5 Bad Reasons to Start a For-Profit Social Enterprise
Harvard Business Review, by Rich Leimsider
Should a new social good organization choose a for-profit model or a nonprofit one? This is a question we face each year at my organization, Echoing Green, when we evaluate thousands of business plans from social entrepreneurs seeking start-up capital and support. This year, nearly 50% of those plans proposed using a for-profit model. And when we asked these entrepreneurs why, some of their reasons were just plain bad.
They are not alone. New entrepreneurs are increasingly starting for-profit firms whose primary purpose is social impact. Supporting this trend is a tremendous increase in capital available for “impact investing.” According to a recent JPMorgan/GIIN report, impact investors invested nearly $11 billion across 4,900 deals in 2013, up 250% from 2011.
At Echoing Green, the social impact of our portfolio is our highest priority, so we’re agnostic on which form the organization takes. With the new possibilities for for-profit models (including B Corps, L3Cs, etc.), social entrepreneurs now have more options. This can be a good choice for the right organization but too many entrepreneurs seem to be making the decision for the wrong reasons.
Here are some of the worst reasons we hear for starting a for-profit to do good:
Bad Reason #1: Only for-profits use “business discipline.” It’s easy to scan headlines and see undisciplined for-profit companies (take GM, American Apparel). If “business discipline” means a thoughtful, hard-nosed, numbers-driven, approach to delivering results, businesses such as Teach For America (with a $250M annual operating budget), the multi-billion-dollar-lending BRAC, or even institutions like Harvard University or the Cleveland Clinic are great examples of disciplined nonprofits. Clearly, for-profits don’t have a monopoly on discipline.
Bad Reason #2: Only for-profits can sell a product or service. This is a misunderstanding of corporate law in most countries. Whether your organization is a for-profit or nonprofit doesn’t typically affect your ability to sell products. There are some nuances in China and India, but in most parts of the world, and certainly in the U.S., nonprofits may sell products (Girl Scout cookies!) and for-profits can accept donations. In the 2013 class of Echoing Green Fellows, five of the 12 nonprofits earn revenue, and five of the seven for-profit companies have received donations.
Bad Reason #3: Only for-profits properly compensate employees. Many nonprofit social entrepreneurs earn a good living. And in sectors such as education or healthcare, nonprofit compensation is often at the same level as that of for-profits. But it is true that when nonprofit leaders earn salaries close to for-profit peers they are scrutinized. And it is certainly true that because nonprofits have no share ownership a Facebook-like founder’s payday is not in their future. Commitment to social entrepreneurship may mean lower lifetime earnings. So talk of “proper compensation” may be a signal that a particular entrepreneur is not a good fit for our model, which demands deep commitment to the social purpose.
Bad Reason #4: Only for-profits have a sustainable revenue model. There are usually two intertwined misconceptions here. First, there is the earned income fallacy (see Bad Reason #2). If an earned income model is most sustainable for a particular company, they can pursue it as a nonprofit. The second misconception, however, is that philanthropic revenue is somehow less reliable than earned income. The official statistics show that more than 50% of start-up for-profit businesses fail within the first five years. Earned revenue can be highly variable. And examples such as the United Way or the Catholic Church make it clear that organizations can rely heavily on donations and still be sustainable. In fact, according to the National Philanthropic Trust, when the S&P 500 fell by 45% after the 2007 recession, U.S. charitable giving dipped only 10%.
Bad Reason #5: Nonprofits are “old-fashioned” and only for-profits earn respect in their sectors. While few entrepreneurs express this sentiment directly, we do hear it. Entrepreneurs are deeply influenced by the people around them. In the early years of Echoing Green our applicants had often worked for nonprofits or gone through social justice-oriented law schools. These days our Fellows are more likely than ever to have an MBA. According to a recent survey by AshokaU, for example, 64% of universities that teach about social entrepreneurship do so via their business school, rather than public policy, social work, etc. And it seems that on a business school campus – and, truth be told, in many parents’ living rooms – starting a for-profit business has much more cachet than starting a nonprofit.
Of course, there are good reasons to set up a for-profit too. Echoing Green first supported a for-profit in 2007 and since then we have provided $10.4 million in start-up capital to 47 for-profit companies. Here are some of the best reasons we’ve heard for using a for-profit model:
Good Reason #1: When local laws require it. While most countries now allow some form of nonprofit corporation, in several places that classification comes with such challenging restrictions (no government protests in China, need parliamentary decree in Lebanon, difficult to raise money abroad in India) that it is not practical. In these cases, the best way to have a deep social impact may be through a for-profit.
Good Reason #2: If equity investment is the best way to get start-up capital. The rise of the impact investor is an important development in the social sector, and no social entrepreneur should leave mission-aligned money on the table. Joel Jackson (a 2011 Echoing Green fellow) launched Mobius Motors as a social purpose car manufacturer to democratize transportation in East Africa. Philanthropic donors were not able to provide the millions of dollars necessary to support design and production, so selling equity to mission-aligned investors made good sense. The trick here is not to lose sight that this will close off some philanthropic doors, and that equity investors will want to influence the business to get their money back.
Good Reason #3: To send a signal to key partners or others about the role of for-profit markets. In some cases an entrepreneur is working to improve for-profit capital markets or with for-profit entrepreneurs. David del Ser (a 2009 Echoing Green fellow) created Frogtek to provide big-company-quality business intelligence to raise the income of shopkeepers in the poorest parts of Latin America. As a for-profit, David can rely on a higher level of trust from his customers who know that they are facing similar challenges in the world.
Jane Chen (a 2008 Echoing Green fellow) did it right when she and her co-founders at Embrace began with a social goal to save lives with an innovative low-cost infant warmer, and chose the model (and then evolved it) that best served that goal.
The point of all this is not to prove that the for-profit or nonprofit form is inherently best for social impact. In fact, the point here is the opposite. Our best chance to make the world better is to agree that the choice among corporate structures should be made entirely in service of social impact.