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Dennis R. Young

Chapter 3 made a general distinction between public and private benefits produced by social purpose organizations. This chapter further differentiates within and between these broad categories in order to account for the myriad combinations of SPO finance. In brief, it is argued that the better that an SPO understands the nature of the benefits it provides, the more successful it can be in generating the necessary economic resources to support its operations and achieve its mission. Traditional microeconomic theory focuses on markets and is concerned primarily with “private goods.” Public goods come into play in this theory to describe conditions of “market failure” where, without some form of modification through public policy or alternative mechanisms of resource allocation, markets will not by themselves allocate resources efficiently. A wide variety of mechanisms, including subsidies, regulation, taxes, direct government provision, or the engagement of alternative quasi-public organizations, may then be considered to correct market failures.

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Mixed income strategies

A Benefits Approach

Dennis R. Young

Previous chapters have explored, within the framework of benefits theory, why SPOs often pursue one of several different varieties of income as their primary source of sustenance. As such, organizations have been cited that depend on fee or earned income, contributed income, governmental support or investment returns for a large proportion if not most of their revenue. These primary source-reliant SPOs pursue essentially different logics in building their business models. Nonetheless, in most cases, such SPOs also supplement their support from other sources. Moreover, as this chapter emphasizes, many SPOs are even more diversified, relying primarily on no one source and dividing their dependence among alternative sources more evenly. There are several factors that may lead to this pattern of finance. As organizations grow, they become more capable of administering more than one type of income. For example, in the aggregate, smaller organizations are much more contributions-dependent while larger ones are more fee dependent (Boris and Roeger, 2010) suggesting that many SPOs that begin with a contributions base ultimately find markets for their services as well. Moreover, as SPOs inventory their assets and capabilities they may find some of them underutilized and potentially capable of generating income in one manner or another. For example, attractive physical assets of arts or cultural institutions allow them to generate rental income, or intellectual resources of educational institutions permit them to generate new income streams through public lectures, training programs or consultation services. A desire to manage risk through diversification may also motivate these strategies, a subject discussed in Chapter 11.

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Investment income-reliant SPOs

A Benefits Approach

Dennis R. Young

Many SPOs depend on returns from investments for a portion of their incomes though it is relatively rare for such organizations to rely almost entirely on such funds. The principal exceptions are grant-making and operating foundations which are endowed with large corpuses of funds and use the financial returns on those funds to generate income for grant- making or operations. Many other SPOs have endowments of course, as well as other special purpose funds that generate financial returns. Overall, investment income is a very small part of SPO operating income though it can be a very strategic component – providing a margin of flexibility when other sources are insufficient. For reporting public charities in the U.S., for example, investment income comprises roughly 3 percent of annual revenue (Roeger et al., 2012). The connection between benefits theory and investment income is more nuanced than it is for other sources of SPO support because these funds do not derive directly from an exchange relationship with an SPO’s beneficiaries. Rather they are enhanced (or diminished) by the acumen of managers and trustees who manage the funds. Still, benefits theory provides insights into the generation and impact of investment funds in several ways. First, the sources of funds constituting the corpus for investment must come from somewhere; thus benefits theory can help address the question of how to raise the capital from which investment returns are generated (see Chapter 10). Second, investment income affects managerial incentives to connect benefits with income. This can be a positive or negative effect – investment income provides a margin for innovation and a possible cushion in difficult times but it may also undermine accountability to beneficiaries and the propensity to exploit prospective sources of support. Finally, investment income does have a beneficiary relationship with future generations because it takes the form of income dispensation over long periods of time. These connections will be addressed below.

