Properly Capitalizing Enterprises

As an investor and a grant maker, much of “Heron’s impact” isn’t ours at all, but is the aggregate impact of the enterprises that we invest in. Enterprises do things like hire people, use resources, manage waste, and design products. They can do any of these well or poorly, with positive or negative repercussions for their employees, customers, suppliers, investors, neighbors, and other stakeholders. We think of the collective positive and negative impact of any enterprise as its net contribution to (or detraction from) the world.

In our role as a capital provider to both nonprofit and for-profit enterprises, we have seen that proper capitalization is an essential ingredient for healthy, resilient enterprises that serve clients, investors, and other stakeholders with excellence over the long haul.

 

Photo by David Takisaki

Table of Contents

The Problem of Precarious Nonprofits

General Operating Support

- Enterprise Capital Grants

What do we mean by “properly capitalizing enterprises”?

 

The Problem of Precarious Nonprofits

Heron has long been committed to supporting organizations that help people and communities help themselves out of poverty. However, we realized years ago that some of our nonprofit grantees were in precarious positions.

General Operating Support

Even though many of our grantees were receiving grants from other organizations, those grants were often restricted for very specific uses.

Restricted funding is popular because it allows foundations to track their dollars and hold their grantees accountable for the funds. But restricted funds can make it hard for nonprofits to pay for the day-to-day expenses required to keep the nonprofit running (like paying employees, covering the rent, and keeping the lights on).

Bill Dietel, our former board chair, observed, “Grantees often spend too much time piecing together the financing puzzle of restricted grants.” After seeing the struggles of our grantees, we became convinced that many of them needed general operating support rather than restricted funding.

General operating support (also known as “core support”) is designed to be flexible revenue that covers whatever day-to-day operating expenses the nonprofit deems necessary. For a decade, Heron’s primary grantmaking tool became general operating support.

Enterprise Capital Grants

While providing general operating support proved helpful to our grantees, we eventually reached the conclusion that it still was not enough to ensure the security, flexibility, and success of a nonprofit.

Similar to for-profits, nonprofits periodically need larger infusions of equity-like capital to grow or change. We often spoke to nonprofits who said that they could produce more revenue — and better serve their missions — if they had the upfront capital required to make investments in operations (like acquire a new license or upgrade their technology).

Some of these nonprofits managed to quietly reserve a piece of their general operating grants each year so they could eventually pay for such large, lumpy expenses. But as these organizations diligently grew their net assets, they were often ironically chastised and abandoned by their funders for becoming “too bloated.” Other nonprofits managed to keep their funders in place through the growth, but they were scolded for “losing their net assets” when the organization eventually made the large investment that they had been saving for.

After watching this pattern for years, Heron began to supplement its general operating support with Enterprise Capital Grants, which are grants that are explicitly designed to give nonprofits the type of capital they need to grow or change. As Clara Miller wrote in Nonprofit Quarterly, Enterprise Capital Grants allow “growing nonprofits to plan for and pay the inevitable deficits incurred on the way to reaching and maintaining an enhanced and durable level of operations.”

Learning about the struggles of nonprofit capitalization opened the door to discovering the capitalization struggles faced by all types of enterprises. And, as a result, properly capitalizing enterprises has become an underlying pillar in our work.

What do we mean by “properly capitalizing enterprises”?

A properly capitalized enterprise is one that has access to the right kinds of money at the right times. With the right mixture of debt, equity, cash, and/or grants, an organization can operate with flexibility when it needs to change and with resiliency when it faces a crisis.

The capital markets include many players providing different kinds of capital to different types of enterprises. Problems can arise, however, when an enterprise needs one type of capital (such as general operating support) but investors are only willing to provide another type (such as restricted debt). This is particularly common in the case of nonprofits, which often have trouble finding the type of flexible grant dollars they need.

For-profit companies tend to be better capitalized than nonprofits, but even for-profit companies can suffer from poor capitalization. Founders, for example, often complain that their private equity investors force them to take on more debt than the company can responsibly withstand. Workers, on the other hand, sometimes note that their company’s capitalization structures leave them out altogether, even though employee inclusion could incentivize higher levels of productivity. And many privately held businesses find themselves positioned for an initial public offering, or IPO, regardless of whether an IPO is in the long-term interests of the company.

As a private foundation with a full spectrum of financial tools at our disposal, we try to start with the question, “What type of capitalization does this organization need?” and, if possible, provide it with that type of capital. In partnership with others, we are also exploring alternative ownership, operating, and compensation structures that may help for-profit and nonprofit enterprises alike better achieve their goals — and better serve the communities in which they operate.