Towards greater financial sustainability in the social sector

Much has been written about the financial sustainability of social purpose organizations and social enterprises. As consultants working in the humanitarian ecosystem, we constantly get asked by social investors as well as social enterprises to assist them with #fundraising strategies to become more financially sustainable and independent and it is this growing demand which has led me to write this article.  

My hope is that this article will provide some guidance to organizations that is currently facing financial constraints due to diminishing income and a lack of know-how to grow and diversify their income so that they can serve their constituents better.

Financial sustainability is the most important factor to validate your organization’s existence:

Financial sustainability is probably the most fundamental skill and competency that every social purpose organization and enterprise must master. It is no longer good enough to create products, services and solutions to solve some of humanities biggest challenges. Social purpose organizations must also be able to create impact and they must generate a predictable inflow of cash to support their operational needs.

• For most for-profit entrepreneurs, external fundraising starts the first time the organization needs to spend more cash than the founders can provide and continues at key points as the company grows. 
• But for nonprofit entrepreneurs, the fundraising process may never cease. And issues of financial sustainability become even more challenging as the organization work to scale their impact. 

Most social purpose organizations continuously grapple with innovative ways to generate more predictable revenue over time, so they can align the work they need to do with the amount of cash they have to do it.

But, as social purpose organizations journey becomes more complex, so too does the funding landscape. Sources of capital continue to evolve, with the field now moving toward funding tied to performance-based milestones and syndications of multiple funders (with similar objectives) leveraging government and private funds.

The dance of achieving #impact while fundraising is a two-part tango that nearly every social purpose organization has encountered, often with both excitement and trepidation. It is a tough burden that is placed on organizations aiming to help solve the world’s problems.

As social purpose organizations drive toward scaled impact, the journey can be accelerated—or significantly slowed—by the strategies and tactics used to manage their financial needs. Accessing the right financing at the right points in the journey is critical to scaling success. Every organization undergoes an evolution of capital over time. But how do you ensure that that evolution supports your goals instead of the whims of available capital driving your goals?

In the section below we provide some guidance for how to ensure greater financial sustainability:

Option 1: Finding flexible capital

Generally, the most effective financing strategies stem from the organization creating a clear strategic direction and then working to find funders and sources that fit that strategy. This clarity allows social purpose organizations to make choices at each stage of their journey about the best sources and types of capital, whether it be capital that allows for flexibility to test and iterate, to assess and prove impact, or to crowd in key stakeholders critical to scale. In the most sophisticated cases, financing serves an integrated function of both achieving a strategic goal and sustaining the organization.

Many organizations also think about using revenues from their own work to drive towards sustainability, ideally to unlock new forms of capital needed to scale (e.g., impact investment capital) or to become less dependent on external capital. Social enterprises can make significant progress toward achieving operational self-sufficiency or sustainability. Yet there are very often natural limits in an organization’s ability to pursue this objective without sacrificing mission goals. Many of those who have navigated these natural limits have emerged with increased clarity that enables them to pinpoint a more feasible balance. In turn, they become more proactive in accepting only funding relationships that are aligned with this clarity.

How to do it:

• Sell funders on your vision and milestones rather than on your specific activities to give yourself the most room to develop and shift resources according to need. 
• Create a clear operating plan and treat your donors and investors as partners, informing them as you learn, so that you can build trust. The more trust, the more likely they will provide more and more flexible funding.
• Look to build relationships with local, high-net worth individuals and corporate donors to raise your unrestricted funding levels.
• Seek out social entrepreneurship-focused foundations and accelerator programs, which aim to invest flexible capital.
• Through detailed cost accounting, tell a clear story with specific figures about what you need unrestricted money to do and why it is necessary.
• Be crystal clear about the costs that will not decrease as you scale both your business and development models and thus will require ongoing unrestricted subsidy.
• Carve out an R&D fund to encourage investment from donors interested in funding innovation but less willing to commit to more general flexible funding.
• When working with corporates, find out what they care most about in terms of marketing, branding, or integration with their businesses. These factors may matter more than restrictions on the cash they provide.
• If you have recurring revenues and can afford regular payments, consider low-interest loans as a strategy to garner capital with more flexible use restrictions.

