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Impact Investing

Foundation-Owned Social Enterprises: A New Way Forward?

A novel impact investment model can help social enterprises and foundations generate a high social return on investment.

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The Universal Anaesthesia Machine used for a procedure at Haitian Christian Mission Hospital in Haiti. (Photo by Steve Rudy)

A recent evaluation of the Rockefeller Foundation’s Program-Related Investment Fund concluded that it has “generated modest financial returns for the Foundation, contributed to investees’ financial sustainability and generated positive social returns on a variety of fronts,” and that “the Rockefeller Foundation has contributed to the rapid evolution of the PRI field for the last two decades.”

Program-related investments (PRIs) can be powerful social investment tools. They also take many forms, including purchases of passive debt and active equity. The health care social enterprise I work for, Gradian Health Systems, benefits from a very promising active equity investment: It’s wholly owned by a family foundation.

We call this model “foundation-owned social enterprise,” or FOSE. In legal parlance, Gradian is known as both a “single member limited liability corporation” (SMLLC) and as a “disregarded entity” of the family foundation; functionally, this means that the foundation alone owns the company, and that Gradian’s financial statements roll up to the foundation’s 990 for tax reporting.

While SMLLCs are common in the business world, to our knowledge, they are little used in the social sector. Under the right conditions, however, the FOSE model can be an attractive option for both investors and investees, provided the investor is more committed to achieving a social, not just financial, return on investment.

Of course, the term “social enterprise” covers a broad array of organizations—both for-profit and nonprofit—that use commercial strategies in the service of promoting a social goal. Some, like Warby Parker, produce high financial returns and look financially identical to typical enterprises; others expect lower financial returns and receive investment support from organizations like Acumen Fund; still others generate small or no returns and are generally incorporated as nonprofit organizations. Entrepreneurs are experimenting with each of these models, creating hybrid social enterprise models that fit the needs of their consumers and markets.

How FOSE Works

At Gradian, we sell the Universal Anaesthesia Machine (UAM), a medical device designed specifically to address the difficult operating theater environments found in many low-resources hospitals throughout the world. In contrast to traditional anaesthesia machines, the UAM can function without consistent electricity or a source of compressed oxygen—two major concerns for low-resource hospitals. It is also simple enough that hospital technicians can perform maintenance and repair.

Rather than donating the UAM to hospitals that need them, we sell the device at our cost, allowing us to keep the price as low as possible, scale production to meet market demands, and conserve philanthropic funding for overhead and the most broken aspect of the low-income medical device market: robust after-sales training, maintenance, service, and support.

This structure has worked well for us and our parent organization, the Nick Simons Foundation, and we think it holds promise for a wide variety of social enterprises and foundations. Most obviously, the investment reduces (or eliminates altogether) the need to spend time and resources on fundraising and financial reporting, which allows the social enterprise to focus on operations. A startup social enterprise can also cheaply piggyback on the foundation’s existing hard infrastructure (such as office space and technology) and soft infrastructure (such as tacit knowledge and mentors).

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The Universal Anaesthesia Machine in Connaught Hospital, Freetown, Sierra Leone. (Photo by Steve Rudy)

Owning a social enterprise (or creating a disregarded entity) allows a foundation to efficiently effect change using market mechanisms to sell a good or service, while using philanthropic resources to address market failures and advocate a cause. Critically, it is also a tax-free investment vehicle for the foundation, fulfills the foundation’s requirement to spend 5 percent of its endowment annually, and because SMLLCs are autonomous legal entities, protects the foundation’s assets from any liability to which their investees expose them. We think this model could provide a more efficient option that conventional grant- and donation-based models.

The FOSE model isn’t appropriate for all social enterprises or all foundations. If it’s likely that a social enterprise will be profitable, a foundation’s funds are probably better invested in higher-risk, lower-return ventures, as the social enterprise can probably raise capital in more traditional debt and equity markets.

But FOSE has a great deal of potential to fill the gap that exists between typical social enterprises and traditional grant-based nonprofits. Social enterprises that use markets but don’t expect market returns on investment are great candidates for the model, as are foundations looking for new ways to efficiently meet their social impact goals.

As foundations experiment with the FOSE model they will likely iterate and improve on it, honing it into an even more powerful tool for social change. For that to happen, though, more individuals, foundations, and social enterprises need to learn about it, scrutinize it, and ultimately take the leap and give it a try. Let us know if you or other organizations you know are operating as a SMLLC owned by a 501(c)(3)!

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COMMENTS

  • BY Leonard Mafrica

    ON August 6, 2014 06:00 PM

    This is a new concept to me.  I have worked at nonprofits that own for-profit corporations as a way to fund - or subsidize their high-cost, mission-centered initiatives.  These usually are not social enterprises, however, often complementary to the organization’s mission.  The FOSE is a much clearer path for foundations.—Leonard Mafrica (@LenMafrica), nonprofit executive.

  • patrick westerlund's avatar

    BY patrick westerlund

    ON August 7, 2014 12:04 PM

    It is great to see this gaining more exposure. The Tony R Wells Foundation, a family foundation out of Columbus, OH, USA is pursuing this with a portfolio of social enterprises, or FOSEs.