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Income portfolios

A Benefits Approach

Dennis R. Young

As suggested in Chapter 3 the income support of SPOs is naturally conceived in terms of “portfolios,” for three reasons. First, it is the rare SPO that produces just one type of benefit. Second, as benefits theory articulates, different types of benefits are associated with different sources of income. Third, SPOs span a very wide variety of missions, services and hence benefits; thus, the particular mix of income sources is not formulaic, that is, no one size fits all. Rather, the key question for any SPO is – what specific combination of earned income, contributions, government support, and investment income best supports the particular mission and circumstances of the organization? More generally, it is sensible for SPOs to think in terms of portfolio mixes in multiple ways. SPOs manage portfolios of programs, assets, and investments as well as income sources. These portfolios of course are interrelated. Investment portfolios, for example, consisting of cash, stocks, bonds, and real estate holdings, determine the level of investment income, as well as its volatility or risk, a potentially important component of an SPO’s income mix, as considered in Chapter 8. There can be a fine line as well between investment portfolios and earned income. For instance, an SPO might own a mission-related business (for example, a museum’s off-site gift stores) whose net sales can be seen as either earned income or returns on investment. Asset portfolios, which may include real estate, equipment, financial assets, intellectual capital and social capital, also influence the ability of an SPO to generate different forms of income. For example, financial assets generate investment income, physical assets such as attractive buildings and grounds can generate earned (rental) income, intellectual capital can lead to earned income opportunities through licensing of patents or marketing of expert knowledge, and social capital in the form of community relationships can translate into capacity for charitable fund-raising. (It is also important to recognize that some assets can be a net drain on revenue, for example, depreciating equipment or buildings, or art collections in storage.)

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Government-reliant SPOs

A Benefits Approach

Dennis R. Young

Many SPOs, especially those in the social services where benefits are redistributive in nature, or in such fields as relief and development, criminal justice or environmental protection where benefits are widespread and public in character, depend heavily on government support through programs that have been enacted via a political process which in principle at least, reflects a public consensus. Such organizations may not be able to charge for their services because of their public goods character, and they may be hampered by serious free rider problems if they try to subsist on philanthropy. This chapter will illuminate the rationale for government- derived support and will offer examples of SPOs where a government-reliant income portfolio prevails. Understanding the opportunities for government support requires an appreciation of the complex, multifaceted relationships between SPOs and government. Broadly speaking these relationships fall into three categories – supplementary, complementary and adversarial (Young and Casey, 2016). In particular, SPOs often supplement with their own resources the public services that might otherwise be provided by government. Alternatively, SPOs may work in complementary fashion to help deliver services that government pays for. Finally, SPOs may advocate for government to develop new programs and government may oversee or regulate services provided by SPOs. Each of these kinds of relationships reflects ways in which government can help finance the work of SPOs.

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Dennis R. Young

This book applies benefits theory to the financing of nonprofit and other social purpose organizations. Individual chapters are devoted to organizations primarily reliant on earned income, gifts, government support and investment income, respectively, as well as organizations that are highly diversified in their sources of operating support. The book is intended to guide managers and leaders towards finding the best mix of income sources for their organizations, to help educate future managers about resource development and to stimulate additional research on the financing of nonprofits and other forms of social enterprise.
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Fee-reliant SPOs

A Benefits Approach

Dennis R. Young

Earned income plays a major, often dominant, role in the financing of many nonprofit organizations, and even more so in some of the new forms of social enterprise such as for-profit social businesses. Indeed earned income is the mainstay of nonprofits in the U.S. in health care and a principal financial pillar in sectors such as education and the arts. Following benefits theory, one would expect the missions of earned income-reliant SPOs to be centered on the provision of private goods. However, important nuances to this connection, especially links between earned income and public, group, redistributive benefits and exchange benefits, are also explored in this chapter. VARIETIES OF EARNED INCOME Earned income is a broad concept that includes many variations of revenue derived from exchange in the marketplace. It is thus important to examine the varieties of earned income in order to analyze basic issues such as the pricing of services, use of an SPO’s assets to generate earned income, and the different ways that earned income impacts an SPO’s mission and overall income. In addition, examining these variations allows an appreciation of both the purposes of earned income generation, and the blurred boundaries between earned income and other sources of funds such as philanthropy and government support. Broad subcategories of earned income include fees for services, memberships, commercial sales, royalties and license fees, rental income, and special events.

