Unlocking Profit Potential: Your Organization's Guide to Social Entrepreneurship

Unlocking Profit Potential Your Organization’s Guide to Social Entrepreneurship

B OARD S OURCE E B OOK S ERIES

B OARD S OURCE E B OOK S ERIES

© 2002 BoardSource. First printing, April 2002. ISBN 1-58686-049-6 This publication may not be reproduced without permission. Permission can be obtained by completing a request for permission form located at www.boardsource.org. Revenue from publications sales ensures the capacity of BoardSource to produce resources and provide services to strengthen the governing boards of nonprofit organizations. Copies of this booklet and all other BoardSource publications can be ordered by calling 800-883-6262. Discounts are available for bulk purchases. The views in each BoardSource publication are those of its author, and do not represent official positions of BoardSource or its sponsoring organizations.

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“Whether or not organizations succeed in creating community wealth (i.e., resources generated through profitable enterprise to promote social change) depends on their ability to think in new ways about assets they may have previously taken for granted or not initially recognized as such. Fortunately, the best practices from the business world and the experiences of the most innovative pioneers in the nonprofit world have led to the development of specific processes that help organizations do just that. It all begins by believing and understanding that you are worth more than you think.” — Bill Shore, The Cathedral Within

Contents Introduction.....................................................................................1 I. The Options of Social Entrepreneurship .....................................3 II. Corporate Partnerships vs. Business Ventures............................7 III. Should Your Nonprofit Consider Social Entrepreneurship? ...11 IV. The Board’s Role in Social Entrepreneurship ...........................17 V. The Role of Non-Board Members..............................................19 VI. What Constitutes Success?......................................................23 VII. Risk Factors ............................................................................25 VIII. For-Profit Subsidiaries...........................................................30 IX. Build vs. Buy ............................................................................33 X. The Importance of the Business Plan .......................................35 XI. Moving from Planning to Implementation..............................38 XII. Potential Roadblocks ..............................................................40 XIII. Steps to Success.....................................................................42 Conclusion.....................................................................................45 Appendix I: Frequently Asked Questions .....................................46 Appendix II: Business Acquisition Screening Criteria ..................48 Appendix III: Defining Success .....................................................50 Appendix IV: Capacity Readiness Tool..........................................51 Appendix V: Corporate Partnership Questions.............................53 Suggested Resources ......................................................................54 UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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Introduction The nonprofit sector is changing. As the demands placed on the sector continue to increase, resources do not. Under the budget plans from 1997 to 2002, nonprofit organizations lost more than $40 billion in federal funding. The recession that began in 2001 as well as events of September 11, 2001, and the effects they had on the economy have also affected the nonprofit sector — the endowments of many private foundations are shrinking, and other donors are cutting funding from some nonprofits to give money to disaster relief organizations. Despite these challenges, there is an increasing need for services from nonprofit organizations and a demand for more complex services. In response to these needs, more nonprofits are being created. In the United States, there are more than 1.6 million nonprofit organizations. More than 700,000 of these are 501(c)(3) organizations. According to information compiled by the Boys and Girls Club of America, every month the IRS charters about 3,000 new 501(c)(3) organizations. With all these nonprofits being created, organizations with similar missions operating in the same area can end up competing with each other. In response to these pressures, many nonprofit organizations have stopped relying solely on donations from foundations, individuals, or the government. Instead, they are taking a proactive approach to generating revenue. These organizations are conducting profitable enterprises that generate revenue while fulfilling their missions. The staff leadership and board members of these organizations are social entrepreneurs — they balance the need to generate revenue with the organization’s mission objectives. Social entrepreneurship can come in a variety of forms, including • generating sustainable new resources to support the organization’s mission, • working with existing markets to generate revenue for nonprofits, • securing unrestricted funding to allow greater flexibility, • decreasing dependence on traditional funding sources to become more self-sufficient, and • finding new ways to leverage existing assets. Many nonprofits have found that successful ventures in social entrepreneurship can lead to improvements throughout their organizations. With a more efficient revenue strategy in place, board members can spend less time on raising funds and more time focusing on the mission, programs, and services of their organizations. The benefits of social enterprise may sound tempting, but nonprofit board and staff members need to be aware of the potential risks involved as well. A poorly planned business venture could lose money, thus hindering the organization from being able to fulfill its mission. For some organizations, social enterprises — both successful and unsuccessful — can become a primary focus of operations that unnecessarily distracts attention from them fulfilling their mission. Successful social enterprise requires board and staff members to assess the risks involved (see page 25) and be willing to take them. UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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A nonprofit should be in good shape before experimenting with social entrepreneurship. It should have stable leadership, a solid financial position, a united staff and board, and a clear vision for the organization that includes sustainability objectives. A nonprofit does not, however, need a staff and board full of MBAs or financial gurus to launch a successful business venture, although these skills can be helpful. This booklet will do the following three things: 1. educate board members about the concepts of social entrepreneurship and the options that are available, 2. inform board members of key issues they should be aware of in order to make decisions regarding social entrepreneurship, and 3. give board members direction on how they can be involved in social entrepreneurship. In this booklet, board members will find • descriptions of alternative ways nonprofits can raise revenue, • case studies of nonprofit organizations that have experienced success with various business ventures, • guidelines on determining the best business venture for the organization and getting it started, and • steps to take for preparation and implementation of a revenue strategy.

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I. The Options of Social Entrepreneurship Earned-Income Opportunities The following graph illustrates the multiple pathways to revenue generation for nonprofits:

Business venture strategies are income-generating opportunities that may be directly related to the organization’s mission. For example, if you provide job training to a client population, a service enterprise opportunity such as custodial work or light manufacturing may be an appropriate venture to provide training and make a profit. Similarly, depending upon your organization, a product, such as a curriculum, or a retail establishment, such as a religiousoriented bookstore, may be linked to your organization’s mission. Alternatively, the venture may simply be supportive of the organization’s mission-related activity. A financial management service to other nonprofits may not be related to your UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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mission, but the service might be based on your organization’s strength in this area of operations, and the profits can be used to support your mission. An example of unrelated businesses in the product and retail categories include the increasingly popular automobile donations and auctions. If your organization provides services or products to disadvantaged populations, a revenue opportunity might simply be to expand your services or products to client populations that have an ability to pay. Corporate partnerships are less flexible than business ventures because the asset you are often leveraging is your mission or assets related to your mission, such as a service or your client base. What attracts partners are the specific assets you have because of your mission and how these assets can translate to their bottom line. Corporations already have a handle on their most obvious business issues and need access to something tangible or intangible that allows them to effectively differentiate their product and ultimately grow their revenues. Whereas business venture opportunities can be limited only by market dynamics and your ability to execute on the opportunity, corporate partnerships are completely dependent upon the uniqueness of your organization. (For more on business ventures versus corporate partnerships, see page 7.)

W HAT ’ S D IFFERENT

ABOUT

S OCIAL E NTREPRENEURSHIP ?

Social entrepreneurship is… • generating sustainable new resources to support the mission, • engaging market forces to work for the nonprofit sector, • allowing for greater flexibility by bringing in unrestricted revenue, • decreasing dependence on the external funding community, and • devising new ways to leverage existing assets. Social entrepreneurship isn’t… • traditional fund-raising, • grant money, • gifts or donations, • leftover wealth, • a quick fix out of a financial crisis, or • a practical option for every nonprofit.

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Another way social entrepreneurs are generating more revenue for their organizations is by purchasing franchises or existing small businesses. These businesses are not always related to the organization’s mission, so they can be set up as for-profit subsidiaries. Purchasing existing businesses works well for some organizations because it saves them and the initial investment that is required to create a new business. However, purchasing an existing business is by no means a hassle-free solution. Nonprofit board and staff members must carefully research the business before buying it to ensure the organization is not inheriting a financial disaster. (For more on purchasing existing businesses, see page 33.) As more nonprofits experiment and find success with different revenue-generating strategies, the list of possibilities will continue to grow.

S TAYING C OMPETITIVE In order to make a profit from social enterprise, the organization must be able to stay competitive. Often competition causes nonprofits to streamline operations to become more effective. Nonprofits may also have to discontinue fee-for-service programs that are not generating enough revenue or create new programs that are in-line with both the organization’s mission and financial objectives. For the organization to reach its objective of generating surplus business revenue to funnel back into its programs, it must have a portfolio that actually generates a profit. This is not to say that every program that is not profitable should be discontinued. If an organization’s program is the only one in a community that meets a particular need, it is the nonprofit’s obligation to fulfill its mission and continue to meet the needs of the community through that program. If a program is losing a significant amount of revenue, however, the organization should seek new sources of funding or other alternatives to help support the program.

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C OMMUNITY FAMILY L IFE S ERVICES : M AKING IT W ORK Every day, about 500 government workers and others with jobs nearby gravitate to a restaurant called Third & Eats in Washington, D.C., for breakfast and lunch. The restaurant doesn’t make a profit, but it fulfills its mission — to train homeless and lowincome people in the culinary arts. With a regular staff of four people plus eight to ten trainees, the restaurant sells good food at cheap prices. Trainees work there for only four months, then are placed in other jobs, says Reverend Tom Knoll, executive director of Community Family Life Services, which started the restaurant. Then a new batch of trainees takes their place. The trainee program has about a 50 percent dropout rate, says Knoll. “Some people start and they say, ‘I didn’t know I would be standing on my feet all day.’ Or ‘I have to go to court for three weeks.’ Then they drop out and come back — or sometimes they don’t come back at all.” Third & Eats is a nonprofit restaurant. The trainees are too slow and too inefficient for the restaurant to make any money, says Knoll. But it does a brisk business nonetheless. “We’re successful because of our location,” he says. “We have 15,000 federal workers within two blocks of our restaurant and maybe fewer than five lunch places for them to eat in those two blocks. So we have a captive audience. And the training is successful because we have the right team and the right staff.” Raising capital to start the restaurant was a struggle. It was hard to find either grants or loans. “Banks do not give a lot of loans to restaurants because one out of every four dies in the first year,” explains Knoll. Eventually, he got a 30-year loan from the Lutheran Church, Missouri Synod. The work of running a restaurant staffed by these trainees doesn’t get any easier with time. Integrating the training into a business operation is a challenge. “You have homeless people who have a hard time dressing appropriately or taking care of their own personal hygiene, and now they’re serving customers food. Or people who come to work high on drugs. How do you deal with that? Do you let them stay high and deal with the customer, or do you have them removed or dropped from the program?” Knoll said. Nevertheless, the program works. It places 90 percent of the trainees who finish the program, and in 10 years it hasn’t missed a single payment on its loan. A sign of its success: The judges at the U.S. Tax Court, across the street from Third & Eats, didn’t like the food in their cafeteria, so they asked Knoll if his group could take it over. He accepted their offer. The cafeteria serves the same menu as the restaurant and just breaks even. But it’s worth it. It uses the large kitchen to run a $187,000 catering business, the profits of which subsidize the restaurant. Knoll warns that restaurants and catering are very tough businesses to run, especially when they have a mission of training people with social problems. “A lot of nonprofits today, when they talk about opening a business, say, ‘Maybe we ought to start a restaurant,’” says Knoll. “A lot of our graduates say the same thing. But mom and pop restaurants survive because mom and pop work 15 or 16 hours a day. Nobody talks about that. That’s why many of these businesses don’t make it.” UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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II. Corporate Partnerships vs. Business Ventures While most of this book discusses business ventures, corporate partnerships are another way nonprofits can diversify their revenue. A corporate partnership is a relationship between a nonprofit and a company. In exchange for money, products, services, or other considerations, the nonprofit provides the corporation with recognition and occasionally permission to use the nonprofit’s name in corporate marketing. Corporate partnerships can be a symbiotic endeavor for nonprofits and corporations: Nonprofits receive the funds needed to support the organization’s mission, vision, and values; and corporations benefit from the opportunity to have their names associated with a wellrespected nonprofit and to give back to the community.

