Strings Attached

By Vvyan Tenorio
(published in The Deal.com December 9, 2004)

Before his retirement a little more than a decade ago, Mario Morino was a pioneering software entrepreneur. His company, Morino Associates Inc., which he co-founded in 1973, was financed by private equity firm General Atlantic Partners LLC in 1983, then in its formative years as an information technology and communications investor.

For Morino, it was an enriching experience in more ways than one. His company merged with Duquesne Systems Inc. in 1989 and became Legent Corp., which was acquired by Computer Associates International Inc. in 1995 for $1.8 billion, a landmark deal at the time.

Beyond the monetary rewards, the relationship with Greenwich, Conn.-based General Atlantic inspired Morino to embrace a new life as a full-time philanthropist in the mode of a venture capitalist. In 1994 he formed the Morino Institute to help improve the lives of youth from low-income families.

He then went a step further and, borrowing some of the basic tenets and terminology of venture capitalism, co-founded Venture Philanthropy Partners in 2000. Today VPP, based in Reston, Va., is one of perhaps more than a dozen organizations that espouse what's known as venture philanthropy, a form of philanthropy with strings attached.

While it means different things to different people, venture philanthropy usually involves a process of "investing" capital in nonprofit "managing partners" and providing strategic assistance beyond financial contributions. Investments are made based on a well-developed, long-term business plan, sometimes marked by performance milestones, and measurable charitable results. Ultimately, the goal is to build organizational strength, thereby increasing a nonprofit's effectiveness.

There are those who say venture philanthropy is nothing more than a trendy repackaging of familiar practices. But its fundamental premise - that as with business, different types of funding are needed at different stages of organizational development and that performance needs to be assessed against long-range goals - has been catching on among larger, more traditional foundations.

"For a whole variety of reasons, there is more focus today on developing a well-articulated strategy and how to execute it, on questions of accountability and transparency in the world of the nonprofits," says Phil Buchanan, executive director of Center for Effective Philanthropy Inc. of Cambridge, Mass.

As a concept, venture philanthropy has been tossed around since John D. Rockefeller III coined the phrase in the late '60s to describe the "imaginative pursuit of less conventional charitable purposes than those normally undertaken by established public charitable organizations." But it wasn't until the '90s that the concept became popularized, resonating among newly wealthy entrepreneurs and venture capitalists who latched on to the notion of "virtuous capital" to generate social investment returns.

At its peak in the late '90s, dozens of proponents created a wealth of venture philanthropic efforts. A few of these ceased operations amid the collapse of the technology and telecom bubble, but several organizations have endured. Perhaps because it was a bit of a fad at the time, the label has spawned variations, such as "high-engagement philanthropy" or "entrepreneurial philanthropy." As Morino points out, "Venture philanthropy has become more a metaphor, a working framework, than anything else."

In this broad category are groups leaning heavily toward educational and social programs, such as the NewSchools Venture Fund, co-founded by Brook Byers and John Doerr of Kleiner Perkins Caufield & Byers; Social Venture Partners, formed by former Aldus Corp. head Paul Brainerd; New Profits Inc., backed by Mark Nunnelly, managing director at private equity firm Bain Capital LLC; the Partnership on Nonprofit Ventures, a joint effort of the Yale School of Management and the Goldman Sachs Foundation Partnership; and Robin Hood Foundation, founded by hedge fund manager Paul Tudor Jones.

Of a slightly different stripe is REDF, formerly the Roberts Enterprise Development Fund, founded by George Roberts of leveraged-buyout firm Kohlberg Kravis Roberts & Co. (see box), which supports nonprofit businesses or so-called social enterprises.

Unlike traditional grant-making, where a foundation lays down core principles and waits for applications, venture philanthropy targets specific recipients. Proponents view the philanthropy sector as a pyramid where the bottom is populated by thousands of small, neighborhood organizations with annual budgets of $1 million to $2 million or less, while so-called loyalty-based foundations that usually fund museums and hospitals are at the top. It's the middle tier, comprising groups with $3 million to $50 million, that VPP and others view as the sector offering the most opportunity for the group to make a difference.