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Cross-currents in SPO finance

A Benefits Approach

Dennis R. Young

Think of a social purpose organization as a ship at sea (hopefully not the Vasa!). The compass has two dimensions: North-South and East-West. North is the direction of positive social impact – achievement of the organization’s social mission. East is the direction of financial reward or surplus. All social purpose organizations want to head North but not necessarily true North. Traditional nonprofit organizations whose bottom line is social impact want to travel as close to true North as possible, allowing for sufficient margin of financial surplus to ensure their organizational integrity, growth and vitality. Cooperatives and other limited-profit distribution SPOs, such as the U.K.’s community interest companies (CIC’s) want to tack slightly more to the East to satisfy their chosen balance of mission impact and net remuneration to investors or members. Social businesses constrained less by strict limits on profittaking (for example, L3Cs as discussed later) would tack even further to the East, and avowedly socially responsible or sustainable businesses (for example, B corporations) even more so to the East. Purely profitmaximizing businesses wanting to be socially responsible would of course head a bit north of due East. All this seems clear enough, but as any sailor as well as Lewis Carroll’s Bellman, knows, the sea is a tricky environment, with few safe harbors, where the winds change and the weather is stormy as often as not. Moreover, the seas are not homogeneous, with different patterns of current flow in different regions – calmer seas in some places, rougher and more volatile in others – and in any case, different from one place to the next. In the environment of social purpose organizations, various winds have blown in and out over the past several decades, and different policies and conventions govern conditions in different parts of the world.

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Contributions-reliant SPOs

A Benefits Approach

Dennis R. Young

Many SPOs produce group goods whose benefits are shared collectively by particular beneficiary groups, for example alumni of a university or sufferers of a disease on which research is being carried out, or art lovers of one genre or another. Such organizations may not be able to charge for all of the benefits they provide nor attract society-wide support through government, but may be able to support themselves substantially through philanthropy. This chapter explains the rationale for philanthropy as a key source of SPOs’ income as it relates to their missions and circumstances, and also offers examples of organizations that are primarily philanthropy dependent. Contributions income tends to be concentrated in certain fields of social endeavor. For example, while contributions account only for approximately 13 percent of the revenues of reporting public charities in the U.S. overall (McKeever and Pettijohn, 2014), they account for 69 percent of the revenues of international and public affairs public charities, 45 percent of the revenues in arts, culture and humanities, 49 percent in environmental and animal charities, 20 percent in human services, 17 percent in education, and only 4 percent in health care (Roeger et al., 2012). Benefits theory suggests that these proportions roughly reflect the ratios of public or group and private benefits associated with the services provided by SPOs in these various broad fields of activity. However, the phenomenon of private giving is much more nuanced than that. First, there are many different sources and varieties of gifts and contributions income; second, the motivations of donors and the mechanisms available to solicit their support are also manifold. This background is prerequisite to understanding the strategic place of gift income in the income portfolio of any particular SPO.

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Capital financing

A Benefits Approach

Dennis R. Young

Benefits theory applies to both capital and operating income; however, capital income involves a number of nuances requiring special attention. First, it is important to note the connection between capital funding and investment income; the latter derives from returns on financial capital accumulated as endowment or other invested funds. As a result, as discussed in Chapter 8, investment income is only indirectly connected with benefits and beneficiaries. However, the investment capital from which investment income is generated is more directly linked to benefits and beneficiaries. An arguable exception is accumulation of capital through retained net earnings, an internal strategy not linked directly to benefits and beneficiaries. Although even here there is an indirect link to beneficiaries through the operating revenues, such as fees or gifts, from which surpluses may be generated. Second, investment capital for endowments is just one of several forms of capital used by SPOs. In particular, while virtually all SPOs produce services as opposed to physical goods, thus requiring significant allocations of labor, they also require capital assets such as buildings or equipment. Indeed, SPOs in some fields of service are relatively capital intensive – requiring significant funding for physical plant. Third, different legal forms of SPO, for example, nonprofits versus social businesses, are more adept than others at attracting alternative forms of capital financing – for example sale of equity versus receipt of capital grants. Fourth, recent innovations such as social impact bonds, program-related investments, community bonds, community investment notes, crowd-funding, social investment funds, and new hybrid legal forms of SPO such as L3Cs, benefit corporations and community interest companies have been devised to bridge the barriers that reduce access of SPOs to various sources of capital.