SHARE OUR STRENGTH BOTH SIDES

AND

AMERICAN EXPRESS: A PARTNERSHIP BENEFITING

Share Our Strength is a nonprofit organization that works to end hunger and poverty in the United States. The nonprofit supports food assistance, treats malnutrition and other consequences of hunger, and promotes economic independence among people in need. The organization has a history of creating corporate partnership programs and causerelated marketing initiatives. One of the most successful partnerships Share Our Strength entered was with American Express, when the two entities launched the Charge Against Hunger campaign in 1993. The partnership has benefited both sides. American Express had found that many merchants were not accepting their cards because the transaction fees were higher than those for other credit cards. The company began looking for a way to integrate itself with the restaurant industry since restaurants account for a large percentage of the charge business. It started by offering to sponsor Taste of the Nation, a national SOS benefit event that was popular with chefs across the country. SOS received $400,000 for the event and a promise for future collaboration with American Express. From this, the Charge Against Hunger campaign was born. In this campaign, American Express donated two or three cents to SOS every time someone used an American Express card. The Charge Against Hunger program lasted until 1996 and raised more than $21 million for SOS to hand out to charities. In addition, AMEX continues to be an avid supporter of SOS and is one of the key sponsors for its national Taste of the Nation event.

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Both business ventures and corporate partnerships have advantages and disadvantages that staff and board members must consider before deciding which strategy is best for their organization.

B USINESS V ENTURES — P ROS • Business ventures present opportunities to many more nonprofits than do corporate partnerships. There are a variety of ways nonprofits can leverage their assets to find new sources of revenue through venture-related activity. • The American economy is built upon the continued emergence and growth of small businesses — more than 5 million small businesses were in operation in 1999. • Nonprofits that launch business ventures become less dependent on the size and strength of the organization and more dependent on the actual business opportunity. This can be especially advantageous for small organizations. • The size and scope of a business venture can be as small or as large as the organization wants — it will depend on the organization’s definition of success. • The marketplace rewards performance; business ventures typically reward success through opportunities to generate revenue or diversify into further opportunities.

B USINESS V ENTURES — C ONS • Failure could cause the organization to lose the initial investment. • If the marketplace is excessively competitive, the organization will be under increased pressure to perform competitively. • It may take some time to generate a profit — few businesses are profitable in their first year. • The nonprofit may have to go into debt to finance startup costs and working capital needs. • The talent needed to launch the business venture often doesn’t exist within the organization and may require bringing in new staff. • There could be tension between the culture of the nonprofit and the business because the priorities of the two entities may be at odds even though they appear to be working to support the same mission. • A business is something that has to be built, a partnership just has to be supported.

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C ORPORATE PARTNERSHIPS — P ROS • If the agreement with the corporate partner is structured properly, the organization is guaranteed to make a profit. • Corporate partnerships typically do not require upfront payments that could cause nonprofits to go into debt. • If the nonprofit picks a good partner, there could be positive co-branding opportunities and the potential for regional or even national exposure. • Corporate partnerships give nonprofits access to corporate marketing talents and skills. • Less structure is required to succeed with a corporate partnership than with a small business. • Corporate partners will reward success — if the arrangements meet or exceed the needs of the corporate partner, long-term relationships could result.

C ORPORATE PARTNERSHIPS — C ONS • Few nonprofits possess enough of a brand or market presence to make it on a corporate partner’s radar screen. Corporate partnerships are often a luxury for nationally recognized or strong regional nonprofits. Locally based partnerships do exist, but are often small in scale.

P RESENTING Y OUR A SSETS TO PARTNERS The following is an example of the assets Share Our Strength presented to American Express when forming their partnership. Share Our Strength has a number of key assets at its disposal, some of which are far more valuable than others in terms of creating community wealth. Our assets include • extensive network of chefs and restaurateurs, • entrepreneurial spirit and innovative culture, • strong expertise about health and nutrition, • network of poverty and hunger nonprofits, • recognized name and solid reputation, and • charismatic, strong leadership.

• The skills required for nonprofits to sell and manage the partnership are often hard to find and are usually not available among existing nonprofit personnel.

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• Some for-profits may have a hard time perceiving a nonprofit as a partner rather than a grantee. Moving from a philanthropic relationship to a business partnership with a corporation can be a difficult transition for a nonprofit to achieve. • Maintaining momentum with a corporate partner can be difficult, and corporations often are not willing to support underperforming relationships. • Corporate partners typically will want unfettered access to senior leaders of the organization and will expect a high level of support and service from the nonprofit.

O PERATIONAL P HILANTHROPY Ultimately, what your organization should strive for is what some in the field have termed operational philanthropy — a complete synergy of your venture or partnership objectives with the business operations objectives of your partners or key clients. A nonprofit that establishes itself as strategic partner that adds significant value to its business relationships will find considerable opportunities available to help maintain or grow its business or partnership. This doesn’t just have to translate solely into revenue enhancement, which is to be expected, but also into other benefits such as investment capital, skills training, access to best-practice information and equipment upgrades. The bottom line is that your partner or client now sees your organization as a critical driver of their own success and as a result has a vested interest in your own long-term success. To make the organization more appealing to potential partners, the nonprofit should demonstrate how it can be a valuable business partner.

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III. Should Your Nonprofit Consider Social Entrepreneurship? Before determining how your organization can generate revenue, you must first decide whether your organization is ready to take on a new business venture. Board members should discuss the following questions to determine whether social entrepreneurship would be worthwhile for the organization. What is your current economic situation? Social entrepreneurship is not a get-rich-quick scheme for nonprofits. It often takes two to three years for a small business to break even, let alone generate a profit. Organizations launching business ventures need to be financially stable and able to afford the investment social entrepreneurship requires. Is there a need to diversify funding? If your organization gets most of its funding from one source, social entrepreneurship may be an option worth considering. Organizations that are getting a sufficient amount of funding from a broad variety of sources may not have as great a need for alternative sources of revenue. How good is your organization at traditional development? If you know your organization could hire development staff that could bring in more money than a business could, your organization should probably stick with traditional fundraising. If, however, your organization has a hard time finding funding from traditional funders or existing funding relationships are reaching a mature level, it may be time to try social entrepreneurship. Have you effectively tapped your development opportunities? Is your list of potential funders continuously growing, or has the funding well run dry for your organization? Organizations that have only touched the tip of the iceberg when it comes to development opportunities may not need to consider social entrepreneurship. How stable is your management situation? An organization that launches a business venture must be secure. Times of high staff turnover or executive transitions are not the times to start a new business venture. Are you an entrepreneurial organization? Is your organization flexible and open to new ideas, or do staff and board members tend to stick to the traditional, more conservative ways of doing business? If your organization has a history of being innovative and resourceful, the organization will be more likely to have success with social entrepreneurship. What are the opportunity costs? In other words, are there other ways the money might be spent more productively? For example, if a nonprofit invested in a small business activity when it could have used that money to hire a grantwriter who could bring in more money

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than the business activity, the opportunity cost is the money invested in the business that is lost because hiring a grantwriter would have been more effective. What are the risks? The board and staff must assess the potential risks involved with social enterprise before deciding whether the organization is ready to try a new business venture. It is worth noting that the risks can be multiple and not limited to economic issues. (For more on the risks of social entrepreneurship, see page 25.) What is your risk profile? Staff members, board members, and constituents also need to be willing to change and to take risks, even if that means going against institutional culture. In order to make the organization more comfortable with taking risks, there should be a clear connection between the venture and how it will support the organization’s mission. If staff and board members can see that the earned income strategy does indeed relate to the organization’s mission and could possibly make the nonprofit more effective, they will be more likely to be supportive. Do you have the capacity to support a social enterprise? In addition to money, an organization needs time, people, and energy to support a social enterprise. Few nonprofits have the resources to suddenly spend the vast majority of their time on a new business. Therefore, many organizations often spend a year or more planning and saving for a venture. How will external stakeholders respond to a social enterprise strategy? External stakeholders could include funders, clients, constituents, or the general public. Their reaction to a venture or partnership strategy is important, especially if an uneducated impression could pose problems for your nonprofit. For example, some funders may decide to cut funding because they may think the organization is becoming self-sustaining and no longer needs outside support. Board and staff members should identify all external stakeholders before launching a venture to ensure the organization maintains proper communication with these stakeholders throughout the venture planning process and at strategic intervals thereafter. How does your board feel about social enterprise? The board must be supportive of the venture. If board members are involved in planning the venture from the start, they will be more likely to be supportive throughout the process. Board members should serve on the business project team so they can be involved from day one. (For more on the business project team, see page 22.) This does not mean that they shouldn’t ask tough business questions about the venture for fear of not being supportive. Board members with business savvy may need to be reminded that they should give a nonprofit business venture the same scrutiny they would give a for-profit venture in their professional lives. Is your staff ready to embrace social entrepreneurship? The staff must believe in what the organization is doing. If the organization does not have support and commitment from the staff, daily demands could end up taking priority over the earned income strategy. Staff members must understand the extra effort the business venture will take and be willing to focus on long-term strategies.

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L EARNING

FROM

E XPERIENCE

If your organization has had previous experience with a revenue-generating strategy — no matter how large or small — senior staff and board members should evaluate this experience to help determine whether the organization is ready for another venture. Discuss what worked well and what could have been better to decide if the organization should try again based on the first experience. When evaluating the previous experience, evaluate not just the business itself but the planning and preparation that was done in advance. Did the organization jump right into the new strategy without doing any research at all? Did the organization conduct the appropriate amount of research so that staff and board members knew what they were getting into? Or, did the organization struggle with analysis paralysis and over analyze the possibilities to the detriment of the business opportunity? Another important factor to evaluate is how well the organization followed through on the first enterprise. Did the organization do what it said it was going to do in the appropriate timeframe, or did it have difficulty meeting expectations and deadlines? If your organization often finds it has shifting priorities and a lack of focus, then it may not be ready for another business venture. If past experiences indicate that the organization should try another venture, staff and board members should ask themselves if the timing is right. Board and staff must ensure that social entrepreneurship can become one of the organization’s top priorities or it will not succeed. If your organization has big plans in the near future, such as a rebranding strategy or a capital campaign, the timing may not be right for a new enterprise.

L EARNING

FROM

O THERS

Evaluating the experiences of other organizations can provide as much insight as looking at your own organization’s previous experience. When considering social entrepreneurship for their own organization, board and staff members should interview other nonprofits in the community who have tried different enterprises. Find out where other organizations had success and challenges. Determine how your organization would respond if faced with the same challenges. These interviews could help board and staff members forecast how the community will respond to a new enterprise.

T HE M ISSION

VS .

