Charities and Business

Wednesday, January 17, at 12 noon, U.S. Eastern time

Rolfe Larson runs a social-enterprise consulting company in Denver. Mr. Larson previously worked at Minnesota Public Radio, where he was in charge of developing new money-making activities.

Jan Cohen directs new business ventures at Hope Services, a Santa Clara, Calif., organization that provides job training and other services to the mentally disabled.

A transcript of the chat follows.

Nicole Wallace (Moderator):
    Greetings, everyone! I am Nicole Wallace, senior writer for The Chronicle of Philanthropy.

Welcome to this discussion about charity business ventures and other income-producing activities. We're pleased to have Jan Cohen and Rolfe Larson as today's guests.

We'll be taking your questions for the next hour. All you have to do is click the link on this page that says "ask a question."

Jan and Rolfe, thanks for being with us.

Question from Cheryl, small church:
    As a small church with some big ideas about sharing faith in new and different ways, our congregation is selling our building and planning to open a coffee house where we can be in relationship with others in a non-threatening environment.

Through this effort, we are expecting to simply cover our operating costs and be able to eventually open other types of businesses where we can serve and be in relationship with others in the greater community.

Our questions include whether we can operate under our existing non-profit status (501c3)as a church, or if we should apply for different status?

Even if we can operate under our current status, will we need an attorney to work through this process with us? Other professional we must use? Other financial or legal issues we must be concerned with or consider?

Janet S. Cohen:
    It's always good advice to speak with an attorney who is familiar with nonprofit IRS rules and laws. However, many nonprofits who operate coffee houses and other "related" businesses keep them "inside" their nonprofit organization, i.e. do not incorporate them separately.

At HOPE Services and other organizations where I have started up and run businesses, we keep all of our businesses within the nonprofit corporation. None are disproportionately big in revenue or consumption of resources compared to the nonprofit itself and all are closely related to our mission.

"Relatedness" is a key consideration by the IRS. You should also set up separate accounts for this business, for tracking and evaluation of the business itself as well as other considerations, but that can be done through accounting coding, just as if it were a separate department.

Rolfe Larson:
    Those are mostly legal questions, and I'm not a lawyer. What I can say is what I have observed, and that is that there are many 501c3 organizations who operate earned income ventures including coffee shops. You should consult with a qualified lawyer to address your specific circumstances.

For the listserv I co-moderate, the npEnterprise Forum (http://www.npEnterprise.net), we maintain a frequently asked questions (FAQ) file on legal issues, with comments from lawyers, which you may want to review before meeting with your lawyer. In terms of other professionals to utilize, I would say the largest issue is to find someone, a consultant or a qualified volunteer, to help you assess the market for this coffee house (given its location, the competition, and so on), to determine whether it will be financial feasible, and also to help you figure out effective marketing strategies.

Question from Eric Loewe, SNEDA, a small community development loan (and equity) fund:
    How do you (1) recruit and retain an excellent managment team and (2) obtain the funds for the period until the double (or triple) bottom line business becomes self-sufficient? Thank you

Rolfe Larson:
    Those are two very big challenges. In most cases, management and initial funds come from internal sources within the nonprofit creating the social venture, rather than from elsewhere. I know, for many organizations, that's not very helpful, but that's the reality.

Sometimes grant resources can be cross-utilized to develop a venture; for example, if a grant calls for some initial outreach and/or a needs assessment, you can make sure you also gather information at the same time about market conditions and competition to help with a future venture.

Some NPOs use their reserves to help start a venture. Initial management is often drawn from the nonprofit, with hiring as needed to backfill their positions.

Finally, in unusual situations (but increasing) funders will support the early development of a venture, as a strategy for the organization to achieve greater sustainability -- in most cases, those are your existing funders, rather than someone with whom you do not already have a relationship.

Janet S. Cohen:
    This really is the same answer that I would give to any small business, in a nonprofit or not.

Recruiting and retaining a management team has a lot to do with "buy in" to the business and the nonprofit and to having experience and being comfortable with the business venture itself. I strongly advocate hiring people who know and have experience in the business you are asking them to manage...for their happiness in the job but also for the success of the business.