"The fact is, a lot of these nonprofits need the exact same things that small businesses that we invest in would need, meaning they need strategic advice, a network of contacts and introduction to other sources of capital," says William Dunbar, a managing director at Core Capital Partners and a founding investor at VPP. "It's a blending of what we do everyday with venture capital." Dunbar is one of more than 30 prominent individuals, including General Atlantic managing partner Steve Denning, America Online Inc. founder Steve Case and New Enterprise Associates managing general partner Peter Barris, who provided VPP's roughly $32 million in funding commitments.

VPP invests about $2 million or $3 million in a nonprofit over a period of three to five years, but the money can only be used to build the capacity of the organization. The key is to find a group that has demonstrated its impact and ability to absorb change in order to grow to the next level. So far, it has allocated about $20 million to nine investment partnerships in the greater Washington area. As with startup investing, the money is disbursed according to the terms and conditions of individual investment agreements.

How VPP invests the money can be a long and involved process, much like the due diligence for a startup investment. At Heads Up, a nonprofit that serves children in low-income neighborhoods, there were initial misgivings over VPP's approach to strategic planning, in Morino's assessment. This process usually involves hiring consulting firm McKinsey & Co., which VPP underwrites. Although Morino himself resisted the practice at first, he says that this "interventionist" planning process has helped groups form a more cohesive, long-range vision and clearer roles for staff and management, and helped create a stronger and more engaged board of directors.

This was certainly the case at See Forever Foundation, a 501(c)(3) nonprofit that supports the Maya Angelou Public Charter School, a two-campus, alternative high school in the District of Columbia. When VPP approached it in 2002, it had one school with 60 kids and a small annual budget. "Our mission was to create a learning environment particularly for at-risk teens, many of whom were dropouts, but after four or five years, we still didn't have a lot of things in place. We had no systems, no strategy for growth, and everyone was incredibly stretched," says David Domenici, See Forever executive director and co-founder.

See Forever went through an intensive process with VPP's strategic advisers. "We were a little cautious at first," Domenici admits. In part, there was concern about investing grant money in capacity issues, which it had never done before. In the end, he says, VPP's assistance, which came in the form of the planning process with consultants and key hires, helped the group determine its own long-term goals and develop the organizational capacity to reach those goals. "VPP doesn't tell you what goals to set, but it supports your efforts to achieve them," Domenici says. It also pushed See Forever to start using performance measures "as a better way to give clarity to the organization," he adds.

VPP's $2 million funding kicked in in 2003 under a multiyear commitment. Among other things, VPP also works with the group to try to raise money from other sources. See Forever has since received contributions from the Bill & Melinda Gates Foundation, Walton Family Foundation Inc. and the Edna McConnell Clark Foundation, also a high engagement philanthropy entity, and it now runs two campuses.

Unlike VPP, the Robin Hood Foundation in New York prefers the phrase "high-impact" philanthropy, with its emphasis on outcomes. After the October 1987 stock market crash, Tudor Investment Corp. chairman and CEO Jones co-founded Robin Hood with Rolling Stone publisher Jann Wenner to run programs to help poor New Yorkers. Robin Hood emphasizes early childhood development, education, after-school programs and job-training initiatives. In addition, it provides survival funding in housing, food programs and AIDS services.

In its first year of operation, it granted $52,000 to two groups. This year, it has given out a total of $52 million. While many of the donors are wealthy Wall Street executives, its directors and supporters come from all walks of life.

As envisioned by Jones, Robin Hood applies investment principles to charity, with a high level of due diligence, engagement and an emphasis on measuring outcomes, executive director David Saltzman says. It differs from VPP in that it continues to fund programs for many years, if these perform to expectations. For instance, the Hope Program, an early recipient that offers job readiness training, placement and retention efforts, has been a grantee since 1989. Part of Robin Hood's support is to help conduct regular evaluations to determine what works and what doesn't. "When a grant is made, we try to leverage that by providing assistance on all levels to maximize effectiveness," Saltzman says. "At the end of the day, there is a bottom line on how a program measures up compared with other programs."

Meanwhile, on the other side of the country in Silicon Valley, veteran venture capitalist Gib Myers, now a partner emeritus at Mayfield of Menlo Park, Calif., began a variation on the theme with Entrepreneurs Foundation. After some 30 years in the business, Myers wanted to retire and was looking for something to do. "I wasn't much aware of community needs, but I asked myself, 'How can we use the venture capital industry to support the community?' " he says.