P ROFIT C HALLENGE

One challenge for some nonprofit organizations is to realize that mission and profit motivations can coexist. In fact, to find success with social entrepreneurship, mission and profit motivations must coexist. The enterprise should be mission driven, but the organization must be mindful of profits as well. Just because you are making a profit from a program or service doesn’t mean you are in any way betraying your mission or your organization’s stakeholders. It means your organization is becoming more self-sufficient and will likely be able to fulfill its mission for years to come. Many nonprofit board and staff

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members feel they cannot generate a profit and support a mission at the same time. These board and staff members must realize the goal of social entrepreneurship is to generate revenue to support the work of the organization. The most effective and long-lasting nonprofits have resources set aside to invest in the growth of the organization. A third issue in the mission vs. profit challenge arises when nonprofits when nonprofits pursue earned income strategies around their existing work and to decide how to charge for products or services. Many nonprofits need to provide their products or services at the lowest possible cost to make them accessible to their constituents, but charging a low cost can prevent nonprofits from making any profit from the products or services. To overcome this challenge, nonprofits have a variety of options, including • setting prices at a sliding scale — those who can afford more pay more, those who can afford less pay less; • charging competitive rates to those who can afford it and offering scholarships or free services to those who cannot; • aggressively researching and targeting third-party payment options (e.g., federal, state, local governments, and private pay). Although these pricing options are more complicated and are more difficult to administer than establishing one set price, these alternatives can help nonprofits generate a profit while fulfilling their missions.

A SSESSING

THE

F EASIBILITY

OF

O PPORTUNITIES

Once your organization has determined it is ready for social entrepreneurship, the board and senior staff must decide which opportunity is the best option. The following guidelines will help board and staff members in making this decision. Evaluate the internal mood. Is there an opportunity that your organization will support? Make sure there is a group of people within the organization, including board members, who have a passion for making the opportunity work. Assess the market. Once you have determined that the idea has support within the organization, see whether it has support outside the organization. What is the target market — what is the customer profile? Is the market growing or getting smaller? Who is the competition? How do competitors position themselves? Determine the internal needs. The first thing the organization will need is buy-in from the board and staff. Once this is accomplished, internal business needs will typically fall into four main categories — capital, staffing, equipment and space, and legal and tax structural requirements. Make sure you carefully think through these issues and have a plan in place to address each one. Match the opportunity with your success criteria. For example, if one of your key objectives is to provide training opportunities for your clients, then make sure there is a fit or that the

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opportunity has been carefully evaluated against others with a stronger profile in this regard. In addition, it is important to stay within your risk profile and have realistic but set revenue and profitability objectives.

F EASIBILITY Q UESTIONS Answering the following questions can help your board and staff determine whether a social entrepeneurship option is feasible for your organization. Internal Factors • Is this opportunity something the organization will support? • How well does the market opportunity fit with the organization’s skills and expertise? • Will we need to buy outside expertise? • What are the resource requirements of the opportunity? • Do we have a potential competitive advantage? • What is the investment required (both operational and capital) to launch and grow the opportunity? • How long will it take to grow this opportunity into a reality? • What is the risk factor? External Factors • How big is the current market? • Is the market growing or contracting? • How is the market segmented? • Who are the key customers? • What are they willing to pay? • Who are the key competitors in the market? • What are the margins for vendors serving the market? • How do competitors differentiate themselves? • What are the barriers to market entry? • How important are strategic relationships in this market? • What is the risk factor?

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J EWISH S OCIAL S ERVICE A GENCY: O VERCOMING P ROFIT C HALLENGE

THE

M ISSION

VS .

Like many other nonprofits, the Jewish Social Service Agency of Metropolitan Washington, in Rockville, Maryland, used to provide its services in a way no business would ever consider. When people called to say, “My mother lives alone and needs care five days a week, four hours a day,” the staff, which provides in-home care among other services, would refer them to a provider in the community. If callers said they couldn’t afford an outside service, the staff would say, “OK, we’ll take care of you.” One day, says Joan G. de Pontet, JSSA’s executive director, “we had a stunning realization that we were doing several bad things. Number one, we were letting essential revenue go outside the network while we were keeping all the need for subsidized care within the network. Secondly, those people with resources were disappointed in us. They were often our boosters, our ambassadors, our donors, and the first time they asked us for help, we said, ‘Fine, we’ll refer you out.’” So JSSA launched Premier Homecare, a separately incorporated nonprofit organization to provide personal care, supervision, companionship, and homemaker services that allow people to continue living in their homes even though they need assistance. The result is an organization that in many ways is run like a for-profit business: People who can afford it pay full price for services. But, unlike companies in the business world, the revenue created by those paying customers is used to subsidize low-income clients. “That’s the intersection of market and mission that defines in our minds a social entrepreneurial venture,” says de Pontet. The startup was funded in part by the Jewish Venture Philanthropy Fund. Getting that funding was quite different from getting a foundation or corporation grant, she says. “It was competitive, and their site visit was different from a foundation site visit, which wants to know more about need. This was more about execution, capitalization, and how you are going to know when you’re on track.” JSSA also solicited legal help, and when it began to experience explosive growth — providing 70,000 hours of service in its first year instead of the anticipated 20,000 — it turned to a consulting firm that helps nonprofits with entrepreneurial ventures. When nonprofits bring in a surplus, their first instinct is to spend it on the constituency, says de Pontet. But the consultant helped Premier Homecare realize money had to be invested back in the company to sustain it. Also key to the organization’s success was hiring a top-notch chief executive to run Premier Homecare, says de Pontet. “We got a person who was willing to eat this, sleep this, breathe this. That got us through some very tough times. You really have to hire the right talent. This is not necessarily, as a traditional nonprofit, the kind of talent you have on your bench. You really have to find somebody who will be paid differently, think differently, and act differently. It is small business development.” To be a success, it takes planning, hard work, and a dedicated staff, says de Pontet. “It’s not something you can do in your spare time.”

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IV. The Board’s Role in Social Entrepreneurship The board plays an integral role in social entrepreneurship. Without support from the board, the organization should not launch a new enterprise. Therefore, it is important that the staff and board work together. The staff should make every effort to include the board and gain their support for the idea. The board should view and evaluate social entrepreneurship as an investment, not an expense, and therefore make judgments based on the merits of the business opportunity. In order to support the enterprise, the board needs an honest description of the organization’s financial situation and the earned-income strategy. The staff should not candy coat the venture in an attempt to gain support but should provide the board with a clear picture of the strategy, the challenges, and the competition. The most important role of the board in social entrepreneurship is to keep sight of the organization’s mission and ensure that the enterprise does not conflict with the mission. Senior staff and board members should work together to define long-term goals so the board will be able to gauge whether the organization is on the right track. The goals should be in concert with the organization’s core values to help ensure the organization stays focused on those values during the venture. Board members should frequently check on the progress of the enterprise and make sure it is in line with these goals. If the organization seems to be moving in a direction that is not in line with its mission, the board should work to steer the organization in the right direction. In addition to working on the mission side of the enterprise, board members can be a valuable resource to aid with the business side as well. Many nonprofit members come from the for-profit world and have experience in areas such as accounting, marketing, public relations, and law. These board members can provide valuable insight and advice on starting and running an enterprise. The organization should use the talent and expertise on the board to work for the organization. Board members should ask the tough business questions they might ask of the for-profits they work for, such as the following: • Is this a good investment? • What risks are involved? • Are there better, more profitable things we could be doing with our time and resources? • When will the venture become profitable? In addition to their own knowledge and experience, many board members will have contacts in the community who may have expertise not found on the board that could be critical to UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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launching a successful enterprise. Staff and board leadership should encourage board members to think of whom they know who could help the organization with social entrepreneurship. The help could come in the form of advice, counsel, pro bono services, or in-kind donations. Board members can also help social entrepreneurship ventures by raising the capital needed to start the enterprise. Many organizations will have to launch an extra fundraising effort in order to cover the initial costs, and the board should lead this effort. Board members can start by setting funding goals and considering their own financial contributions to the effort. Then they can stay involved by finding prospects and helping with cultivation, solicitation, and stewardship. Another role of the board in social entrepreneurship is to make sure the board has the talent the organization needs for the venture. If the board lacks expertise in a crucial area such as finance or commerce, the board chair should look outside the board for the information it needs. The board could get this knowledge either by recruiting a new board member with the appropriate background or by looking outside the board for advice and assistance. Sometimes organizations starting a social enterprise may experience some turnover in both the board and the staff. Board members should realize that when the organization gets involved in social enterprise, it may have different needs from the board and may be seeking different qualifications from board members. If some board members find they no longer have anything to offer, they may choose to leave the board to make room for someone with the appropriate experience. Finally, it is the board’s responsibility to make sure the organization stays focused in its efforts. Social entrepreneurship can be a long and complicated process. A staff with multiple priorities to juggle can easily be sidetracked and could end up moving the enterprise in a different direction. It is the board’s job to make sure things progress in a timely manner and according to the plan.

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V. The Role of Non–Board Members For many organizations, much of the knowledge and expertise needed to launch a social enterprise cannot be found among the current board members. To meet these needs, nonprofit leaders will have to look outside the board for help. Non–board members are most commonly involved in social entrepreneurship in three ways: 1. serving on the advisory group, 2. participating with the business project team, or 3. providing guidance and counsel on subject matter areas within the realm of their expertise as needed.

T HE A DVISORY G ROUP ’ S R OLE The advisory group serves as a sounding board so the nonprofit can test hunches and receive feedback. Advisory group members should have specific skills and knowledge about the industry and the business the nonprofit is planning to launch. Examples of appropriate expertise are as follows: • If your nonprofit wants to get into retail, good advisory group members would include suppliers, buyers, other retailers, retail-marketing experts, and bankers. • If your organization is planning on buying an existing business, it would be helpful to include experienced buyers and sellers, business brokers, and financial and legal duediligence professionals. Generally, the advisory group meets a few times before the business is launched so the leaders of the enterprise can seek feedback on their ideas. The responsibilities of the advisory group include the following: • Test hunches. For example, the board thinks the organization could provide programrelated services for a fee to generate more revenue. Before launching the business, the board should test this theory with an advisory group made up of people in the field. The advisory group can tell board members if they have a good idea or if the board is overlooking major challenges that could prevent the business from succeeding. • Identify competitors. Before the organization implements the fee-based program idea, it should know who its competitors are in the public, private, and nonprofit sectors. The advisory group should know who the main competitors are and offer valuable insight on their competitive positioning.

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• Identify customers. Knowing that there is demand for your program-related services from an audience who has the ability to pay is not always enough — the organization will want to know the characteristics of this new customer segment, especially as it pertains to their purchasing behavior. If the advisory group can help your organization develop a target list of potential customers, the staff can use this list to conduct useful market research. • Solicit feedback. The advisory group should be honest and up front about the business idea. Find out what problems advisory group members see with the business plan. Such feedback could impact the chances of succeeding. • Identify barriers to and enablers of success. If the advisory group members have experience within your program area, it should be easy for them to provide the organization with some guidelines on the possible challenges the organization could face and brainstorm potential solutions. • Discuss industry dynamics and the political environment. Again, people with experience in the industry you are about to enter should be able to provide valuable advice based on their own experiences and the knowledge they have. • Recommend how to best position your product or service and sell it effectively. There are few things that are more important than understanding your market niche and how to leverage this to your benefit. Unless you are entering a commodity business whose sole purchasing criteria is price, then you must prove how you are differentiated from the competition. Once leaders of the enterprise receive necessary feedback, the advisory group usually disbands. However, some members of the advisory group may turn out to be valuable resources, and the organization may want to consult these members as needed for additional guidance and advice once the enterprise is under way. In rare circumstances, if the business is being set up as a separate entity, advisory board members may consider a more formal board role, but the case will need to be compelling and not dilute the initial process. When working with the advisory group, it is important for board and staff members to remember that the advisory group members are experts in the field who are donating their time and knowledge to the organization. Nonprofits can usually highlight the fact that advisory group members are donating their services to a nonprofit to get more time and information from them than a for-profit could. However, the enterprise leaders should be sure they are not wasting advisory group members’ time. The advisory group will expect to see a professional business plan that demonstrates that enterprise leaders know what they are doing.

