Earning income, serving the community: Guidance for building a social enterprise

Nonprofit charitable organizations receive contributed and earned income from a complex array of sources. ^1/ Contributed income comes from individual donors, foundation grants, United Way, and others. Contributors often place restrictions on how the money is used. Earned income, which allows nonprofits more flexibility and autonomy, is generated from government contracts, third-party payments, and direct fees and charges paid by clients or patrons. Because many types of contributed income come with strings attached, nonprofits are eager to increase the percentage of their total income from earned income.

Some nonprofits receive earned income through their ongoing, core activities. A nonprofit theater, for example, is expected to generate income from ticket sales. In the past decade or so, more nonprofits have been seeking opportunities to generate earned income from some less expected activities. For example, a theater could increase its earned income by offering acting classes to the public.

When nonprofit organizations adopt entrepreneurial, market-based strategies in order to earn income in support of their missions, the ventures are generally referred to as social enterprises. The creation of social enterprises is a longstanding tradition. For example, in the early 1800s, Sister Elizabeth Seton sold clothing in order to fund her school for impoverished children in Emmitsburg, Md.^2/ From its earliest beginnings, the Girl Scouts of the United States of America has sold cookies in order to fund its programs. And then there is the interesting case of the Mueller Macaroni Company, a social enterprise owned by New York University in the 1950s.

On the surface, social enterprises appear to be purely beneficial. However, there is concern in some circles that promoting social enterprises could undermine the integrity of nonprofit organizations. In the following article, Kate Barr, executive director of Nonprofits Assistance Fund, offers guidance to nonprofit organizations that are considering the idea of social enterprises. Barr describes important steps in building a social enterprise and cautions that without a clear focus on mission and a well-thought-out plan, nonprofits embarking on commercial ventures may fail to maintain their organizational values. Community Dividend

Nonprofit organizations earn income from a range of activities, including providing health care and educational programs, operating retail stores, performing plays and concerts, and offering training workshops and consulting services. The percentage of total income that a nonprofit generates from these activities is closely tied to the field of service in which the organization operates. According to data from tax returns filed by nonprofit organizations, health care nonprofits may receive 85 percent of their income from fees for services, while environmental, animal, and international service organizations are likely to receive less than 25 percent from earned income.

For nonprofits that want to boost their earned income, establishing a social enterprise may be an appealing option. However, before and after nonprofits dive into new business ventures, there are some important matters they should consider. The following guidelines are intended to encourage thoughtful planning as nonprofits examine the possibilities of social enterprises.

Assess the organization's readiness. Before a nonprofit organization jumps into planning a social enterprise, it's helpful to assess the organization's readiness for the task. Understanding and building market-based activities may require different leadership attributes, management skills, and capacity than the organization's core programs require. To assess its readiness, a nonprofit should conduct an honest evaluation of current board and management skills and capacity, staff composition, external relationships, and financial condition. Also, the nonprofit should assess whether or not it has a supportive organizational culture. If there is discord among board members, staff members, or key stakeholders, it may be an obstacle to creating a successful social enterprise. The first step in building a successful enterprise is to confirm buy-in before making a commitment.

Choose an enterprise that fits the mission. Over the years, those working in this field have learned that a social enterprise is most likely to succeed if it has a strong connection to the nonprofit's mission. A business activity that advances the mission is likely to attract and maintain commitment from the board, staff, and community and become an important part of the nonprofit's strategic plans. Business activities with a weak connection to the mission can quickly drop from the priority list or become a distraction from the organization's primary purpose.

Identify the opportunity. When starting a social enterprise, a nonprofit should place high priority on finding a bona fide market opportunity. Identifying market opportunities may be difficult for nonprofits, since they operate in an environment that is focused on community need rather than marketplace demand. The distinction is crucial, but it often takes several discussions to sort out. Take one of the examples mentioned in our introduction: A nonprofit theater decides to offer acting classes. Perhaps the students at a local school have limited options for afterschool activities. By offering acting classes, the theater could help meet a community need for quality youth programs. However, the market demand for acting classes is a different question. To determine the market demand, the theater would need to research competing providers of performing arts education, demographics of the prospective students, possible pricing for classes, and costs of delivering the classes.

Nonprofit organizations that are looking for a social enterprise opportunity can start the brainstorming from one of two directions: the demand of the market, or the assets and capability of the organization. Suppose the theater in our example decides to offer lighting- and set-design consultations. The theater may have been asked for technical help for years before recognizing that these requests added up to a market demand. Using the other approach, our theater could conduct an inventory of its assets and capacity and identify that its technical capabilities are assets that can be marketed in a unique way for consulting and training. For both the demand-driven and organizational-asset approaches, a full inventory is a helpful step, followed by market research to identify the most viable and fruitful market-based enterprises.

Address the essential questions. The operational requirements of starting and growing a social enterprise are familiar to anyone who has started a small business or written a business plan. The plan for a social enterprise must address all the questions that are addressed in a typical business plan, in addition to questions of mission fit, organizational structure, and governance. Essential questions for a social enterprise include:

• What is the service or product?
• How well does it align with the mission?
• How much demand is there for it?
• Who is the (paying) customer?
• What is the competition?
• How will the service or product be delivered?
• Who will run the venture?
• How much time, start-up investment, management attention, and other resources will be required?
• What are the full costs of the venture?
• What are the financial prospects?
• What are the risks?

Find sources of capital. All businesses need capital to fund their start-up phase and continuing growth. Owners and shareholders of businesses provide capital through equity investments, personal assets, and loan guarantees. However, since nonprofit enterprises cannot sell equity shares or offer a financial return to investors, they face challenges in attracting capital. Where can nonprofits turn for funding? The most common source of start-up capital for nonprofit enterprises is internal funding from reserves or other activities. Less common sources include one-time start-up grants or long-term, flexible loans from philanthropic sources. Nonprofits may also turn to business loan sources, such as commercial banks or community development financial institutions.

Achieve a "double bottom line." At the outset of building a social enterprise, nonprofits must understand both the financial- and mission-based goals of the venture. This "double bottom line" can be a complex thing to measure and balance. Financially, some social enterprises can grow to become self-sufficient or profitable, with surplus funds generated to support other programs of the organization. Many other enterprises, however, never break even. That doesn't mean the enterprise is a failure, though. From a mission-based perspective, the enterprise may be considered a success if its products or services help strengthen, support, or extend the organization's core activities. The key to measuring the success of a social enterprise lies in how closely the enterprise ties to the mission and how realistic the nonprofit's financial expectations are.

For further guidance on building a social enterprise, contact Kate Barr at kbarr@nonprofitsassistancefund.org or 612-278-7182, or visit www.nonprofitsassistancefund.org.

In November 2008, Nonprofits Assistance Fund and MAP for Nonprofits announced that they will form a Minnesota Social Enterprise Network in 2009. To learn more about this venture, visit http://www.nonprofitsassistancefund.org/news/106/
Announcing_the_Social_Enterprise_Network.

1/ As used here, the term nonprofit charitable organizations refers to organizations described in Internal Revenue Code section 501(c)(3).

2/ Kathleen D. McCarthy, American Creed, University of Chicago Press, 2003.