Obtaining the funds has a lot of do with good business planning and knowing how much you will need and being realistic about how long it will take to become self sufficient, or whether the business will always need a subsidy. There is no substitute for business planning and then "running this plan past" people who have been in this business for their input on how realistic the projections are.

A business advisory committee of people in that business is so important to realistic planning. This group also gives you the credibility to get the start up funds you might need to get you through the "hard times". Then of course there are always mid course corrections, as no business goes as planned. You have to have "staying power" but also you need realistic planning and experienced people working in the business. And sometimes, of course, the business will not ever break even and you have to admit it and decide whether to exit or continue to subsidize it because it is critical to the mission of the organization.

Question from Melissa Ransdell -- Comprehensive Health Education Foundation:
    I'm curious about your knowledge of any success of new social enterprises launching within established -- typically risk-adverse -- cultures of established nonprofit organizations. Any that have worked well,and if so how?

Rolfe Larson:
    If by social enterprise you mean nonprofits that generate earned income, then the vast majority of nonprofits do that, in many cases as a significant source of revenue.

The recent 2007 Nonprofit Sector in Brief (Urban Institute) indicates that more than 70% of nonprofit sector revenue comes from fees from selling goods and services. While that figure includes health care organizations, this clearly shows the significance of earned income to the nonprofit sector.

I have worked with dozens of established nonprofits that have launched successful social enterprises, and have come across hundreds more through the workshops I teach. This is not to say that it's always easy for established organizations to pursue social enterprise strategies. I agree with you that they are often risk-averse, which is why nonprofits tend to be cautious in pursue risky ventures. This is not necessarily a bad thing. While risk is an essential component of any enterprise, social or otherwise, seeking lower risk ventures can be a smart strategy.

So instead of the question of whether social enterprise can or cannot be successful -- we know it can be, as has been demonstrated throughout the sector for decades -- the real question is what works for a given organization. The answer to the question depends on the strengths, capabilities and leadership of each such organization. Earned income strategies that build on those characteristics are far more likely to succeed than ventures that do not. And for some organizations, it's better for them to build their capabilities first, and then pursue earned income strategies later as an additional sustainability strategy.

The other point I'd like to make relates to how one defines success in social enterprise. Often financial goals are important, not surprisingly, but usually that is not the sole yardstick for success. The most important measure of success, I would argue, is the extent to which the venture helps the organization accomplish its mission, for which financial benefit is but one element. Ventures are often invaluable for an organization in terms of building capacity to be more effective in pursuing its mission, such as developing better systems for measuring outcomes, internal cost accounting, and information processing.

The current issue of The Chronicle includes a number of examples of successful social enterprises. The Social Enterprise Alliance (http://www.se-alliance.org) is a membership organization that includes 1100+ members, most of whom are affiliated with nonprofits that operate earned income activities. And the listserv I co-moderate, the npEnterprise Forum (http://www.npEnterprise.net), with 4000+ subscribers, includes a daily conversation about what works (and what doesn't work) in the world of social enterprise.

I hope you will feel free to check out any of those resources to provide you with the many examples there are of social enterprises that have been successful.

Janet S. Cohen:
    Many cultures are risk averse, as are individuals themselves. This is one of the reasons why it is so important at the start of the exploratory process for an earned income venture or enterprise, to involve key stakeholders, take the time to communicate the driving forces, market opportunity, and other reasons why the group is embarking on this course.

I think it's the start up process and communicating with key stakeholders inside and outside of the organization all through the market research and planning process that is key. It is also important to take steps to mitigate risk, whether those be a advisory committee of people in that business, impartial people or Devil's Advocates to review and ask questions about the market research and financial projections, hiring someone to run the business from the start who knows that business, etc, etc.

Many typically risk averse groups have done this successfully, including health related groups, disability related groups, library collaboratives, etc. Those who I've worked with and for who were the most successful in keeping the blood pressure of the leaders on the Board and staff down to normal focused on good communication, rigorous market research, and encouraging a couple of Devil's Advocates to question assumptions and projections.

And of course every successful venture has to have a "champion" behind it...the more risk averse, the more a key champion needs to be the CEO or Executive Director!!