Option 2: Diversify your funding sources and types of capital, including impact investing:

Aiming to create funding relationships with a diverse group of funders has several advantages. Diversifying funding sources reduces the risk of any one funder changing strategy and evens out cash flow. Diversifying by funding 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 impact data or success stories to share as well as a story of momentum. Organizations with strong revenue models can also engage with impact investors to diversify their capital mix.

How to do it:

• 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.
• 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/investor 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 investor and funder relationships.
• 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 clear 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 in the future.
• Look for creative ways to engage with impact investors, and do not be afraid to invent new structures that work best for both of you.

Option 3: Don’t be scared of results based funding

Many organizations around the world are starting to experiment with results-based financing (RBF), where a payer (a foundation, international donor, or government) conditions its payment to a service provider (a social enterprise, NGO or private company) on desired outcomes. Results-based financing is often seen as a tool to unlock private and/or public capital and provide flexibility to achieve outcomes. These structures incentivize service providers to drive toward cost-effective impact and funders—including governments—to recognize the full costs of achieving targeted outcomes.

An RBF tool that is gaining popularity is Social Impact Bonds (SIBs, also known as Pay for Success contracts or Social Benefit Bonds). SIBs are unique in that they involve an investor who provides the capital up front with the promise of repayment with some level of financial return if outcomes are achieved.

How to do it:

• Do some hard introspection about why RBF is right for you. Do not pursue it because it is new and trendy. Do it only if you are genuinely convinced it is strategic and aligned with your goals.
• RBFs take more time and money than you will project. Be ready for that.
• Start with a grant-funded pilot so that you are in a better position to negotiate contracts around what it will take to deliver outcomes. Be proactive and accept only partners who are right for you, who align with your purpose, and with whom you can learn.
• Be wary of building a model based on secondary data, and, especially, on government data: ask how recent and how trustworthy it is (is it self-reported?), and how often it will be updated. Wherever possible, conduct a baseline or use a third-party evaluator to conduct an assessment.
• Be very careful on pricing of outcomes delivery since you will be accountable to that price for the remainder of the contract. A strong experimental study can convince stakeholders of your efficacy and help you arrive at a more accurate price point.
• For RBF offerings, look carefully at the funding term sheets. Governments may underestimate the true cost of implementing services. For example, the cost models in government offerings rarely include full legal, administrative, and pre-launch costs. You should double or triple your estimates and spend the time to fundraise around these items up front.
• Look at everyone’s costs, not just your own. If the third-party evaluator is receiving more money than the service provider, the SIB arrangement may not be scalable. Do not assume that pro-bono legal help will suffice.
• If you are taking the role of an implementing organization, you will likely have to expand your team to get this done. You will need to have the best impact assessment and analytics you can afford. And it can take years to find the right people with specialized skill sets.

Option 4: Reduce your costs

Social purpose organizations and impact entrepreneurs continually reduce ongoing costs in many ways, including making improvements to their business and development models that decrease operating costs, leveraging opportunities for economies of scale, or increasing the efficiency of required inputs (e.g., materials, human resources, and other supply resources).

Another option is to change the “build vs. buy” frame, making strategic decisions about which pieces of the solution the organization needs to operate directly (“build” internal to the organization’s operations) versus outsourcing to other organizations (“buy”). Buying could be in the form of having another organization (e.g., another social enterprise, a government partner, etc.) implement a piece of the model or better aligning with other organizations that can deliver complementary pieces of an overall value chain and hand-off to the primary organization, or vice versa.

How to do it:

• Even small tweaks can add up to large savings over time, but the process of testing tweaks takes time and resources. Have systems in place to set criteria for what you test and at what level of effort.
• Always keep impact at the fore and ensure that your cost efficiencies do not have a reducing effect on quality.
• Map your ecosystem to identify other actors in your value chain whose work you might be able to leverage.
• Pay attention to the scaling limits of your value chain partners. Can they scale as fast as you can?
• Create a performance-based culture and processes that incentivize cost efficiency (e.g., embed discussions within performance reviews, staff meetings, and post-action reviews of programs or events).
• Leverage technology, when appropriate, to drive cost efficiency.
• Consider implementing through other partners, but be careful about program fidelity; if something needs to be implemented, can you document and train effectively to outsource or does it need to stay more firmly under your control?

Option 5: Earn some of your income

Earning income can be a powerful tool to fuel the growth, development and scaling of your organization and its programs. Money gained through earned income is unrestricted, not subject to changing priorities of funders, and can often help to drive quality by ensuring direct connection with customers and other stakeholders. It can also be empowering for customers to be actively engaged as decision-makers in the process, rather than more passive aid recipients.

