets under management by 2022, helping the organization break even. While the need for higher returns, enhanced liquidity, specific geographic restrictions, and fund size have prevented some investors from investing, WaterEquity sees tremendous potential for future funds.
Advice from the Field on Diversifying Funding
If you’re just considering…
- Note that diverse sources can help you smooth out cash flow but can also create more relationships to manage, come with more restrictions, and require additional management and staff time to service a larger number of relationships.
- Pay close attention to political costs with your current stakeholders as you triangulate relationships with new entities.
If you’re just getting started…
- Build a story of momentum with your current funders to provide a signaling effect to help get new funders to commit.
- Ensure alignment between funder goals and your own; if your goals cannot be aligned, say no to the cash.
- Avoid mission creep at the programmatic level as you diversify relationships.
If you’re digging deeper…
- For most government funders, you need to provide higher evidence of impact, so plan for that as you diversify.
- Take the lead with funders; drive your own deal terms.
- If you have both investors and donors, be crisp in communicating your goals to both and setting expectations with each. Be sure each understands what you are learning overall so that none is surprised by your strategic pivots.
- Look for creative ways to engage with impact investors, and don’t be afraid to invent new structures that work best for both of you.
Read next: Leveraging Results-Based Financing (RBF), Leverage Hybrid Legal Forms, or return to see all articles in Money Matters.
This article was written by Catherine Clark, Erin Worsham, Kimberly Langsam, and Ellen Martin and released in March 2018.
