Non-Profits And Financial Engineering

By: Roy Salisbury | Sunday, December 18 2016

Non-Profits need to catch up with the for-profit sector when looking for funding solutions for projects, programs and working capital. Financial engineering in the for-profit sector especially the larger enterprises has been a staple. Non-Profits are a major economic force here in the United States representing close to a Trillion dollars of the US GDP and 10% of the workforce.

“The financial crisis of 2008 deeply damaged the credibility of financial innovation in the general public’s mind. As the collapse of markets dried up credit across the system, the notion that securities such as collateralized debt obligations and credit default swaps are enablers of growth suddenly seemed implausible, if not deluded. Indeed, those instruments are often described today as weapons of mass destruction.

It’s easy to forget that the same instruments have had a positive and transformative effect on society. Even as the dust from the real estate implosion lingers, we can see that homeownership would be impossible for millions of people if banks could not pool mortgages and sell collateralized bonds against those pools. It isn’t only the middle classes in developed nations that have benefited from debt pooling. Microfinance is now a $65 billion market, serving more than 90 million borrowers in some of the world’s poorest countries. Its growth was accelerated by the ability of investment banks to pool the microloans of many lenders and issue collateralized debt obligations against them in the international financial markets, freeing up the capital of those lenders and allowing them to make additional microloans.

Financial engineering, then, can be a powerful force for change. It can permit the mobilization of more capital for investment than would otherwise be available. It can generate rich opportunities to fund projects that fuel economic growth and improve people’s lives.”

The example of Microfinancing is relevant because it is taking hold in the US in the for-profit sector, and should and will be making inroads into Non-Profits sector. For example, a Non-Profit wants to put on a large event but does not have the capital, but has the staff and experience. Investors can put up the capital based on a fair return tied to the level of success of the event.

“Fifty years ago, Microsoft, Wal-Mart, Intel, Apple, Cisco, Oracle, and Google didn’t even exist. Today each one has a market value exceeding $100 billion. Meanwhile, many companies that were business giants in 1960—including Bethlehem Steel, U.S. Steel, CBS, RCA, GTE, ITT, and LTV—have disappeared, shrunk, or merged into other companies. These dramatic shifts in fortune are vivid examples of the cycle of creative destruction famously described by the economist Joseph Schumpeter.

Few new nonprofit ventures, in contrast, ever reach national scale (Habitat for Humanity and Teach for America are among the exceptions), and the largest nonprofits rarely fall out of the top rankings or disappear. Apparently, Schumpeter’s cycle doesn’t operate in the social sector.”

Currently there are 1.6 million non-profits registered with IRS compared to 2009.

“That few innovative nonprofits grow to a significant size is, at first, surprising, since each year people make massive new investments in this sector. In both 2007 and 2008, donations to nonprofits in the United States exceeded $300 billion—more than 2% of GDP. But small local organizations dominate the sector. More than 700,000 nonprofits operated in the United States in 2009. Ninety percent of them had annual budgets of less than $500,000, and 99% spent less than $10 million on their constituents. The average grant size for large foundations was only $50,000.”

The statistics remain relative and the growth of the non-profit sector cannot be ignored as an economic generator.

“While small may be beautiful, size matters when it comes to having a substantive impact on society’s pervasive and complex problems. By leveraging economies of scale and management talent, large nonprofits can deliver improved services at lower cost. They can offer their staff better compensation and career opportunities. They have greater capacity to conduct experiments, assess innovations, and share best practices across multiple locations. In an effective system, innovative nonprofits with the best management and social change agendas would grow in scale and scope while less effective and efficient ones would diminish and eventually disappear.

Why, then, do the dynamics in the for-profit and nonprofit sectors differ? Why do effective business start-ups grow into large, successful corporations while their nonprofit counterparts struggle to achieve national scale? We believe that a lack of development in the mechanisms and institutions that channel information and money between donors and nonprofits is to blame.”

The non-profit sector does not know where to go to get access to the different types of financial recourses nor do they know how to communicate to the resources if they stumble thru the door. Most do not understand that as a non-profit (cause) they are a business as well. Most lack the business acumen needed to communicate in business terms that capital markets understand. It should be noted that the capital markets lack access to data to identify opportunities in the non-profit sector.

“The good news, though, is that a new generation of charitable foundations and intermediaries is changing the game by measuring the social impact of donations and offering ways to funnel dollars to the most-effective nonprofits. “

The non-profit sector has an opportunity to catch up and access more abundant capital from donors and sponsors who will remain very important to the Non-Profit community. The non-profit sector has grown while the private sector has been stifled and it is possible that accelerated growth opportunities for both may be opening based on political agendas in play.

According to a 2012 report by the Center for Civil Society Studies at Johns Hopkins University, nonprofit employment represents 10.1 percent of total employment in the United States in 2010, with total employees numbering 10.7 million. The nonprofit workforce is the third largest of all U.S. industries behind retail trade and manufacturing.

During the Great Recession (2007 to 2009), the nonprofit sector gained jobs at an average rate of 1.9 percent per year, while the private sector lost jobs at a rate of 3.7 percent per year.

The average annual growth rate for employment has been higher for nonprofits during the 2000-2010 period at 2.1% whereas the for-profit sector shrank by -0.6%.

Nonprofit employment by sector is approximately 57% for health services, 15% for education, 13% for social assistance, 7% for civic associations, 4% for other, 3% for arts and culture, and 2% for professional services. (Source grantspace.org)

It is my opinion that a new breed of Non-Profit organizations will emerge based on financial engineering and the access to capital markets

(“Source: Harvard Business Review Robert S. Kaplan Allen S. Grossman From the October 2010 Issue)