Question from Jed Emerson (various affiliations):
    It seems this topic is often teed up in a "good vs. bad" manner -- Should or should not nonprofits be involved in business venturing -- when in fact the issue is really one of to what degree nonprofits should be using business practices to advance their interests.

Should NPs become more business-like? Of course! We should look to use as many financial, marketing, and management tools as we can in order to advance our social strategy. But should all nonprofits go so far as to launch a market-based business venture -- of course not, since the particular skills, assets, and market opportunities that make for success will shift depending upon context.

My question: why is it so hard to even have this conversation in this space without people going all bonkers about mission drift and failed examples we all know of? Why isn't this simply viewed as one more option for some nonprofits, but not a panacea for all -- instead of it being this "cut and dry" debate that tends to draw two sides where there shouldn't be any?

Rolfe Larson:
    I agree with you Jed: I think ALL nonprofits should include business practices as part of their activities to pursue their mission. And probably most should include some kind of earned income in their toolbox. And a few, say 5%, are in a position to launch a stand-alone market-based business venture.

The debate should not be about whether earned income makes sense for the nonprofit sector. Of course it does -- it already does in a BIG way -- that's worth debating. The larger, more important issue is figuring out which tools, including earned income, makes sense for given nonprofit to best pursue its mission. So let's move beyond IF, to the better question of HOW and HOW MUCH.

Janet S. Cohen:
    I totally agree that it's time to move beyond the theoretical discussion. Many of us have worked in organizations that have remained busy "doing it" and changing lives as a result, while others keep discussing whether we should do market based activities. Why everyone cannot see this a one option for many groups, especially in this current environment of so much competition for charitable dollars and grants, is hard to understand.

Diversification of revenue is something that is considered essential for individuals and businesses. It is even more important for nonprofits, many of whom have "fickle" funding or funding that can decline due to no fault of their own, but political or other factors beyond their control. Having a variety of funding sources, some self generated and relying on market need and interest, allows those nonprofits, for which it is appropriate and who choose to run these activities, to demonstrate to our various publics that we are committed to sustainability and continuing to meet the need that gave rise to our missions and organizations over the long haul.

Question from Brownbag Foundation:
    Can a charity set up a direct sales business to sell vacuum cleaners door to door?

Janet S. Cohen:
    A charity can do whatever business ventures it chooses. The IRS, the Board, and funders can be concerned about whether these activities, as they are called, are "related" to the tax exempt purpose of the organization. If they are not related, the organization will pay taxes, just as any other business might. If a business furthers and is related to the mission of the organization, taxes are not due on sales, as the government assumes the money that might be otherwise paid in taxes will be used to further the mission.

Rolfe Larson:
    Again, this seems to be a legal question, and I am not a lawyer. The one example to consider would be Girl Scout cookies. The overall point is that the activity needs to be closely tied to the charitable mission of the nonprofit. For the Girl Scouts, my understanding is that selling cookies is a central component of building character, teamwork, and entrepreneurship for the girls, and thus an important part of its mission.

Nicole Wallace (Moderator):
    Rolfe Larson and Jan Cohen will continue to take your questions throughout the hour, and we encourage you to join the conversation. To submit your question, just click on the link that says "ask a question."

Question from Rick Schofield, small nonprofit:
    1. I imagine as a small non-profit that it's a bit harder to get a business off the ground or may not be feasible. It could easily be part-time job for a year for someone to research and do the leg work for it. Any suggestions on who should and should not do it? Or maybe partner with another organization?

2. I could see how this could go a long way to supporting and organization long-term especially during expansion of the organization. Could you talk about reasons why some don't "make it"?

Janet S. Cohen:
    1. I think the challenges of doing a business venture in a small singularly focused organization are often less that a large one with many stakeholders and competing priorities for leadership. Yes, it could be and should be a part time job for someone, or a team, to research and find the best single idea for YOUR organization to do where YOU are located. It needs to be done by someone who loves to do this exploration and research. It needs to be someone who wants to do it, is a champion for the idea, and if not the Executive Director, someone who has the total support and commitment to this from the E.D. To answer your question about who should not do it...Someone who is not passionate about the concept and interested in finding the right pieces to put in the puzzle to get the right picture for your future.

