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Social Finance Week: The unexpected venture capitalist

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In 2004, Jessie Huggett joined an Ottawa-area dance company and developed an innovative dance about the experience of having Down syndrome. Response to “I am Me” inspired company director Hannah Beach to create Dandelion Dance Company and later to add a unit on inclusion in a classroom resource book. The first run of the book sold out almost instantly, and schools and programs asked for a DVD/CD to accompany the book. Having already invested her own money in publishing the book, Beach needed a backer for the expanded project and she turned to an unexpected venture capitalist – the Down Syndrome Association of the National Capital Region (DSA-NCR).

Her request is part of a shift in roles: charities and nonprofits have always invited people to invest in their mission but today organizations are figuring out new ways to accomplish their purposes in innovative partnerships where at least sometimes the roles are reversed. Mission-related investing is a new trend in which charities – often foundations – invest in community good, including social enterprise.

Mission-related investing can offer organizations new partners whose values and work aligns with their own – and can even create a new source of revenue for the charity or nonprofit. In 2010, The State of Community/Mission Investment of Canadian Foundations: A Report of Community Foundations of Canada and Philanthropic Foundations Canada by Coro Strandberg noted, “With between $17 and $20 billion in Canadian community and private foundations alone, the opportunity exists to find ways to invest some of that capital directly in support of foundation mission.” The report added "...the model by which foundations fund grants from their return on invested capital may leave their assets significantly under-leveraged for charitable purposes.”

However, as Derek Gent, executive director of VanCity Community Foundation, whose organization is a leader in this movement, says, “There are very few business activities out there that just kick off excess cash. If you find one, let me know.” Others go further: Bob Wyatt, executive director of The Muttart Foundation says, “I believe that such ventures should be considered by a pretty small number of organizations. I don’t think ‘social entrepreneurship’ is a silver bullet.”

And, like any investment strategy, there are major risks – charities can risk losing their charitable registration, while nonprofits can lose their tax-exempt status, depending on how they approach their investments.

Whether your charity or nonprofit decides to invest is up to you, but CharityVillage hopes at least to demystify the process of becoming an unexpected venture capitalist.

Who’s who?

Editor’s Note: On CharityVillage, we sometimes use the terms charities and nonprofits virtually interchangeably. When it comes to legal matters, though, there are important distinctions to be made: all charities are nonprofits but not all nonprofits are charities. For the purpose of this article, nonprofits will mean nonprofit without charitable status, while charity will refer to those with charitable status.

Can a nonprofit turn a profit?

In November 2009, the Canada Revenue Agency (CRA) made a key ruling to answer that question. The answer is yes, but only by mistake – for instance, if a nonprofit sets a reasonable budget but ends up spending less, the profit would not cause the organization to be penalized.

Beyond this, however, any intentional enterprising activity by a nonprofit with the intent of earning a profit can lead to the organization losing its tax exemption status if audited by CRA. Profit is not defined in terms of bottom line at year-end but any activity that generates revenue. It also does not make a difference whether the surplus is directed to other mission-related activities within the same year. The only exception is if the profit is generated to purchase a community-focused physical asset.

In fact, Stacey Corriveau of the BC Centre for Social Enterprise estimates that 75% of nonprofits are offside in terms of intentionally generating margins to feed their programs without paying corporate income tax on year-end net profits. She says her conversations with CRA concur with her research.

But, as Corriveau, whose own nonprofit voluntarily remits corporate income tax says, “Losing tax exemption is not the end of the world, but the organization should be aware of this reality going in. We don’t have to fear generating profits because we pay tax like a regular corporation, freeing us to be more self-determining.”

Even if a nonprofit loses its tax exemption status, it remains a nonprofit in the eyes of its incorporating province. The change is that it must remit income tax on its bottom line for every year that it continues to intentionally generate profit.

Charities making money

Mission-related investment is different for charities. A charity’s funds have to be used for charitable purposes, but there are two types of mission-related investment that charities can engage in: investments to generate income and investments that accomplish the charity’s mission.

If a charity invests in order to generate income, it must be able to show that the investment is a prudent one. Directors of any charity have a fiduciary responsibility to act responsibly, and may have personal liability attached to such investments. Canadian law says, in making investment decisions, a director needs to “exercise the prudence of a reasonable man.” A court must be able to say an investment was reasonable given the available information at the time of investment.

Because donor dollars are the seed capital and because of the risk of losing charitable status, experts we spoke to suggest that charities looking to invest should seek legal counsel and also do due diligence – determining the risks and whether the charity will recoup its investment.

Malcolm Burrows, head of Philanthropic Advisory Services for Scotia Private Client Group says charities should learn from labour-sponsored funds. Popular in the late 1990s and still accounting for approximately 40% of all venture capital in Canada, labour-sponsored funds offer tax breaks to investors whose venture capital is invested through labour unions. Burrows calls the concept “a disaster” due to “lousy returns, bankrupt companies, and high fees” and says this is what charitable investors should avoid.

However, Wyatt says, “There may well be cases in which a charity, to fulfill its charitable purposes, could do something like this and it would make a great deal of sense. One has to think with the head as well as the heart.”

When Beach approached the DSA-NCR, the board evaluated her proven track record and solid business model as well as her passion. They decided to support this initiative, believing it would benefit not only their membership, but the community at large. The proposal matched the DSA-NCR’s purposes of creating positive awareness and making lives better for individuals with Down syndrome, and their caretakers.

Wyatt says, “Charities should not undertake such an investment unless they’ve done their homework. Take personalities out of it: ask yourself, ‘If this was someone we didn’t know, would we go along with it?’” He adds, “Charities finding ways to accomplish more with resources is a good thing, assuming you’re going to get paid back but you need to figure out what risk you are taking.”

In addition to a charitable investment being a prudent one, it cannot create a “private benefit,” meaning the charity financially benefits someone outside charity in a way that is not consistent with charitable purpose. This can be done deliberately – someone with a fundraising business sets up a charity and hires the fundraising business so that the majority of the funds raised go to the fundraiser. It can also be done inadvertently – Wyatt tells a story of a hypothetical company that contracts to use a charity’s logo on products; when the logoed products sell at a much faster rate than the same products without logo, this constitutes private benefit. Giving private benefit leads to sanctions and possible deregistration.

Charities helping charities

If the goal of the investment is to do more charity work, this is called program-related investment (PRI). A charity can only invest in another charity, but the prudent investment requirements are less stringent. Interest rates on PRIs are generally expected to be below fair-market value, in order to maximize benefit to the investee.

If the investee is not a charity but the investing charity’s CRA-approved charitable objects align with the project in question, Corriveau notes, the charity can contract with the for-profit to get the project done, but the charity must retain direction and control over the project.

Not simple, but satisfying

Mission-related investing requires thinking outside the box – but also being able to check off all the right boxes. It is anything but simple, and yet like so many other innovations, it can very much be worth the effort.

Nancy Huggett, whose daughter Jessie’s dance continues to inspire so many, says, “The DSA-NCR's investment in the curriculum and books that Hannah has created repays itself ten-fold in its impact on the lives of people with Down syndrome across the country, and on the wider community. The DSA should be mighty proud to have had a hand in making this resource and inspiration available to all."

Susan Fish is a writer/editor at Storywell, a company that helps individuals and organization tell their story well. She has written for the nonprofit sector for almost two decades and loves a good story.

Photos (from top) via iStock.com. All photos used with permission.

Please note: While we ensure that all links and email addresses are accurate at their publishing date, the quick-changing nature of the web means that some links to other websites and email addresses may no longer be accurate.

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