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D AVIS M EMORIAL G OODWILL I NDUSTRIES : F INDING THE S ECRETS TO S UCCESS Davis Memorial Goodwill Industries had been a long-time provider of custodial services. The nonprofit has 350 employees, many of whom have disabilities, and works primarily for government buildings in Washington, D.C. When the nonprofit decided it wanted to expand its custodial business to include commercial properties, it found that it was hard to get a foot in the door. To get feedback from commercial property owners, Goodwill set up an advisory group. The advisory group consisted of about 12 senior property managers in the Metro Washington, D.C., area. The group included not only people who were familiar with the business but who also made the decisions when it came to hiring custodial services. “The key to our success was that we had a well-known property and development manager who headed up the operation,” Davis Memorial Goodwill Industries President and CEO David Becker said. “He told property managers he was working with Goodwill and wanted to invite them to the meeting. In large part these people came because of who was asking them. If we hadn’t have gotten the right guy to head up the advisory group, it wouldn’t have worked as well as it did.” The advisory group met about four times over the course of a year. The goal of these meetings was for Goodwill staff to find out how their organization could do business with these firms and others in the area. The advisory group gave staff members advice on all aspects, from marketing to contracting for services. Many advisory board members said they would be willing to give Goodwill work if the quality of their services were equal to the for-profit competition. After the advisory group disbanded, Goodwill’s workload increased from generating $7 million in revenue to $10 million, and two advisory group members contracted for Goodwill’s custodial services. One of them is still a client. “The advisory group helped us get our foot in the door to build some credibility with folks that would give us a shot,” Becker said. “Some advisory groups give nonprofits a lot of advice, but they don’t help them get a foot in the door. You’re wasting your time with an advisory group if it doesn’t contain the right people. Once you have proven yourself to this group, it can become a natural springboard to future opportunities.” In addition to choosing advisory group members well, Becker recommends being well prepared when working with the group. The nonprofit must make sure the business planning is far enough along so you are getting the most appropriate and timely advice possible. “You have to be prepared to strike when the iron is hot,” Becker said. “You can’t go back to a group after a year with more questions.”

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T HE R OLE

OF THE

B USINESS P ROJECT T EAM

Before the business gets under way, it is helpful to have a team of people to do the planning and research in preparation for the business. This team should be made up of a variety of people, including • an internal champion of the idea, usually a senior staff member; • the organization’s chief financial officer; • a senior marketing staff member; • board members who are dedicated to the idea; and • outside experts in the industry or consultants — especially helpful if board and staff members have minimal knowledge of the industry or business matters. Once the board and senior staff have decided to try a social enterprise, the business project team is responsible for all the feasibility testing and initial planning and research. The business project team leads the organization in deciding which opportunity is best to pursue. Then the team creates the business plan and works with the advisory group to test the business validity of the opportunity. This team is also responsible for making sure the right people are hired to lead the business. Once the business is up and running, this team usually disbands or plays a minimal role.

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VI. What Constitutes Success? The definition of a successful social enterprise will vary based on the size of the organization, the size of the enterprise, the cost of the investment, and the expected size of the profit. The board should have a clear idea of what success means to the organization before the enterprise begins so it can gauge the business’s progress. When determining what success means to them, board members must keep in mind that profit margins in most small businesses are lean at best, and they only happen to those who work hard and are disciplined in their approach. The types of businesses many nonprofits consider (e.g., low-skilled, laborrelated businesses) often have net margins of less than 5 percent. Moreover, a false notion is held by many that business is, by definition, profitable. In fact, many small businesses operate in a survival rather than success mode and are often struggling to meet expenses. Answering the following questions can help board members get a feeling for what constitutes success for their organization: • How much money do we want to make and how quickly? A new business can take a few years to get going and become profitable. Large organizations can sometimes handle the long wait, whereas small organizations tend to rely more on a fast return. • How easy will it be to implement the idea? When answering this question, the board should consider the amount of resources the idea will require, the amount of time it will take to implement the idea, how the idea fits with existing talent on the staff and board, and how the idea fits with existing organizational capacity. • How does this fit with our mission? A nonprofit’s social enterprise could bring in millions of dollars; but if it conflicts with the organization’s mission, it should not be considered a success. • How does this fit with our existing assets? It is often easier to leverage strengths you already have rather than starting from scratch. • How does this fit with our geographic scope? The scope of the business venture should be in line with the organization’s reach or growth objectives. For example, a communitybased nonprofit should be wary of launching a venture that requires a national audience. • How well does the business leverage existing contacts? For example, if your board members know a lot of people in the restaurant industry but no one in the publishing industry, it may be easier to take advantage of those contacts and start a food-service enterprise than to try to publish and sell books. • How competitive is the marketplace? Intense competition usually puts pressure on price, quality, and service. Are you up to this challenge?

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• What is the risk-versus-reward profile? Big returns normally require big risks. Generally, the returns diminish as the risk level decreases. Social entrepreneurship is not the best solution for risk-adverse organizations.

The Community Wealth Zone Generally, nonprofits should select venture or partnership strategies that meet three main criteria: 1. organizational capacity to support the enterprise, 2. marketable assets, and 3. market opportunity.

Opportunities that intersect all three requirements are said to be in the community wealth zone, where social enterprise has the highest likelihood for success and organizations therefore are more likely to lead to a more successful revenue-generating strategy. Where nonprofits often stumble is in selecting opportunities that may play to the strengths of one area. For example, the market opportunity may be significant, but the organization may not have the organizational capacity to execute the opportunity. This doesn’t mean that the opportunity ceases to exist, but to be successful the nonprofit needs to address its capacity shortcomings. The actual zone itself may vary in size depending upon the organization and what it brings to the table. However, fitting your enterprise within the zone is critical when planning and ultimately evaluating the enterprise. The answer to this exercise should be clear to everyone and not forced, so that your organization doesn’t try to create opportunities that in truth don’t exist for the organization. Moreover, strengthening this point of intersection — the community wealth zone — should be the goal of any sound business strategy.

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VII. Risk Factors Before launching a social enterprise, the board and staff should be fully aware of the risks involved. The risks can come in a variety of forms and could potentially damage the organization’s finances, operations, or reputation. By conducting thorough due diligence, board and staff members can identify the potential risks and prevent some of them from damaging the business venture or the organization. One place to start is to look to other organizations that have launched similar enterprises and learn from their experience. In addition, rather than starting a due-diligence process from scratch, take advantage of the multiple professional resources at your disposal including the talents of existing board members or the example found in Appendix II, page 47.

F INANCIAL R ISKS The financial risks involved with social entrepreneurship tend to be the ones the staff and board think of first and the ones that could potentially do the most damage to the organization. When assessing the financial risk involved in a venture, the board must assess the opportunity cost. Nonprofit organizations must also understand the venture could lose money. No matter how much research and planning an advisory group does, there is never a 100-percent guarantee of success with a business venture. Most ventures will take anywhere from two to five years to become profitable. The staff and board must determine whether they are more interested in short-term profitability and a more focused and potentially limited revenue growth curve or a bigger return on a larger, more long-term investment. The organization should have a definition of what success means and a plan to achieve that success. If the organization cannot attain its definition of success, it should have a plan for how to exit the enterprise and recover. Board and staff members should realize that traditional funders could decide to decrease funding if they know the organization is launching a business enterprise. The funders could disapprove of the way the money is being spent and decide not to contribute to the enterprise, or they could see the venture is working well for the organization and decide the nonprofit no longer needs their support. Financial success also can bring risks to the organization. A successful business will generate operating and maintenance expenses that may exceed the initial investment the organization expected. The organization should have a plan for how it will handle success.

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O RGANIZATIONAL R ISKS The nonprofit must be prepared for organizational change. Growth is usually a good thing for nonprofits, but the organization must have a plan for how it will manage that growth. Organizations not prepared for rapid growth can end up with unclear lines of responsibility and accountability, confusion between board and staff responsibilities, and could potentially lose sight of the organization’s mission. Before starting a business venture, the organization should have a plan to keep the staff and the board informed as things progress and be clear on any changes in responsibility or accountability. Organizational change can be especially hard on staff leaders because they are often the ones leading the change. The board should be prepared to offer support and guidance to the chief executive and senior staff as necessary. The extra work created by the enterprise could cause staff members to take on additional responsibilities and could divert their attention from other responsibilities. Although the enterprise should be one of the organization’s top priorities, it should not take time or energy away from the regular work that needs to be done. If an enterprise is going to require significant extra effort from staff members, make sure there is a way for the regular work to be done as well so that nothing important falls through the cracks. As the organization grows accustomed to the new enterprise, management will see new needs for certain types of skills and expertise. Although the first instinct may be to try to train existing staff members to learn the business skills needed to lead the enterprise, board members and senior staff must understand that some staff turnover during the creation of a new enterprise is not unusual. The organization will probably need new talent to lead the effort, and the existing staff may not be interested in or capable of acquiring the talents necessary. The mission and the welfare of the organization should be kept in the forefront as the organization goes through its growing pains. Adding a for-profit subsidiary comes with different organizational risks. The for-profit’s objective is different from the nonprofit’s, so the subsidiary will have to be structured differently from the nonprofit, and the decision-making processes between the business and the nonprofit will have to be defined. The staff of the for-profit subsidiary will likely be different from the nonprofit staff, and tensions could arise if the relationship between the two entities is not handled with care. If the business is successful, the needs of the for-profit could surpass the capacity of the nonprofit. For example, the nonprofit could be able to provide marketing support for the subsidiary in the beginning, but if business grows rapidly the nonprofit’s marketing department may be unable to meet the needs of the for-profit. With all of these changes, conflict within the organization is inevitable, although the severity and the source of the conflict will vary. In many cases, conflict arises because there is one group committed to the venture idea and another group that sees the venture idea as conflicting with the mission. A business venture cannot be launched without resolving this conflict. Whatever the source of tension is, the board and the chief executive must acknowledge that conflicts are to be expected when an organization goes through a significant change. Rather than berating an individual who does not agree with the course of action or is frustrated by all the change, the organization should have an established procedure for UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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handling conflicts for both board and staff members. (For more information on conflict resolution, see Keeping the Peace in Suggested Resources, page 54.)

R EPUTATION R ISKS A poorly launched venture could damage the organization’s reputation. To prevent this, the organization can do several things. Above all, the board must make sure the venture will not conflict with the organization’s mission. In addition, the organization must make every effort to educate people on what it’s doing so that no one gets wrong impressions. Funders could learn about the organization’s new business and think the organization no longer needs money from outside funders. Or, for-profit competitors could cry unfair business practices because they have to pay taxes while their nonprofit competition does not. To manage these risks, the nonprofit must clearly communicate with funders, clients, and other stakeholders what it is doing and why. The organization should be able to anticipate the questions it will receive and be ready with an appropriate response.