Myers and others lamented the sharp contrasts of enormous wealth and talent and poverty and unemployment in the Bay Area. Philanthropy was a fairly low priority. "There is no history of an active philanthropy culture here that you've had in many places for generations," he says. "The question was how to make a fundamental change in the culture."

Launching EF in 1998, Myers first asked startup entrepreneurs to donate stock. The aim was to guide donors in getting immersed in community activities, so that the community grows as their businesses grow, Myers says. EF initially practiced a form of venture philanthropy, but EF soon had more money than it could effectively handle. "On the one hand, we were going after companies to try and change the culture; on the other, we were taking money and trying to put it to work," he says. "We realized that community involvement and grant-making are two different businesses."

Instead, EF had a company sign up through an equity donation, usually the amount of stock it would give to a company director. When the equity becomes liquid, EF works with the company to distribute half of it to a community nonprofit of the company's choice or to set up a donor-advised fund with a community foundation. The other half goes to EF's program services.

At the height of the technology boom, EF signed up 130 companies, though that's gone down a bit. The level of engagement also varies greatly, but supporters believe EF's efforts have been successful to the degree that companies buy into the philosophy.

"I think you could argue that there's a link between a company's financial success and its attitude towards philanthropy and the community," says Kevin Scott, a director at 3i US in Menlo Park and among those trying to spread the gospel to portfolio companies. "Companies that cultivate the philanthropic culture develop a virtuous cycle, where they attract and retain employees who manage their relationships and constituencies better." EF now has close to 300 members through affiliates in Atlanta, Boston, Dallas, Hawaii, Portland and Tel Aviv.

Another model of philanthropy, Social Venture Partners, took root in Seattle in 1997, focused largely on education. The brainchild of PageMaker software creator Brainerd, SVP was founded by about 40 like-minded beneficiaries of the local technology boom looking for a way to give back to their community.

SVP works with much smaller, six-figure nonprofits and relies on a high degree of volunteerism from donors. SVP members write smaller checks - a $5,500 annual commitment for two years - but the investors also commit to working closely with recipients. "Our folks give time, money and expertise," executive director Paul Shoemaker says.

At the height of the tech boom, SVP in Seattle had 282 partners. That number has fallen off to 270 since the downturn, though SVP's success in Seattle has also led to copycats across the country. It now has a formative national network in 23 other cities. "A lot of times, philanthropy is a solitary activity, but ours is a connected community, where members work together to figure out where the money goes, help solve the problems of a nonprofit and educate themselves about community issues," Shoemaker says.

SVP has raised about $20 million over the past six to seven years, but Shoemaker points out, "We are still growing as we go." SVP in Seattle has about $1.5 million in revenue, a small portion of which covers administration costs. The bulk of it goes to partnerships with K-12 education, out-of-school and environmental organizations in the Puget Sound area.

Just how effective is venture philanthropy in all its forms? "It's too soon to measure the long-term success," Core Capital's Dunbar says.

One drawback is that the sort of high-level engagement promoted by entrepreneur philanthropists who put in a relatively low level of investment isn't necessarily viewed as helpful. "That could sometimes create all sorts of tension and challenges, depending on the implementation," Buchanan says.

From periodic feedback from investees, the foundation executives say they have played an important role in helping to build and strengthen a specific set of nonprofits. But those successes in turn create a new level of challenges associated with scale and sustainability amid a chronic lack of sufficient funding.

"The question of scalability of nonprofits is a really complicated and interesting question," Buchanan says. "As with business, there can sometimes be a rush to growth and scalability, but can nonprofits grow like franchises? It may make sense for some and not for others."

Nonetheless, Buchanan believes that venture philanthropy has played a role in the past couple of years in engaging more traditional foundations in constructive dialogue. As a result, the emphasis on performance assessment of nonprofits has also engendered performance assessment within foundations themselves.

"People have moved beyond labels to have a real conversation about what is the right approach or what approach makes sense in light of what we're trying to accomplish," he adds.

SVP's Shoemaker sees venture philanthropy as a tiny but innovative segment of philanthropy, just as venture capital accounts for a small but dynamic share of financial capital that the American economy relies on.