2. Why some don't make it is a long answer...summed up: wrong time in the market or for the organization, wrong product for the market, wrong price, wrong location....or impatience to wait for break even.

Question from Laura, mid-sized mental health services agency:
    What are the common difficulties in creating a for-profit business when the parent company has 501 (c)3 status?

Rolfe Larson:
    I'm not sure exactly what you're after with that question. Let me try, and you can clarify your question if I missed your point.

I'd say these are the major difficulties: (1) internal culture: creating an environment where customers wants and needs are important, where some level of taking risks is encouraged, where business decisions are made quickly by the person best equipped to make them (often the direct manager, not the ED)

(2) understanding the marketplace, and what customers would be willing to pay for (and how much). Many nonprofits assume that what they value will also be valued by others.

(3) marketing -- many nonprofits assume that "build it and they will come" will actually work for them in the marketplace. Sadly, it rarely does.

(4) unrealistic expectations -- that a venture will quickly generate piles of dollars so that we no longer have to pursue grants and fundraising. Then, if that doesn't happen quickly, they want to shut it down and call it a failure.

I do want to add that there are many opportunities that nonprofits have with earned income ventures. For one thing, they already have extensive experience in the community, and often a powerful reputation. Both are assets that a small entrepreneur starting a business typcially does not have.

Question from Lisa Aldridge, Roseburg Senior Center:
    "Relatedness to your mission" is a real road block for us. We are having a hard time figuring out a social enterprise for a senior day recreation center that reflects our mission. It seems a lot of social enterprises are utilized for job training, but our seniors aren't looking for job training. How could something such as a coffee shop or an event rental facility be tied to our mission?

Rolfe Larson:
    First, it doesn't have to be related to your mission -- that's only a tax issue. If it's not mission-related, you'l probably have to pay unrelated business income tax (UBIT) on the net income (NOT on gross revenue), like any other business. And like any other business, you can deduct appropriate expenses, including reasonable overhead, before paying taxes. Paying taxes is not a bad thing -- if you're paying them, you're profitable and that's a good thing!

Also, there may be some mission-related ventures you could explore. I know of one senior's group that, every year, creates the premier guide to senior facilities (assisted living, nursing homes, etc) for the metropolitan area -- and sells thousands of copies.

Question from Christian Brown, Red Cross:
    We are a small chapter looking to grow and expand our reach in a fairly insulated community. ... It is an area that is severely depressed economically and all of our past ventures have not been very successful. What would you say are some of the key things we can focus on to make things more successful? We have tried media blitzes for events, as well as informational blitzes. Is there another way we can go to make something successful and more sustainable?

Rolfe Larson:
    I would need to know more about your community to more fully address that question, but off the top of my head:

Are there things that can be made and "exported" out of the community, and in so doing bring in outside dollars?

What is it that people need and are willing to pay for in your community? (A thrift store comes to mind.)

How have your ventures been managed and marketed in the past? Can you get advice and help from successful small business owners in the community, by creating a venture committee? I have seen this work very well in a number of small, and in some cases economically depressed, communities. It may be that things can be improved with your existing ventures with enhanced advice from local experts.

Janet S. Cohen:
    As someone who is "market focused," I would suggest that if you don't have the right event or service for the market, no amount of media blitzes will make it successful. Success comes from rigorous market research to find where the opportunity is, what people want and don't have, etc.

I worked with one Red Cross group that was successful doing the babysitter CPR and other classes in Spanish, because that was truly the need in the community and it gave the teens there a way to make money. But in other communities that would not at all be the right thing.

I would recommend that you spend more time up front finding where the need is and exactly what people want and how they would want it specifically focused on the needs of your community...that will save you a lot of time later on marketing efforts and trying to figure out why it didn't work.

Question from Nick Cavanaugh, Syracuse Cooperative Federal Credit Union:
    Could you speak more to the differences and advantages/disadvantes of setting up a business within the non-profit vs. incorporating separately?

Rolfe Larson:
    Gosh, I could go on for pages and pages on this topic.

In a nutshell, the issue reflects complex balancing between numerous issues. In general, I believe the presumption should be to keep the activity within the nonprofit, except when there are compelling arguments to the contrary -- such as preserving the tax exempt status of the parent nonprofit, or protection against real (not low-probability, hypothetical) liability issues.