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U NRELATED B USINESS I NCOME TAX A labyrinth of rules limits and taxes but doesn’t prohibit a nonprofit from generating revenue from activities unrelated to its mission. The aim of the Internal Revenue Service regulations is to eliminate any unfair competition with for-profit businesses that have to pay income tax on similar activities. A nonprofit can be enterprising and run a business as a secondary, but not primary, activity. Any nonprofit that has more than $1,000 in unrelated business income has to pay unrelated business income tax and file the IRS Form 990-T. Unrelated business income is derived from any unrelated trade or business regularly carried on. Four characteristics must be present for net income to be taxed: 1. Revenue-producing activity is unrelated to the organization’s primary purpose. 2. Activity is regularly carried on (not a one-time event). 3. Activity looks like a for-profit activity (no volunteers or donated goods). 4. Business is active versus passive (income comes from payment for goods or services rather than from interest or dividends).

S UBSTANTIALLY R ELATED Income from an activity related to mission is not taxed. Examples of activities determined unrelated by the IRS include the following: • Rental of equipment and other personal property, such as computers or phone systems, generates unrelated income if the rental is undertaken to cover costs with no direct connection to the nonprofit’s own exempt purpose. Rental to another nonprofit is not subject to tax if it is mission related, such as rental of a museum’s art to other institutions to ensure maximum public viewing. • Providing services, such as technical assistance or administrative support, that don’t serve the exempt services of the nonprofit, is considered unrelated activity. The IRS classifies the revenue as related only if the services themselves contribute to the good of another nonprofit. • Sale of advertising in a nonprofit periodical is considered unrelated. Only where sponsors are listed without normal advertising copy or use of language that markets or promotes the sponsor can the money given for the listing be considered nontaxable.

N OT R EGULARLY C ARRIED O N A sporadic or occasional unrelated activity is not taxed. The frequency and continuity of the nonprofit’s activity are compared with those of similar activities conducted by commercial enterprises. For example, a concession stand at an annual fair would be taxexempt, but a café open daily could be taxable.

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N OT B USINESSLIKE The following types of activities are not subject to unrelated business income tax because they are not businesslike and do not compete with the activities of commercial businesses: • working with all volunteers; • accepting donated goods; • bingo games conducted in accordance with state and local laws; • public activities such as fairs and expositions that promote educational purposes; • hosting conventions and trade shows related to the organization’s mission; • low-cost gift premiums distributed with no obligation to purchase; • mailing lists; or • facilities, such as a bookstore or cafeteria, used in the nonprofit’s programs and operated for the convenience of constituents.

PASSIVE I NCOME M ODIFICATIONS A tax-exempt organization is not taxed on income it receives passively, such as • dividends; • interest; • royalties; • rents; or • payments with respect to security loans, annuities, or capital gains.

C ALCULATING THE TAX Gross unrelated business income, minus deductions and a $1,000 exemption, is taxed at corporate or trust income tax rates. A Form 990-T is filed, and the nonprofit is taxed just like a normal taxpayer. Ordinary and necessary expenses directly connected with carrying on the unrelated activity are deductible. The nonprofit that pays attention to the rules can take advantage of the exclusions and modifications to avoid income tax. When unrelated income is taxable, good accounting records can be maintained to reduce and minimize the tax burden by capturing costs that can be reasonably allocated. A nonprofit has many opportunities to realize additional income from revenue-producing activities without jeopardizing its exempt status.

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VIII. For-Profit Subsidiaries Some nonprofits decide to form for-profit subsidiaries as a way to generate revenue that can be transferred back to the nonprofit. Nonprofits usually form for-profit subsidiaries when it is not practical or legal to form a nonprofit subsidiary. It is important to note that there are other options besides going the for-profit route including establishing the business as a nonprofit subsidiary or division within the existing organizational infrastructure. For-profit subsidiaries come with their own set of risks and should be established carefully. A for-profit subsidiary of a nonprofit needs separate articles of incorporation and a separate employer identification number. It must register for business and file tax returns, just as if it were an independent corporation with no relation to the nonprofit. Accounting records for the forprofit subsidiary must always be separate from those of the nonprofit because they are filing under different codes of the IRS. To be sure the nonprofit is not overlooking any details, board and staff members should talk to a lawyer and an accountant and obtain any other necessary outside help from the beginning of the process. In some cases, the nonprofit shares the stock of the subsidiary with the public. As long as the nonprofit owns more than half the stock, it is still considered a subsidiary. If the nonprofit holds less than half of the stock, it no longer owns a substantial portion of the for-profit; and that business can no longer be considered a subsidiary of the nonprofit. The for-profit subsidiary should have a different board, if not always different board members, from the nonprofit. As board members are usually not involved in the day-to-day management of the organization, having board members serve on both the for-profit and nonprofit boards may not present problems. Each board is working in pursuit of a distinct mission; so if board members do serve on both the nonprofit and for-profit subsidiary boards, they should be clear on what purpose they are working toward and when. These board members should also feel comfortable wearing two different hats. Sometimes the missions of the two entities could come in contact, and board members serving on both boards must be able to handle these situations. Therefore, even if the board members for the two boards are the same, each board should have separate meetings and separate minutes to help members keep each board distinct. If the nonprofit will be purchasing goods or services from the for-profit subsidiary, the two entities should make an arrangement up front that any goods or services the nonprofit will purchase from the for-profit will be purchased at fair market value. This way there will be no suspicion that one entity is taking advantage of the other. If the nonprofit pays the subsidiary too much for goods or services, it could be argued that the for-profit subsidiary is reaping a greater profit from the nonprofit. If the nonprofit gets a great discount from the subsidiary, it could be argued that there is a close or intimate relationship between the two entities or undue control or involvement between the two entities. UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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The nonprofit should not be involved in the day-to-day management of the for-profit subsidiary. If it is, the IRS could find that the two entities are operating as one and could combine them. It is usually wise to have a separate staff for each entity. This can prevent any confusion with the IRS and can help prevent confusion among staff members. Rather than trying to switch back and forth between nonprofit and for-profit motivations, the nonprofit staff members will always know that the organization’s mission is their main motivation, while the staff members of the subsidiary will know that profits are the main motivation. However, if the staff does have to split time between the for-profit and the nonprofit, accounting records should be meticulous so all expenses can be traced, including staff resources.

A LLEGHENY C OUNTY B AR A SSOCIATION : S TARTING A F OR -P ROFIT S UBSIDIARY In nonprofits, as in for-profits, being prosperous in a business venture requires flexibility. Unforeseen circumstances can spell the end of a once-fruitful enterprise, or they can mean a sudden boost for another venture. The key is keeping an eye out for new business ideas that make sense and knowing when to give up on something that isn’t working. For the Allegheny County Bar Association in Pittsburgh, being flexible allowed the nonprofit to launch a for-profit subsidiary. For years, the nonprofit Allegheny County Bar Association has offered services, such as equipment rentals and video depositions, to lawyers. But then its for-profit competitors cried foul. “In my early days here, competitors were saying we were competing unfairly, and we had certain tax advantages that didn’t exist in a for-profit, and more than likely, we did,” says Executive Director David A. Blaner. So three years ago, the nonprofit created a for-profit entity, ACBA Services, Inc., to offer those same services and more. “We really built this thing for the purpose of saying, ‘We’re going to compete, and we’re going to compete on a level playing field and pay our federal income tax, our state taxes, and all those things’,” he says. In just those few years, the association has seen the winds change more than once, dropping businesses that were no longer cost-effective and starting others when it saw a need. For example, one of its services helps attorneys take video depositions of doctors and engineers who don’t have time to appear in court. But when lawyers in Pennsylvania take a deposition by video, they also have to have a court reporter make a written transcript. “We found that our customers were calling us for video teleconferencing, but then they had to make another phone call to an independent court reporting agency,” says Blaner. “So we formed a court-reporting business, and it’s now our largest business line.” Other business lines have been dropped when they became less profitable. For years, the bar association had been leasing photocopiers for $60,000 a year to the county law library so district attorneys, courts, and public defenders could make 25-cent copies from books that could not be checked out. Then came the Internet. Soon attorneys were able to go online and get the same information without leaving their offices, says Blaner. “We saw a steady decline in income and the usage of those copiers, so we decided to close it down.” UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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One business line that has seen a sudden surge in popularity is video teleconferencing, whose revenues doubled in the two months after the September 11, 2001 terrorist attack on New York and Washington, D.C. “Literally within a day of September 11, we had people calling us saying, ‘I can’t go to New York, but I have to have this business meeting. Could you videoconference me in?’ Not only attorneys, but people in general see this as a viable alternative,” says Blaner. The businesses have generated significant sums of money, he says, and the dividends benefit the bar association. Blaner credits the success with a change of attitude at the association. Many of the services ACBA offers have been provided by the nonprofit for years but were not considered business ventures until Blaner came on board and saw things differently. “I’ve been able to get the boards and different groups to change their thinking,” he says. Now they realize how much more efficiently these ventures can work in a for-profit mode.

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IX. Build vs. Buy Not all social enterprises must be started from scratch. There are many good existing opportunities for the discerning buyer. When looking for a business for your organization, consider the following options: • Franchises. Many corporations sell franchises to individuals or other organizations, and some franchisers may reduce or waive franchise fees for nonprofit organizations. The clear benefit of a franchise strategy is that you are buying an established (and, it is hoped, tested) business model. • Family businesses. Don’t assume that you have to be in the family to get in on a familyowned business. By the time the business reaches the second or third generation, there may be no interest in continuing the family legacy. These situations could present opportunities for your organization. • Other small businesses. Small businesses tend to have a high rate of ownership turnover because of changes in the economy or other factors. A nonprofit could take over an existing business and save itself the startup expenses. Although purchasing a pre-existing business can save an organization from a lot of the development and planning work, nonprofits should conduct extensive due diligence when acquiring a business or franchise. As with any new enterprise, the organization should put much effort into researching the opportunity and should expect some initial expenses, such as consulting fees for lawyers, accountants, or other professionals. Board members or local small business owners can also provide valuable advice. Consider forming an advisory group to serve as a sounding board during the preliminary stages. If pursuing a franchise strategy, be prepared to undergo fairly significant due diligence from the perspective of the franchiser, who will want to carefully vet the relationship. Lastly, before buying any business, the business project team or board members should take the time to prioritize the organization’s needs. The group should distinguish priorities that are nonnegotiable from needs the organization would like to see met but are not necessarily deal breakers. Before making a decision on whether to acquire a business or franchise, make every effort to get to know the business and the industry as well as possible. Ask the business for financial statements from the past three to five years and carefully examine them, looking for holes or inconsistencies. Make sure you know what you are looking for when reviewing the financial statements — if not, seek help from an accountant. The board and senior staff should be confident that the information presented in the financial statements indicates that this business is healthy enough to consider acquiring — this is not a time to go on instincts.

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Get as much information as you can from the seller. Interview the seller more than once to make sure you clearly understand the motivation for selling. Go over the business’s history, and find out how the seller imagines the future of the business. Ask if the owner is willing to stay on in a transitional role until the transfer is complete and the nonprofit is comfortable running the businesses independently. In addition, speak to current customers of the business — especially top customers. Find out from them what things worked well and what didn’t work. The feedback from customers could serve as an indication that the seller is leaving the organization in good shape, or it could be a sign that the business needs to move in a new direction to meet the demands of its customers. Once it has done the appropriate background research, the organization should assess its comfort level. Rarely will all the board and senior staff members be 100-percent sure of a business acquisition, but the organization should try to get as close to that point as possible. The numbers may look good, and the customers may sound happy; but if members of the board and staff still feel instinctively that this business isn’t a good fit with the organization, listen to that feeling. However, if the organization finds something wrong with every single opportunity it explores, then maybe it is time to reassess the acquisition strategy — perhaps the organization isn’t ready to acquire a business at all.

