(originally published: http://dealbook.nytimes.com/2012/12/11/in-new-brand-of-philanthropy-nonprofits-invest-in-for-profits/)
BY STEPHANIE STROM
IMPACT INVESTING A private school in Hyderabad, India, is financed by a company set up by Gray Ghost Ventures.
When the W. K. Kellogg Foundation set aside $100 million in 2007 to invest in companies that could produce both social and financial benefits, it was considered revolutionary. Historically, major foundations had used mainly stocks, bonds, real estate and other traditional asset classes to build their endowments.
Now, such investments are increasingly common — and profitable.
In 2010, the Kellogg Foundation invested $5 million in Wireless Generation, a tiny educational software maker working to improve public education in New York City. Just 219 days later, it made a 25.9 percent return after Rupert Murdoch’s News Corporation bought Wireless Generation for $360 million.
“The customer and market insights that the private companies we’ve invested in have, whether it be in food, health care, financial institutions or education, sharpened our ability to target our grant making and public policy efforts,” said Sterling K. Speirn, the foundation’s chief executive. “Similarly, I think the companies we have invested in are able to leverage not only our patient capital but the different kind of knowledge assets we bring to the relationship.”
Philanthropy is taking its cues from Wall Street and Silicon Valley. The language of finance is so common that it is sometimes hard to tell the difference between an investment conference and a fund-raiser. Grants are referred to as investments, and public-private partnerships as innovations. Money used to buy vans, computers and buildings is called growth capital.
“It’s not just the language that is changing,” said Antony Bugg-Levine, chief executive of the Nonprofit Finance Fund. “The actual distinction between the two sectors, for-profit and nonprofit, is starting to collapse.”
The shift stems from a new generation of philanthropists, like Bill and Melinda Gates Pierre and Pam Omidyar and Steve and Jean Case, hoping to stretch their dollars. As they see it, the pool of philanthropic assets — even at a whopping $4 trillion-plus — is too small to make a dent in seemingly intractable social problems like malnutrition, chronic homelessness, water quality and sanitation. So they are trying to find ways to reuse existing financing and to attract new types of capital.
“If we really want to produce transformational change, change in a disruptive, exponential kind of way, there is going to have to be more than philanthropic dollars involved,” said Steve Goldberg, a social investment adviser at Caffeinated Capital, which advises investors, governments and nonprofits.
In essence, the philanthropists want to enlist the capitalists — and they are making small inroads.
Last year, Morgan Stanley made a $12.5 million investment in the Bay Area Transit-Oriented Affordable Housing Fund, alongside foundations and government organizations. The housing group has financed a project in San Francisco’s Tenderloin district that will include 153 housing units and a development in San Jose that will provide 64 affordable housing units for older people.
Goldman Sachs has garnered attention for investing $9.6 million in the country’s first “social impact bond,” an emerging mechanism for harnessing private capital to underwrite social programs. The money helps finance a four-year program aimed at reducing the recidivism rate of male prisoners at Rikers Island. If recidivism declines by more than 10 percent, Goldman stands to make a $2.1 million profit. In the worst case, it loses at most $2.4 million.
Skeptics worry that some social services will be forgotten by deep-pocketed investors looking for financial returns. Programs that focus on feeding the hungry or on education may be particularly vulnerable amid cutbacks in government spending.
“Part of the problem with using the language of Wall Street in philanthropy — social impact bonds, impact investing — is the implication that there are market solutions to everything,” said Phil Buchanan, president of the Center for Effective Philanthropy, which generates data and research to help foundations. “In fact, many of the problems being addressed by nonprofits are a result of market failures.”
It is also too early to tell whether this is a philanthropy fad or a sea change in charity. Matthew Bishop, co-author of “Philanthrocapitalism ,” said that while the movement had grown significantly since the book was published in 2008, it had not necessarily led to big changes in charitable giving and investing.
Impact investing, still a relatively small portion of philanthropy, could also face growing pains. Mr. Bishop pointed, in part, to the problems with microfinance , where pension funds, banks and other financial firms poured money into tiny loans meant to improve the lives of impoverished entrepreneurs.
As microfinance institutions began to act more like mainstream investors, they suffered from declining credit quality, rising competition and weak regulations. “If you just focus on the business model and don’t work on building the marketplace in which that business is to function — the regulatory infrastructure and so on — you can produce some pretty bad outcomes,” Mr. Bishop said.
The Gates Foundation, the world’s largest, is taking a blended approach, combining grants with targeted investments. It has a $1 billion pool for investments and loans that further its philanthropic goals, and it spends more than $3 billion a year on traditional giving. It recently made equity investments in biotech companies like Visterra and Genocea, which are working on technologies that complement the foundation’s work in global health.
The foundation has also made several deals aimed at reducing the price of vaccines. This year, it created a sort of purchase guarantee, effectively promising to buy a GlaxoSmithKline product. The deal gave GlaxoSmithKline the security it needed to invest in manufacturing a less expensive rotavirus vaccine.
“There’s a lot of potential for working with pharmaceutical companies and others to create access to products for the poor,” said Julie Sunderland, senior program investment officer at the Gates Foundation.
Other philanthropic ventures are also trying to leverage existing resources. Gray Ghost Ventures, an investment firm established by Bob Pattillo, a real estate developer, provides capital for projects that address the needs of low-income communities around the world. It has invested in companies that cater to the poor, like D.light Design, which is developing low-cost lighting products for people without reliable electricity, and Babajob, a Web- and mobile-based job search and placement business aimed largely at India’s maids, gardeners and other household workers.
Gray Ghost has also set up the Indian School Finance Company to lend money to private schools, which serve more than 60 percent of the country’s students. Such schools find it hard to obtain financing for improvements and upgrades. The company is trying to fill that gap with midsize, market rate loans. “Making those investments can help them attract more students, so they generate income to pay off the loan and more kids get an education,” said Jennifer McReynolds, head of investor relations at Gray Ghost.
Mr. Pattillo’s private foundation, Gray Matters Capital, supports the project philanthropically. For example, it offers fellowships to recent college graduates to work on the administrative side of the private schools.
“We need to harness the best of both the capital markets and the social sector to address problems we cannot solve inside the two silos,” Mr. Bugg-Levine, the Nonprofit Finance Fund chief, said. “The ensuing confusion is a small price to pay if what it ends up in is adaptations that bring some sustainability to our social endeavors.”