Alongside the increasing competitiveness of philanthropic and government funding—earned income is an attractive option for social enterprises to pursue. However, while a powerful tool, it is not a panacea. Earned income strategies require significant time and resources to assess and implement. They require staff with specific skill sets, such as the ability to test product/market fit and pricing, conduct accurate financial projections, and simply determine which core assets - from content to goods and services to data—might be sellable while still aligned with your organization’s objectives.

How to do it:

• Evaluate and test before diving in to earned income: what are the risks, challenges, and market demand for the goods or services you want to sell? What is realistic to expect in terms of returns and profits?
• Make sure you are ready to pursue earned income—have effective systems in place to track financials, staff skills and the capacity to evaluate and implement business related endeavors, and of course, board risk appetite and clarity on the organizations mission and strategic objectives.
• Carefully and narrowly define your target customer. Ensure everyone selling in your organization can articulate the core customer’s characteristics.
• Avoid mission creep by clearly understanding the drivers of impact in your business and development models, measuring them routinely, and having go/no go checklists to hold your team accountable.
• Pilot and test changes to your intervention to ensure that the increases in financial sustainability do not have unwanted (negative) consequences on impact.
• Find a metric that allows you to balance impact and effective use of funds and lets you compare across programs (your own programs to guide decision-making, as well as external programs to make the case to funders).
• Getting to economies of scale takes time and you must first invest in scaling. 
• Consider different cross-subsidy models, e.g., differentiated pricing, and differentiated products.
• When cross-subsidizing, carefully balance your core customers against your up-market customers to ensure that you are staying on mission.

Option 6: Consider and leverage hybrid legal forms

Social enterprises are increasingly exploring the strategy of creating hybrid forms to expand impact and income. Hybrid models bind nonprofit and for-profit entities together through governance and/or contract mechanisms—for example, a for-profit company that creates a nonprofit foundation, or a nonprofit that launches a for-profit to pursue a different type of revenue-generating activity. These models are often structured as parent-subsidiary relationships or as contract hybrids wherein contracts align their objectives on a long-term basis.

Regardless of the form, hybrid models can expand impact, increase access to different capital sources or customers, and provide important risk mitigation. Alongside those benefits, hybrid forms incur costs as they require additional overhead to manage two (or more) entities as well as additional legal complexity to ensure adherence to charitable restrictions/legislation—so that potentially conflicting transactions occur at arms-length.

How to do it:

• Consider a hybrid from a position of financial health, not desperation!
• Align purpose by starting with mission first and seeing whether a hybrid form helps to expand your impact—not just your bottom-line.
• Make realistic assumptions (and test them) before launching a subsidiary. Will it ever be possible to cover all operating costs and generate a profit for the target audience that you seek to serve? How long will it take you to get to profitability and how much will you need to invest to get there?
• Ensure clarity of boundaries among the entities, clear governance and decision-making rights, and culture alignment.
• Nonprofits can access equity-like funding if they have valuable IP and a strong revenue stream and are willing to create a legal hybrid form.
• Be careful to consider and mitigate all the risks (legal, reputational, financial) of a hybrid structure.
• Make sure to protect your intellectual property and other assets, while maintaining control and alignment with mission.

Mistakes to avoid during your journey to greater financial sustainability:

• Assuming that funders of flexible capital require less rigor for reporting on progress and impact.
• Not understanding the different motivations and communications preferences of investors and donors.
• Not leading your own deal terms. Do your homework and negotiate for what is aligned with your needs and goals.
• Under-planning for the significant time and effort required for set up, including legal and accounting.
• Underestimating costs to deliver on outcomes and using inaccurate secondary data to set the baseline against which you will be judged.
• Draining internal resources to be able to effectively manage the different contracts you will be working with.
• Failing to adequately test the implications of cost-efficiencies on the business and development models you will be using.
• Underestimating the costs to pursue earned income, including staff skills and capacity, systems, time to test and iterate.
• Misaligning the earned income product/service with the organization’s mission and core assets.
• Prioritizing profitability over impact goals.
• Assuming that creating a hybrid will help save a struggling organization.
• Misalignment between teams, cultures, and systems working for separate but related entities.
• Underestimating the costs and complexities of hybrid forms—legal, financial, and reputational.