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X. The Importance of the Business Plan Although some successful businesses have been launched without a formal plan, there is no substitute for doing your homework about the industry, business, and management risks inherent in the opportunity. Knowledge doesn’t guarantee success, but it is certainly a defense against failure. The key is not to get caught up in the volume of research and information required — no business was ever launched with the perfect plan — but rather to illustrate that your organization knows the ins and outs of the business opportunity it is considering. Patrick Lencioni, a well-respected consultant to Fortune 500 businesses, calls this “choosing clarity over certainty.” It is important for the board to ensure any business plan submitted is consistent with the overall strategic direction of the organization. If inconsistencies exist, challenge the business project team or senior leadership to address the issue. Ultimately, the board should have input and final approval of the plan. When evaluating any business opportunity, Mario Morino, founder of the Morino Institute, offers the following questions as critical to the evaluation process: • What is the market opportunity or market niche you are targeting? • What is your solution to the market need in your niche? • What is the size of your market niche, and how is it growing? • What is your economic model? How are you going to make a profit, and when? • How are you going to reach (sell to) the market you are targeting? • What’s the competition? How will it change? What makes your business better than the competition? • What makes you different from the competition and how will you stay different? • How are you going to execute, grow, and manage, your business? • What are the risks? What can stop you? • Why is your business going to succeed? The size and comprehensiveness of the business plan is less important than the organization’s ability to clearly respond to the questions listed above. Many business plans end up being imbalanced because entrepreneurs overexplain what they do know in attempt to hide the things they don’t know. There are multiple examples on how to best structure your plan for its readership. Conduct some cursory research and pick the one you like. All plans typically

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include sections dealing with opportunity identification, product or service description, operations and staffing, marketing, finance, and strategic issues. When creating the business plan, be sure to include a best-case, a worst-case, and an expected-case scenario, especially when it comes to financial forecasting. Rarely do things work out according to the plan, so the organization should be flexible enough to be able to deal with the best-case or worst-case scenarios. The nonprofit should be conservative with the revenue forecast and aggressive with the expense forecast. To help prevent unpleasant surprises, the work plan should include some indicators that will help board and staff members gauge the direction the business is moving. For example, if the organization is not meeting the benchmarks and revenue goals set throughout the plan, the board will know it may be more appropriate to make decisions with the worst-case scenario in mind. If you are seeking outside funding to launch the business, the funder will probably want to see the business plan. Keep this in mind when writing the business plan. Know who your audience is, and make sure the plan includes the things funders will want to know. For example, banks will want to ensure they will get their money back. The business plan should demonstrate the market potential and the organization’s ability to generate surplus revenue to service their debt. Venture capitalists will want to make sure they are backing something with the potential for significant return. They will want to see that the business has growth potential. Foundations will want to ensure that the business strengthens the organization’s ability to conduct mission-related work and tend to be wary of high-risk plans. They usually don’t want to see nonprofits taking too many risks, getting in over their heads in a business venture, and therefore being unable to fulfill their mission. A business plan that will be shared with foundations should demonstrate a direct connection between the business and the organization’s mission. Individual donors can take positions similar to that of a bank or a private foundation, depending on the situation, but rarely do they expect to make a lot of money from this type of investment. A business may be able to be launched without a business plan, but over time, as the business grows, planning becomes more important. According to the U.S. Small Business Administration, about 10 percent of small businesses in the United States go out of business every year. Inc. Magazine, one of the leading authorities on small businesses in the United States, offers the following top three reasons small businesses declare bankruptcy: • outside business conditions, such as competitors or cost increases (39 percent), • financing issues (28 percent), and • inside business conditions, such as loss of customers or mismanagement (27 percent). A business plan should be able to effectively address each of these three issues to demonstrate how the organization plans to avoid becoming another business casualty due to circumstances that arguably are within its control.

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Even organizations that have enough capital to cover startup costs and do not need to prepare a plan for funders should still create a business plan because it forces them to think formally through the opportunity and put their thoughts down on paper. In essence, the business plan can be seen as the tactical road map for the venture or partnership opportunity.

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XI. Moving from Planning to Implementation Developing the business plan is only a small step on the road to progress. The most important part is executing the plan’s objectives. In addition to a business plan, the organization should create a work plan that lists the key steps and milestones necessary to launch the business. The work plan should include a list of major tasks with a sequence of the order of their completion when possible, the time frame for completing the tasks, the resources needed to accomplish the tasks, and the tangible outcomes expected from completion of each task. More important than the work plan is who the organization chooses to do the work in the plan. Nonprofits should never skimp on hiring the right people to run or manage the venture or partnership strategy. In many cases, the board and senior staff will have to look outside the organization to find the right leadership for the enterprise. Stories of organizations with social entrepreneurship experience indicate a direct correlation between the talent and experience of a venture’s leaders and its likelihood of success. Organizations should not try to turn program managers into business managers in attempt to save money — this rarely works. In addition to hiring the right people, the organization needs to ensure the new staff have clear objectives and are held accountable for meeting those objectives. Whenever possible, measure the venture’s progress against industry benchmarks or standard measures of success. If these indicators don’t exist in your industry, create new ones or use the ones created for the work plan. The organization should ensure that it is not performing below industry standards. On the other hand, if the venture is significantly outperforming these standards, board and staff members should be wary. There are several reasons why this could be happening, including the following: • Your pricing could be too low or too high. • Your competitors may have already moved on to new ways of doing business due to changing industry dynamics. • You may have overestimated or miscalculated market demand. • You may have underestimated the number of potential competitors. The customer should be a major consideration during the implementation process. Satisfied customers lead to positive business outcomes; dissatisfied customers can significantly derail the business. Start soliciting customer feedback right away, and act on this information. Customers appreciate the opportunity to provide feedback and expect to see changes based on that feedback, so instill regular customer satisfaction measurement as part of your normal

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business operations. The board should request to see this information periodically to ensure that business is trending favorably against this very important performance indicator. If the business you are launching is a fairly unique or new concept, another strategy to consider is to pilot test your venture with a test audience before jumping aggressively into the marketplace. Employee satisfaction is equally important to customer satisfaction. In fact, some experts believe that it is the precursor to customer satisfaction. The Gallup Organization has conducted extensive research on the link between the workplace environment and business outcomes. Their research clearly indicates that satisfied employees are more customer focused and more productive, lead to increased revenues, and exhibit lower turnover rates. Senior staff should regularly administer employee satisfaction surveys and act on this information, just as they should with customer satisfaction surveys.

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XII. Potential Roadblocks There are many potential roadblocks that could derail your organization’s success with a social enterprise strategy. The board can play a critical role in helping the nonprofit avoid these roadblocks or at minimum identify them as they begin to occur: Accountability: Unlike nonprofit accountability, business accountability is fairly straightforward. You either hit your revenue and profitability targets or you don’t. Don’t try to explain away bad results; instead act on them. Analysis Paralysis: No business was ever started with a complete and perfect understanding of the business opportunity. Overanalyzing the options can lead to confusion and uncertainty. Lack of Buy-In: Getting everyone on the same page, especially key staff and board members, is essential to long-term success. Without the requisite organizational support, your business can quickly become subject to shifting priorities. Lack of Communication: You can never overcommunicate, especially at the beginning of the business planning and rollout process. Make it a priority to keep relevant stakeholders in the loop. Regularly inform them of both your successes and failures to build their trust. Lack of Customer Satisfaction: In business, the customer is always right. Lose sight of this fact and you will be out of business. Nonprofit business ventures will probably have even less margin for error than for-profits in this regard. Unclear Expectations: Make sure the board and staff have a clear definition and understanding of success for the venture strategy. It is easy to get off track and spend time and energy on things that don’t really fit with your initial expectations. Funder Misperceptions: Not all funders view nonprofit ventures as a positive industry development. Audit your existing funding relationships and be sure to educate key funders as to why this is a positive development for your nonprofit. What is the mission outcome? Lack of Knowledge or Talent: Don’t assume you have the talent in-house to effectively assess, implement, and manage the opportunity. Moreover, the venture will require ongoing support that will probably not fit with existing capabilities. Poor Implementation: Most ventures break down during implementation. It’s one thing to conceptualize and plan a venture strategy. It’s quite another to execute your plan. Plan your work and work your plan. Legal or Tax Complications: There are multiple legal and tax issues that need to be addressed as part of a venture strategy. Consult legal and accounting professionals to make sure you are proceeding as you should.

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Lack of Momentum: Organizational fatigue will inevitably set in as you work through the planning and implementation process. Build in timelines and milestones to keep you on track and celebrate short-term wins as they occur. Moreover, always think in terms of next steps. Insufficient Capital: Many businesses end up failing because they are undercapitalized or didn’t think through different business scenarios. Carefully and regularly assess your cashflow needs and don’t try and take financial shortcuts to success. Lack of Passion: There has to be at least one person who truly champions the venture process. This individual needs to have decision-making authority. In many cases the passion and perseverance of this person (or group of people) will overcome many obstacles to your success. Politics: Don’t assume that success with your venture will be enough to satisfy all stakeholders — continue to validate the mission impact. Moreover, your for-profit competition may cry foul if you are too successful — be ready to respond. Lack of Preparation or Due Diligence: Analysis paralysis is one potential roadblock, but so is not doing your homework on the feasibility of the opportunity. You don’t necessarily have to be an expert, but should clearly know what you are getting into. Be aggressive with expenses and conservative with revenue projections. Inappropriate Systems or Organization: Businesses often require a different organizational structure than nonprofits, and the relationship between the nonprofit parent and the business should be carefully structured, evaluated, and monitored.

