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Imagine if your company's investors expected you to end your year without generating a dime in surplus. Welcome to the nonprofit sector, where your investors are foundations, and they expect multi-million dollar enterprises to end their year with zero. This makes nonprofits dependent supplicants year after year—unhealthy enterprises with no cash reserves, and no capital to strengthen, diversify, or build their operations.

Ah, you say, nonprofits should not make a profit. Actually, they should not accumulate profits and return them to investors (shareholders) or to employees in the form of bonuses or unreasonable compensation. But nonprofits do need to accumulate reasonable cash reserves in order to run sound businesses, grow to meet community demands, and invest in new services that respond to community needs. The current financial model makes such sound financial practices nearly impossible.

Nonprofit Finance Fund Capital Partners has a new way: "philanthropic equity"

The Nonprofit Finance Fund (NFF)—helmed by its visionary President & CEO Clara Miller—recognized the limitations of the nonprofit funding model. In 2006, it launched NFF Capital Partners with a novel approach to create growth capital for nonprofits. They called it "philanthropic equity."

Philanthropic equity is designed for funders who are "builders," not "buyers." Buyers fund programs, while builders fund an organization's platform for growth and change. According to NFF, building is critical to the stability, sustainability, and growth of the nonprofit sector. As NFF observes, "Buying doesn't pay for growth, trial and error, shifts in strategy, or changing what an organization is capable of doing. It's about asking the organization to continue to do what it already does, year in and year out."

In four years, NFF Capital Fund's philanthropic equity adopters have raised over $300 million to support their growth. Even more importantly, the growth capital was devised to give each of these nonprofits the opportunity to strategically transition their revenue models for longer term financial sustainability. Nonprofits that had previously been highly dependent on grants and contributions bought time to establish or enhance more diversified income streams including from fees for services.

Additionally, NFF Capital Partners devised and established Sustainable Enhancement Grant methodologies (SEGUE), a new accounting methodology for nonprofits. It tracks growth capital separately and does not count it towards general revenue. As capital is used, the funds are moved back into the revenue line. This allows a nonprofit to distinctly account for money going to build the organization's platform.

"We're trying to decriminalize sound financial practices for nonprofits," explained Craig Reigel to me in a private interview. Reigel was Partner of NFF Capital Partners and has just succeeded George Overholser as the Managing Director. Reigel co-authored the NFF Capital Partners 2010 Performance Report with Overholser. The performance report shows the financial results for each of the eleven nonprofits that NFF Capital Partners assisted with their philanthropic equity campaigns. The report also shows how each organization has shifted its revenue model to be more financially sustainable.

In my twenty years of personal experience building nonprofits, consulting to nonprofits, and training and placing hundreds of corporate executives on nonprofit boards, I have seen how debilitating the traditional funding model is for nonprofits. It impedes growth, and even worse, it hampers nonprofits from establishing sustainable revenue models. Old school grant making makes nonprofits dependent supplicants year-after-year; philanthropic equity helps build strong financially vital nonprofits.

An example: VolunteerMatch built a new sustainable revenue model while growing its services and impact

Greg Baldwin is President of VolunteerMatch, one of the eleven nonprofits in NFF Capital Partner's Performance Report. VolunteerMatch is a national volunteer matching organization. "We raised the philanthropic equity we needed to double our earned revenues in order to become a sustainable enterprise," Baldwin told me in a private interview. Through their participation with NFF Capital Partners, VolunteerMatch increased their fees for services from businesses and others from $1.6 million out of a total budget of $2.8 million (57%) in 2006, to $3.4 million out of a total budget of $3.9 million (87%) in 2009. That's an increase of 21% in the total budget in three years and a significant shift in their revenue model.

"With philanthropic equity, VolunteerMatch achieved both of our goals: to expand our social impact, and to expand and diversify our revenues. We are almost completely sustainable due to earned revenue," said Baldwin. In terms of social impact, VolunteerMatch increased the value of volunteer services it provided from $294 million in 2006 based on the number of volunteer hours served, to $490 million in 2009. Baldwin is optimistic that with the organization's new revenue model, VolunteerMatch is poised to serve tens of thousands of nonprofits in the next couple of years.

For those of you who want to participate, here are the links for individuals, businesses, and nonprofits, and a special link for college campuses.

Other nonprofits in NFF Capital Partners portfolio include Root Capital, Ashoka's Changemakers, VisionSpring, Project HEALTH, DonorsChoose, GlobalGiving, Year Up, Stand for Children, College Summit, and YES Prep Public Schools.

Pioneers: NFF Capital Partners, Edna McConnell Clark Foundation and others

Moving forward, Reigel plans to promote the use of SEGUE for more useful business planning and financial standards, and also increase the number of philanthropic equity clients to 25. "True success, however, will be when the check writers—the foundations and funders—change grant making to embrace this approach to advance the work of nonprofits," explains Reigel.

"It will really take off and change the sector when funders start to demand equity treatment to their grants. That's starting to happen with some foundations. We can see it taking hold." Reigel said that the Edna McConnell Clark Foundation has already made a very significant commitment to philanthropic equity. Other foundations that Reigel mentioned that are engaging included: The Mulago Foundation, Genesis Family Trust, The Bill and Melinda Gates Foundation, and Omidyar Network.

This is a dynamic era for nonprofits in making the world better. The Nonprofit Finance Fund and its Capital Partners are leading the way.