    The key difference is that the Wells Foundation’s social enterprises aren’t wholly owned but rather majority owned joint ventures with nonprofit partners who provide expertise, market access, or other critical resources.

    The idea that they can feed off the foundation’s philanthropic infrastructure, realize synergies, and learn from each other in somewhat of an incubator setting is hugely beneficial and one could make that case that they are more likely to launch successfully to make the impact they were envisioned to create.

  • BY Astrid Scholz

    ON August 7, 2014 08:03 PM

    At Ecotrust we have employed this structure as well, using a SMLLC to disseminate, for example, technologies for marine conservation and planning.

  • BY Robert Neighbour

    ON August 8, 2014 02:31 AM

    Are the activities of Social Enterprises described in the article the solution for low income countries or one of the barriers to long term economic development in those regions creating a culture of aid dependency while providing financial and tax benefits to foundations and not for profit organisation in developed countries?

    The article appears to be as concerned with the maximisation of taxation benefits and liability reductions for Foundations and Not for Profit organisations than it does for the increased provision of appropriate technologies for low resource countries.

    It is generally agreed that the only long term sustainable way these areas of the world will be able to lift themselves from their current situation is through economic development and this requires the activities of the commercial sector. The Not for Profit sector can only provide an interim solution.

    There appears to be no consideration given to the displacement of legitimate commercial products, some of which have been highly successful in providing equivalent solutions for many, many years.

    The displacement of sustainable commercial activities and products by the sale of what are effectively subsidised products does not improve the overall situation in low income countries and could eventually lead to fewer players in the market or even a monopoly situation.

    Questions:

    Do these non-commercial organisations intend to subsidise the sector in perpetuity?

    Is the goal to perpetuate an aid culture and maintain sections of the world as dependencies?

    Is the eventual aim to convert these organisations to commercial companies?

    These are questions that require due consideration and honest answers. 

  • Mel Tremper's avatar

    BY Mel Tremper

    ON August 9, 2014 05:09 PM

    R. Neighbour wrote: “There appears to be no consideration given to the displacement of legitimate commercial products, some of which have been highly successful in providing equivalent solutions for many, many years.”  That may be the case for some items. But it appears that the anaesthesia machines generally available are not, in fact, suitable for low resource medical environments.  While there may be some merit to approaching the FOSE model with his questions in mind, I suspect that patients who have benefitted from the machines would not be overly worried about the philosophical issues involved.
    One possible avenue to allay some of his concerns might be to create the capacity to manufacture FOSE supported goods in the regions where they would be sold.  This way, the regions would be acquiring the capacity to build and distribute items, and at the same time, crucial services (such as medical care) would be able to acquire the items at prices they could afford.

  • BY Mike Miesen

    ON August 12, 2014 08:19 AM

    Thank you all for such wonderful and informative comments! I’m glad to have connected with some of you about the FOSE model.

    Mr. Neighbour raises a number of important points about the FOSE model and Gradian’s use of it to address the challenges of medical device sales, distribution and service in low-resource countries.  As the owner of a company that competes with Gradian, Mr. Neighbour is certainly aware of these challenges.

    My goal for the article was to generate just this kind of discussion; we don’t claim to have found the silver bullet solution for the issues described above. Rather, we think that FOSE – and, more broadly, social enterprise – represents one tool with which foundations can address them.

    The supply of medical equipment to low- and middle-income countries often relies on the donation (or sale) of used equipment that can no longer be maintained, or of new equipment that is inappropriate for the environment. As a result, an astonishingly high percentage of medical equipment breaks – and stays broken – in low-resource regions. We believe this market failure can be addressed by investing in a social enterprise combining market-based incentives for acquisition of anesthesia machines and non-profit mechanisms to fill in where no viable market currently exists.

    As an example, there is a severe shortage of trained biomedical technicians capable of maintaining and servicing medical equipment. We use philanthropic dollars to address this by conducting trainings and advocating for increased attention to the problem. Medical devices fail at astounding rates in the regions we work in, so we also use philanthropic dollars to support a long-lasting service warranty.

    In low-resource regions there is ample demand for medical equipment that is high quality; appropriate for the environment; and coupled with strong after-sales training, service, and support. We believe that the public and private sectors haven’t adequately met this demand, and that using philanthropic resources to do so is both reasonable and responsible. We’re filling a gap – not displacing commercial activities or creating a monopoly.

    To briefly address the questions Mr. Neighbour brings up:

    1) The foundation is committed to addressing the market failures described above. Fortunately, these failures are unlikely to exist in perpetuity, so it is unlikely this will be the optimal use of philanthropic dollars in perpetuity.

    2) Our model is specifically predicated on avoiding conventional aid or dependencies. By investing in training and ensuring our product remains functional, in fact, we hope to reduce the current dependency on outside sources for device donations and maintenance.

    3) The FOSE model allows a great deal of flexibility for “exit strategies.” Like any investor-investee relationship, the foundation and social enterprise must work together to define the right strategy for their mutual and respective needs. At this point, we have no plans to “spin out” independent of the foundation.

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