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XIII. Steps to Success Although the definition of a successful social enterprise can vary from organization to organization, there are some key elements for success that hold true for almost any nonprofit. While most organizations will have steps specific to their needs, the following list includes the basic steps nonprofits should follow to succeed in social entrepreneurship: Step 1. Build the organizational capacity needed to support the enterprise. As mentioned earlier, starting a business requires building an effective asset base. Purchasing these assets can be difficult for many nonprofits, but on the other hand building intangible assets, such as the talents of your people, can be a much more difficult endeavor. Besides your core programmatic strengths, it is imperative that your business has some level of expertise in traditional business functions such as finance, accounting, marketing, operations management, human resources, and information technology. In addition, other areas such as leadership development, strategic planning, change management, and performance management will become equally as important as your business grows. Step 2. Get buy-in from board, staff, and external stakeholders. Board and staff support is the most critical component of a successful enterprise. Without the support of the board and staff, the enterprise will not be able to move forward because there will be no one to carry out the idea. The support of external stakeholders is important as well — without it the venture will not be received well by the community. Step 3. Have an internal sponsor who champions the idea. When things become difficult in launching the enterprise, or when the board and staff get frustrated or lose focus, this sponsor can motivate board and staff members and help them to refocus. The champion should be someone who has decision-making authority, preferably the chief executive. At the same time there should be someone to champion the organization’s mission — preferably a board member. Step 4. Do your homework. The business project team should conduct feasibility research — both primary and secondary. If the organization has done this research, it will be less likely to encounter unwelcome surprises further down the road. Step 5. Keep in mind potential risks. If you have done your homework, you should know what risks the enterprise could face and have a plan for handling them. (For more on the risk factors of social entrepreneurship, see page 25). Step 6. Know the laws. Every state and municipality has a set of laws, in addition to federal laws, that regulate what a nonprofit may or may not do. Nonprofit board members must be familiar with these laws and know how they apply to their organization’s business venture. The board is responsible for ensuring that the organization conducts its business in

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accordance with the law. Sometimes familiarizing yourself with the laws can bring an unexpected benefit to the organization. When researching the federal and local laws pertaining to its business venture, one nonprofit discovered it qualified for an exemption that no one knew about. Step 7. Ensure effective cash management. The enterprise may require financial needs much greater than the nonprofit is used to, and this may lead to new accounting methods. Make sure the board and accounting staff understand what kind of money the enterprise will take and how to manage this money effectively. Step 8. Hire the right talent. With a new enterprise, the organization will most likely need new talents on staff. Many organizations hire new, full-time staff to lead the enterprise. Step 9. Fill the gaps in expertise. If the organization can’t get the knowledge it needs by hiring new staff, there are other ways to get the necessary expertise. Train existing staff in the areas in which you need help, or consider using contract workers, consultants, or advisory group members. Step 10. Draw the connection to your mission. Anecdotal evidence seems to indicate that if the enterprise directly fits with the mission, it is easier for the staff and board to be excited about the venture, and they will be more likely to support it. It will also be easier for members of the community to see the fit between your organization and the enterprise. If the opportunity you are considering isn’t directly related to the mission, make sure you clearly espouse the indirect benefits (e.g., increased revenues, surplus revenues, or revenue diversification). Step 11. Define success for your organization. By answering the questions in Chapter VI, the board should be able to come up with a definition for success. Once success is defined, it is up to the board to ensure the organization stays on track to become successful. Step 12. Develop a good business plan. All of the previous steps should be captured in a well-thought-out, but not necessarily lengthy, planning document.

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P IONEER H UMAN S ERVICES : A N E XAMPLE OF S UCCESS Few nonprofit groups exemplify the spirit of social entrepreneurship like Pioneer Human Services in Seattle. Created in 1962 as a halfway house, the organization exists almost entirely on the money it makes in its business ventures. Today, Pioneer helps 6,000 people with problems like mental illness, drug addiction, and criminal convictions. It provides them with low-income housing, job training, treatment, counseling, and work-release programs. It does all this on a budget of $50 million, 99 percent of which comes from its businesses such as food service, construction, and manufacturing. The other one percent is from unsolicited donations. The businesses make money for the organization, but they also train and employ Pioneer’s clients. “We don’t pursue grants or raise money,” says Larry Fehr, senior vice president, who was executive director of a more traditional nonprofit for 16 years. “This is a unique approach.” Most people who are running the businesses came from the for-profit world, such as Pioneer’s president, who spent 20 years as president and CEO of national and international for-profits. For the most part, Pioneer’s businesses have grown out of work the organization was already doing. It needed to repair its own buildings, so it started a siding and painting business. It was providing food to its clients, so it began four retail food outlets and a food-buying service that acts as a broker for food banks. Over the years the businesses have grown and prospered. Pioneer now manufactures nearly 7,000 parts for Boeing and is a distribution center for Hasbro. Pioneer went this route in part because it was trying to teach its clients to become selfsufficient, so it seemed only fitting for the organization to do the same. Besides, says Fehr, “we don’t have a warm and fuzzy client,” which could make fund-raising a challenge. Supporting the organization with earned income allows Pioneer to use its money as it sees fit, without having to bend to the wishes of donors. Still, running a business linked to a nonprofit is not the same as running a business simply to make money. Because Pioneer is training people to go out into the community and get jobs, it encourages turnover. “You also don’t see many for-profit businesses spend as much time and effort on training and employee assistance as we do,” says Fehr. Pioneer continues to consider new ideas for expansion, in part using venture capital. “The banks that are involved are not doing it through charitable contributions but through investments,” he says. “They receive financial returns and they are also contributing to a social return.”

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C ONCLUSION Nonprofits’ options for raising money are not as limited as they may seem. More and more nonprofit organizations are following the examples of their for-profit counterparts in coming up with innovative ways to generate revenue. Social entrepreneurship has benefited many nonprofits by making them more self-sustaining and less reliant on the generosity of donors. However beneficial social entrepreneurship may be, an organization cannot enter an earned income strategy hastily. Many risks are involved with social entrepreneurship, and a poorly planned business venture could end up damaging a nonprofit’s finances, operations, or reputation. The board must ensure that the nonprofit has done the appropriate research and business planning and has earned the commitment and support from everyone connected to the organization, that the planned business venture is indeed legal, and that board members fully understand the risks involved. Nonprofits today can learn from the examples of organizations that have already experimented with social entrepreneurship. Board members can study the successes and failures of other nonprofits to see which strategies work well and which ones do not. As more organizations get more creative with earned income strategies, the promise of social entrepreneurship continues to grow. The objective of this book is not to encourage your organization to launch a social enterprise or engage in a cause-related marketing partnership, but rather to let you know that these options exist and to encourage you to consider the possibilities. As this book indicates, social entrepreneurship is certainly not for every nonprofit. But for those organizations who think they are up to the challenge and willing to do the due-diligence necessary to explore the possibility, there is significant theory and practice at their disposal.

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A PPENDIX I. F REQUENTLY A SKED Q UESTIONS Are business ventures or corporate partnering strategies a viable option for most nonprofits? Not every nonprofit will find it wise to launch a business venture or corporate partnering strategy, but nonprofits should at least consider exploring the possibilities if they need to diversify their revenue sources. The following conditions may signify that your organization is not ready for social entrepreneurship: • The organization is in crisis. • The organization is looking at a business venture to solve short-term cash-flow needs. • There has been a period of significant transition at the leadership level. • Significant short-term pressure is being placed on program activities because of unforeseen circumstances or changing environmental factors. • The organization has a risk-adverse profile. • The organization has a hard time dealing with or managing change.

Don’t most small businesses fail? Actually, most small businesses survive. In 1999, there were 5.8 million small businesses operating in the United States. Only 528,600 of them — less than 10 percent — closed their doors that same year. According to the U.S. Small Business Administration, after six years of operations, 38 percent of one-person companies are still in business, 76 percent of companies that hire one to four people are still running, and 79 percent of companies that hire five people or more are still open. The following chart provides more information on the success rate of small businesses.

P ERCENTAGE

OF

B USINESSES S TILL

IN

O PERATION A MONG ...

Companies of All Sizes (Soloists Included)

Companies That Hired 1 to 4 People

Companies That Hired 5 or More People

After 2 Years

76%

92%

94%

After 4 Years

47%

80%

87%

After 6 Years

38%

76%

79%

After 8 Years

29%

53%

70%

After 10 Years

21%

41%

62%

Source: U.S. Small Business Administration. The State of Small Business: A Report of the President, 1997.

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Will we have to pay taxes on our profits? First and foremost, always consult a tax attorney and your accountant on tax issues. If the profit generated is unrelated to the mission of your 501(c)(3), then you will probably need to account for it and pay unrelated business income tax. Remember, you only pay taxes on your profits, which means if you are paying these taxes you must be generating a surplus. (For more on UBIT, see page 28.) If the profit generated is related to your mission activity (e.g., providing jobs for clients who need job training), then your profits may be nontaxable.

Will having a successful business jeopardize our 501(c)(3) status? The IRS does have thresholds on earned revenue as a percentage of total budget, but a Chronicle of Philanthropy study of the IRS Form 990s of 14,000 charities found that $61 billion in income from unrelated business activities was shielded from federal taxes in 1998. For information specific to your organization, consult with an accountant or tax attorney.

Should the business be structured as a for-profit subsidiary? Many factors can influence this decision, including • the relevance of the business to the mission; • the amount of unrelated business income tax you could have to pay; • the ability to attract and hire quality staff — if the business you want to start will require a significantly different compensation structure than you currently offer employees of the nonprofit, starting a for-profit subsidiary may be a good idea; • the ability to attract capital and to take on a debt; and • liability protection for the nonprofit parent — certain businesses have more interest than others, and the nonprofit will want to minimize this possibility in the best manner possible. Check with an accountant or attorney for more details.

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A PPENDIX II: B USINESS A CQUISITION S CREENING C RITERIA As previously mentioned, it is important to conduct a thorough due-diligence process when considering a business opportunity. The following table is a sample tool that could be used to guide this process. Ask yourself whether each issue is a potential barrier or an enabler to your organization’s ability to be successful. After ranking every issue, add the scores and divide it by the number of issues you answered (37 if every issue on this list is answered). If your score is above a 5, then the opportunity may warrant further consideration. If the score is less than 5, the business may not be the best investment for your organization at this time.

B USINESS A CQUISITION S CREENING C RITERIA When determining whether to purchase a business, consider the following issues. Ask yourself whether each issue is a barrier or an enabler to success. Issue

Barrier 1

Enabler 2

3

4

5

6

7

Business Development Ability to leverage existing network Competitive positioning required Corporate relationships Customer relationships Industry competitiveness Market growth potential Reputation Status of existing contracts Financial Capital intensiveness of business Cash flow situation Cash required to close deal Comparison to industry financial benchmarks Debt required to close deal Existing debt situation Financial stability over past 5 years Profitability of business model Revenue performance over past 3–5 years Strength of balance sheet over past 3–5 years

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Issue

Barrier 1

Enabler 2

3

4

5

6

7

Mission or Vision Fit with client population Fit with mission objectives Fit with long-term vision Operations Number of employees Employee skill mix requirements Employee turnover rate Labor intensiveness of business Management talent required to run business Workforce skill requirements Other Access to mass transit Average wage rate Fit with culture Lawsuits pending Location Space requirements Status of existing facilities Technology requirements How long has business existed Union status

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A PPENDIX III: D EFINING S UCCESS The following evaluation can help set venture-success expectations before and after selecting a business opportunity. Use this evaluation to track your progress and gauge how closely it meets expectations. This exercise should be completed by the senior staff and board members of the organization to ensure everyone has the same expectations and to facilitate dialogue about reframing those expectations if they are not the same.

D EFINING S UCCESS

FOR

Y OUR V ENTURE

Use the following evaluative criteria to help set venture-success expectations before and after selecting business opportunity: Evaluation Range 0 Don’t Know

1 No leverage

Don’t Know

No competition

Level of competition

Highly competitive

Don’t Know

Unrelated

Fit with mission

Strong fit

Don’t Know

No fit

Fit with strategic goals

Strong fit

Don’t Know

No fit

Strong fit

Don’t Know

No fit

Fit with organizational culture Fit with client needs

Don’t Know

No fit

Strong fit

Don’t Know

Poorly perceived stakeholder Low margin/high volume

Fit with experience or talent Perception of external Margin/volume tradeoff

High margin/low volume

Don’t Know

2

3

BUSINESS SUCCESS CRITERIA

Ability to leverage existing network

4

5

6 Highly leveraged

Strong fit

Well perceived

Don’t Know

Small niche market

Market potential

Broad market potential

Don’t Know

Market is within existing service area

Market boundaries

No real market boundaries

Don’t Know

Emerging/new product or service Short term (year or less) Low investment required to start and run business

Product/service lifecycle Profitability timeline

Mature/established market or service Long term (6 or more years)

Capital investment

Significant investment

Don’t Know

No debt

Significant debt

Don’t Know

Low risk/low to moderate return Easy to implement

Debt required to start and run business Risk-reward element of business Ease of implementation Capacity requirements

Significant capacity investment required

Don’t Know Don’t Know

Don’t Know Don’t Know

Good fit with existing organizational capacity

High risk/high reward potential Implementation requires significant effort

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A PPENDIX IV: C APACITY R EADINESS T OOL Use this form to help gauge how ready your organization is to launch a new business venture. If you score 5 or higher for certain questions, include an example or details to support that rating in the notes space provided. This tool will help guide discussion about the organization’s readiness for social entrepreneurship. If scoring higher than 5, please support with example/detail.