Issues ot balance include: (1) tax issues (separately incorporating can increase the tax burden for unrelated ventures), (2) administrative efficiency (operating a separate entity creates additional expenses, such as legal, and consumes more senior staff time, such as supporting a second board of directors (and coordinating the two boards), (3) public awareness (separation can either help or hinder marketing efforts for both organizations -- study this carefully.

Question from Ian Wilhelm, Chronicle of Philanthropy:
    Are nonprofit business ventures more accepted in other parts of the world, especially South Asia? For example, in Bangledesh, the Grameen Bank and Bangladesh Rural Advancement Committee have received worldwide attention for mixing charity and business, as has Thailand's Mechai Viravaidya. Thanks.

Janet S. Cohen:
    I think nonprofit ventures are accepted throughout the world, just as they are here in the US. What is different here is that we debate whether nonprofits should create and run businesses, while other countries don't do this. But while many debate the issue, many nonprofits just go about their business running earned income ventures or businesses or charging for their services. It may appear as if there are not many doing this in the US, but that's because many are doing it quietly within their communities as they always have.

Rolfe Larson:
    I think nonprofit/NGO ventures are accepted in many countries around the world, including the examples you listed, and others I'm familiar with in India, Australia, Brazil, and so on. I want to add here that they are in fact quite well accepted throughout the US, and exist in every state and probably every city as well. Name any city with more than 50,000 people in the US, and I'll bet you'll find several nonprofit ventures located in that city. It's just that the US press doesn't cover them very often, and, then, every year or two, "re-discovers" social ventures like it's some small new thing that just emerged out of the woodwork. If anything, nonprofit ventures (defined as earned income) defines the US nonprofit sector better than grants and donations do.

Question from Mark Pomerantz, Social Profits:
    I always tell organizations that consult me that earned income ventures should be looked at as part of a portfolio of potential funding sources---events, fees and dues, individual donations and major gifts, legacy programs etc. The more successful a NPO is in diversifying funding the more sustainable it may become.

My question is why relatively few Nonprofit Management programs university based or otherwise are incorporating earned income or social venture development into their curriculum?

Janet S. Cohen:
    I think that these programs try to cover so many different topics, and that fundraising in always a key one of those, that they just don't include this. I think they also see it as a smaller factor in the management picture than other things.

It would be terrific to at least include it in a class on Funding as part of the options for funding an organization and keeping it sustainable, but I have not seen that much yet. I do know that some schools do include Social Enterpreneurship, but these classes are often more about doing business to improve the world, whether nonprofit or for profit in nature.

Rolfe Larson:
    I agree with you that earned income should just be considered another tool to be used to support the nonprofit's activities. My general impression is that more and more univerisity-based nonprofit management programs ARE including earned income into their programs.

What I've been surprised at (and perhaps this is what you're alluding to) is how long it's taken them to get there, and how tiny their steps have been in that direction. While 70% of nonprofit revenue comes from earned income, you'd think, from the way nonprofit management is still taught today, that that figure was 2-3%! But they are moving in the right direction, and we can expect to see more and more of it in the years to come.

Question from mary, small nonprofit:
    I would like a brief overview of the tool to assess entrepreneurial readiness.

Rolfe Larson:
    I'm not exactly sure what tool you are referring to. Perhaps it's the Venture Audit, as described starting on page 29 of my book, Venture Forth, which is available at http://www.fieldstonealliance.org.

The point of this tool -- actually several worksheets -- is to evaluate the strengths and capabilities of your organization to pursue business ventures. It looks at your core customers (who you already have relationships with), core competencies (what you're good at doing), and your internal culture. The basic concept is that the best venture ideas are ones that build on your organization's skills -- just like if you're looking for a job, look for jobs that build on your particular strengths and experience. Hope that helps. Please ask a followup question if there's something else you'd like me to discuss here.

Nicole Wallace (Moderator):
    I'm afraid our hour is up. Many thanks to Jan and Rolfe for sharing their expertise and to everyone who submitted questions! A transcript of the conversation will be posted on this page shortly. If you have any questions about The Chronicle or suggestions on how we can serve you better, please write to us at editor@philanthropy.com.