In conclusion, I would be remiss if I did not consider what funders can do to assist social purpose organizations to become more financially sustainable. The following are some suggestions:

Provide access to flexible funding:

• Fund organizational outcomes, not activities. Organizations need room to pivot, adapt, and innovate around the ways in which they deliver impact to end up stronger with more robust strategies. Funders should shift away from project-based modes of financing—where activities are often prescribed, and it is difficult for the organization to adjust course—to funding the enterprise’s vision, whole business plan, or a set of target outcomes. 
• Measure with milestones. Measure organizations’ progress and results against a few key milestones as opposed to a more granular list of specific activities. 
• Fund for multiple years. Provide multi-year funding (with smooth outflows) where possible, to allow for long-term strategic planning and smoother expenditures. 
• Fund pilots and testing at all stages. Successful scaling organizations continue to pilot-test efficiencies and new ways of achieving impact but require funding to do so. Encourage and support their testing and risk-taking. 
• Encourage and reward transparency. Encourage learning and transparency through your own sharing of lessons learned and incentivizing organizations to reflect on failure and pivots. Build trust by providing timely help, feedback, and questions during non-crisis times. When a problem emerges, help your grantees/investees generate excellent solution options, which will help ensure that they can make the best decisions.

Support efforts to diversify funder bases:

• Make diversification possible. Decrease the management burden attached to spending your capital, so that the organizations maintain capacity to bring in (and manage) additional funders. Collaborate with other funders on diligence, negotiation of terms/outcomes, and reporting/measurement requirements where there is alignment.
• Help amplify key moments. Use key moments of success to act as an advocate and connector on behalf of the organization, to help them bring in new funders. 
• Be a signal to other funders. Support the hand-off/exit process if an organization is graduating from your type of funding. Help make connections and leverage your brand to act as a signal to other funders, even ones with very different capital. 

Support efforts to reduce costs:

• Spend money to save money. Support (financially and with other resources) processes to identify, test, and implement efficiencies. 
• Buying vs. building. Encourage growth through partnerships. Beyond capital, explore providing technical support and network connections to help organizations build value-chain partnerships. Be patient, as partnerships often take significant time to develop. 

Participate in results-based financing:

• Fund RBF design costs. The design, administrative, contracting, convening, and legal costs of an RBF are often not fully accounted for in government tenders that are based on a dollar value per outcome. 
• Provide grant funding to facilitate RBF planning and execution. This can include baseline studies, legal counsel, and new hiring costs for both service providers and intermediaries.
• Support outcomes-focused pilots and upgrades to enterprise performance management systems. Help organizations to understand if RBF’s are right for them and to put themselves in a strong position before entering an RBF contract by funding outcomes-focused pilots. Once the RBF is in place, help organizations upgrade their performance management systems to more efficiently and effectively troubleshoot and pivot as the RBF project progresses. 
• Commit to learning together. The field is still learning how to best design, structure, and implement RBF contracts. Before engaging, commit to learning with the other RBF stakeholders and to continuously adapting the process.

Support efficient impact through earned revenue:

• 100% self-sufficiency on earned income is often infeasible. Recognize that full operational self-sustainability is not always the right target for organizations seeking to change systems. Encourage organizations to identify and define a metric for sustainability or value of impact per dollar that allows them to drive toward best value impact instead. Help organizations understand the information you need to trust their metric. 
• Be the insulation from earned revenue fluctuations. Even organizations with strong earned income streams are likely to suffer shocks to this revenue given the inherently riskier and less predictable environments in which they work—particularly when they test new markets or approaches to achieve more efficient impact. Provide insulation for these fluctuations by providing patient, risk-tolerant capital and encouraging learning and innovation around the “shocks.” 

Support use of hybrid models:

• Support hybrid structuring processes. Many organizations use hybrid forms to unlock new types of capital but require additional resources for the accounting and legal advice necessary to do so. Funders can provide support for that behind-the-scenes process.
• Bring different capital to the table. As organizations adopt hybrid forms, there may be opportunities to fund their work with new types of capital. Know where the tools and resources you can provide fit in the capital stack and seek additionality—filling in the gaps where your offering adds value. Existing funders can either bring new capital themselves or act as a connector with other funders.

Reana Rossouw is the owner of Next Generation and creator of the Investment Impact Index. She works with social and impact investors as well as social enterprises to create, manage, measure, verify and report on impact and return on investment.

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