1) Adaptability: Is your organization adaptive and able to respond to changing industry dynamics? Not Very Adaptive 1 2 3 4 5 6 7 Very Adaptive/Responsive 2) Assets: Is your organization asset rich or asset poor compared to other local nonprofits? Asset Poor 1 2 3 4 5 6 7 Asset Rich 3) Board: Do you consider your board a strong organizational asset? Minor Asset 1 2 3 4 5 6 7 Major Asset 4) Collaboration: Does your organization have a track record of collaborating well with other entities? Minimal Collaboration 1 2 3 4 5 6 7 High Collaboration 5) Creativity: To what extent does your organization cultivate a creative environment? Minimal Creativity 1 2 3 4 5 6 7 High Creativity 6) Crisis Management: How well does your organization cope with and then rebound from crisis? Major Setback 1 2 3 4 5 6 7 Makes Us Stronger 7) Outcomes Focus: Does your organization effectively manage business and programmatic outcomes? Not Outcomes Driven 1 2 3 4 5 6 7 Very Outcomes Driven 8) Accountability: Does your organization hold people accountable for their results? No Real Accountability 1 2 3 4 5 6 7 Full Accountability 9) Self-Examination: Does your organization have a culture that encourages institutional selfexamination? Rarely Reflect/Self-Examine 1 2 3 4 5 6 7 Regularly Reflect/Self-Examine 10) Strategic Focus and Direction: Does your organization effectively think and act strategically? Very Tactical 1 2 3 4 5 6 7 Very Strategic 11) Integrity of Purpose: Is it consistently clear what your organization stands for? Unclear Sense of Purpose 1 2 3 4 5 6 7 Clear Sense of Purpose 12) Leadership Vision: Do staff understand the values, vision, and direction of your organization? Unclear Leadership Vision 1 2 3 4 5 6 7 Leadership Vision Is Clear 13) Management Talent: Does your organization have a strong base of management talent? Weak Base 1 2 3 4 5 6 7 Strong Base

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If scoring higher than 5, please support with example/detail: 14) Marketing/Business Development: Does your organization effectively market its programs and services? Weak Marketing Focus 1 2 3 4 5 6 7 Strong Marketing Focus 15) Market Leadership: group? Market Follower 16) Network of Support: supporters? Weak Network of Support

Is your organization considered a market leader by its peer 1 2 3 4 5 6 7 Market Leader Does your organization have a broad and deep network of 1

2

3

4

5

6

7

Strong Network of Support

17) Culture for Change: Does your organization embrace change or avoid it? Slow To Change 1 2 3 4 5 6 7 Embraces Change 18) Energy/Stamina: Is your organization a fast-paced, energetic place to work? Low Energy/Slow Moving 1 2 3 4 5 6 7 High Energy, Fast Paced 19) Entrepreneurial Culture: Does your organization possess a “can do” attitude where staff feel empowered to make timely decisions? Bureaucratic 1 2 3 4 5 6 7 Highly Entrepreneurial 20) Financial Management: How strong is your current financial position? Cash Poor/Minimal Flexibility 1 2 3 4 5 6 7 Able To Make Strategic Investments 21) Human Resource Management: Does your organization effectively implement HR strategies that create a positive work environment for staff? Minimal Positive Impact 1 2 3 4 5 6 7 Effective Strategic Lever 22) Information Technology: Does your organization effectively leverage technology to its benefit? Minimal Benefit 1 2 3 4 5 6 7 Significant Benefit 23) What major capacity building initiative would you like your organization to take that it hasn't to date?

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A PPENDIX V: C ORPORATE PARTNERSHIP Q UESTIONS Corporate Partnership Feasibility Questions The following questions can guide a discussion among your board members to help determine whether your organization should pursue corporate partnerships. • Is this opportunity something the organization will enthusiastically support? • How well does the market opportunity fit with the organization’s skills and expertise? • Will we need to buy outside expertise? • What are the resource requirements of the opportunity? How much of a stretch is this for our organization? • Do we have a potential competitive advantage? • What is the investment required (both operational and capital) to launch and grow the opportunity? • How long will it take to turn this opportunity into a reality? • What is the risk factor?

Business Partner Questions If the organization decides to pursue a corporate partnership strategy, answering these questions can help. • Does the partner fill knowledge or competency gaps? • Does the partner fill capacity gaps? • Does the partner have access to markets or relationships we would like to penetrate? • Would the partner add value to our existing product line? • Does the partner have an established brand? • Does the partner have cash that could be strategically invested in a joint venture? • Does the partner have a commitment to our mission? • Does the partner understand the needs of our customers or constituents? • If we didn’t establish a formal relationship, would the partner pose a serious competitive threat? • Does the partner offer access to clients we wouldn’t be able to approach? • Does the partner offer access to clients outside our outreach area? UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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S UGGESTED R ESOURCES O RGANIZATIONS Ashoka: Innovators for the Public supports individual social entrepreneurs with financial and other services. Visit www.ashoka.org. Changemakers has a Web site about organizations that have found success with social entrepreneurship. It includes an online journal and an online library. Visit www.changemakers.net. Community Wealth Ventures, a subsidiary of Share Our Strength, is dedicated to helping others design and build successful revenue-generating enterprises. Visit www.communitywealth.com. Echoing Green provides money and support for organizations interested in starting new public service ventures. Visit www.echoinggreen.org. Ewing Marion Kauffman Foundation provides information about nonprofit and social entrepreneurship. Visit www.emkf.org. Morino Institute’s Web site includes articles and speeches about the current state of venture philanthropy and a downloadable report, “Venture Philanthropy 2001: The Changing Landscape,” with detailed information on the mission, size, and types of grants given by 37 venture philanthropy funds. Visit www.morino.org. The National Center for Social Entrepreneurs works to change the organizational culture of nonprofits from behaving like charities to acting like nonprofit businesses. Visit www.socialentrepreneurs.org. Roberts Enterprise Development Fund’s Web site includes a list of organizations across the country engaged in social entrepreneurship. The site contains downloadable reports on social entrepreneurship and venture philanthropy that try to measure the impact of social enterprises on individuals and their communities. Visit www.redf.org.

P UBLICATIONS Alter, Sutia Kim. Managing the Double Bottom Line: A Business Planning Reference for Social Enterprises. Pact Publications, 2000, 356 pages. A very thorough and useful how-to guide for nonprofits considering a social enterprise strategy. Angelica, Marion Peters. Keeping the Peace: Resolving Conflict in the Boardroom. Washington, D.C.: BoardSource* and Marion Peters Angelica, 2000, 44 pages. This booklet, co-published by the Amherst Wilder Foundation, provides a thorough explanation of the types of conflict, the reasons conflicts can arise, and approaches that can most effectively resolve them. Austin, James. The Collaboration Challenge. San Francisco: Jossey Bass, 2000, 272 pages. This book discusses the common elements and strategies that effective collaborations required. Case studies of successful collaborations are included. UNLOCKING PROFIT POTENTIAL / © 2002 BoardSource / www.boardsource.org

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Brinckerhoff, Peter C. Social Entrepreneurship: The Art of Mission-Based Venture Development. New York: John Wiley & Sons, 2000, 272 pages. This book shows how nonprofits can have success in social entrepreneurship by applying the strategies and attitudes that are most common across the nonprofit sector. Dees, Gregory; Emerson, Jed; Economy and Economy, Peter. Enterprising Nonprofits: A Toolkit for Social Entrepreneurs. New York: John Wiley & Sons, 2001, 330 pages. This book is a guide to business plans, financial management, risk resources, accounting, and innovative thinking for entrepreneurial nonprofits. Dees, Gregory; Emerson, Jed; Economy and Economy, Peter. Strategic Tools for Social Entrepreneurs: Enhancing the Performance of Your Enterprising Nonprofit. San Francisco: Jossey Bass, 2002, 360 pages. As a follow-up to Enterprising Nonprofits, this book provides a set of tools for putting the lessons of business entrepreneurship to work in your nonprofit. Tools include examples, exercises, checklists, and action steps that bring the concepts, frameworks, and tools to life. George, G. Worth. Fearless Fund-Raising for Nonprofit Boards. Washington, D.C.: BoardSource*, 1996, 24 pages. Author Worth George has developed a system that will help board members get started on their fund-raising responsibility. The booklet’s centerpiece is a worksheet of 40 specific fundraising activities that range from simple to sophisticated, and all play an important part in the overall plan. Harvard Business Review on Nonprofits. Cambridge, Mass.: Harvard Business School Press, 1999, 209 pages. This edition of Harvard Business Review includes eight essays on nonprofit issues, such as venture philanthropy, social entrepreneurship, business leaders on nonprofit boards, and nonprofit partnerships with corporations. Herman, Melanie and White, Leslie. Leaving Nothing to Chance: Achieving Accountability Through Risk Management. Washington, D.C.: BoardSource* and Nonprofit Risk Management Center, 1998, 32 pages. This booklet presents 10 steps for exercising board accountability and risk management, including formulating risk management policies, establishing sound financial management policies, and ensuring proper management of the board’s activities. Hopkins, Bruce R. Starting and Managing a Nonprofit Organization: A Legal Guide: Third Edition. New York: John Wiley & Sons, Inc., 2001, 344 pages. This book is a practical guide to legal issues of concern to nonprofits, including partnerships, for-profit subsidiaries, liability, staff compensation, charitable giving, and protecting an organization’s nonprofit tax status. Leet, Rebecca K. Marketing for Mission. Washington, D.C.: BoardSource*, 1998, 24 pages. This booklet helps board members understand the differences between for-profit and nonprofit marketing and defines marketing as it applies to mission. It not only clarifies marketing in the nonprofit context, but also shows it as a critical component to mission achievement.

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Sagawa, Shirley; Segal, Eli; and Kanter, Rosabeth Moss. Common Interest, Common Good: Creating Value Through Business and Social Sector Partnerships. Cambridge, Mass.: Harvard Business School Press, 1999, 350 pages. This book demonstrates how corporations, nonprofits, and government agencies can solve many of their problems by working together and serving the common good in the process. Shore, Bill. Revolution of the Heart. New York: Riverhead Books, 1995, 167 pages. Bill Shore founded Share Our Strength to help in the fight against hunger. In this book, he shares his story and presents his vision for revitalizing communities — simple, powerful ways to effect positive social change through personal contributions of skill, talent, and time. Shore, Bill. The Cathedral Within. New York: Random House, 1999, 293 pages. This book shares the stories of social entrepreneurs — people who are tapping into the vast resources of the private sector to improve public life and to create something that endures. Weisbrod, Burton A., ed. To Profit or Not to Profit: The Commercial Transformation of the Nonprofit Sector. New York: Cambridge University Press, 1998, 352 pages. This book examines the relationship between mission and money in the nonprofit sector and focuses on the differences in each of six mission areas — hospitals, universities, social service providers, zoos, museums, and public broadcasters.

*BoardSource was formerly the National Center for Nonprofit Boards.

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