Thursday, May 27, 2010

Philanthropy and the Tyranny of a Good Heart

by R. Todd Johnson*

Social entrepreneurs come in all shapes and sizes. Typically, they have great ideas for changing or healing the world, using the tools of business (whether through micro-enterprise, large-scale internet activism, or some other unique way for reaching the "bottom of the pyramid" or cleaning up and protecting the environment, or simply taking better care of all of God's people.)

And while social entrepreneurs and their models are as varied as grains of sand on the beach, once they've turned over the idea like a piece of grit caught uncomfortably in your shoe, at some point the ask the same, seemingly simple, question: 

"Should I form a non-profit or a for-profit company?"

I hate this question! (And "hate" is probably not strong enough.)

First, why are those the only two choices? Typically, the social entreprenuer seeks both a sustainable model for growing a business, while at the same time doing good in the world. Put another way, they seek to optimize for both objectives. Yet, the primary practical models available today provide the entrepreneur with the opportunity to maximize one or the other, and in so doing, under-emphasize the other (or worse).

Second, this binary choice starts us down the road of bad thinking. With only two possible choices presented, we begin to think in terms of double bottom lines and triple bottom lines, rather than blended value, as recommended by Jed Emerson. (Why is that bad?  Read this.) Soon, we begin to paint non-profits with halos and for-profits with horns, expecting that greed always wins where profit is involved.  (More on that in a future post.)

But perhaps most truthfully, I hate the question because (quite frankly) I don't have much useful or helpful knowledge or skills to offer regarding non-profits. (That is why I send most social entrepreneurs looking to form a non-profit to Robert Wexler at Silk Adler.)

Charity vs. Philanthropy

Honestly, for me there are simply too many problems with non-profits. (More on that in a minute.) I also have problems with our current conception of “philanthropy” and the public policy behind present U.S. tax policy where tax-subsidized dollars are used to accomplish certain ends other than charity. (By charity, I am referring to relief, as in disaster relief, and care for those who are unable to care for themselves, such as the widowed, the orphaned and those living in extreme poverty. I am not referring to art museums and orchestras.)

The question I like to ask when I speak at universities is this: "Does anyone really believe that Harvard (or Stanford, depending on which coast I'm on) will have a hard time building its next building and naming it for a donor if it can't offer the donor a tax deduction?"


Let's face it, we've drifted far afield from the original concept of “charity.” Rather, as a matter of public policy, we instead seem fixated on the idea of tax subsidies for the rich with our tax deductibility system. The result shouldn't surprise us: over time, while philanthropy increases (measured as total aggregate of dollars donated in the form of tax deductible contributions), the world's gap between the rich and the extremely poor grows.

"So what," you might ask? I mean, after all, wouldn't the gap just be much, much worse if there weren't philanthropic dollars flowing to Africa, encouraged by tax deductibility?  Just because some people save their charitable giving for museums or building naming rights, doesn't mean that African AIDS orphans would receive more funding if we drew the tax deductibility line closer to charity.

And you would be right, as far as that argument goes. But the easy point that makes is the argument: "We shouldn't be using our tax policy to encourage wealth redistribution." And although that might satisfy some as the only analysis required for the subject, it misses the real learning to be gained from a look at our tax policy, namely that it creates incredible dysfunction of unintended consequences in the developing world by encouraging too much money to Africa in the form of charity and not enough in the form of creating businesses.

[Now before you write me off as some form of libertarian, please read on.]

Destroying the Entrepreneurs

Outside of direct relief aid and some of the amazing health and education research and development, much (perhaps most) of what is done in the developing world through non-profits and NGO's, could actually be accomplished through a business model, but it would be harder to raise investment funding. Instead, someone begins selling tax subsidized and donor subsidized water pumps in Africa, because it is easier to raise the funding through tax deductible donations rather than through the rigors of proving out the business model for investment dollars, with the great result of increased deployment of inexpensive water moving technology in the developing world to aid rural farmers, but the negative results of (1) killing the market for future indigenous entrepreneurs attempting to sell water pumps at a profit and (2) locking a potentially valuable distribution channel in a non-profit, making it difficult for other for-profits to use.

And that’s before we ever get to the biggest issue facing the African entrepreneur.

Last year, while in Addis Ababa, I visited with my friend Sammy, an Ethiopian entrepreneur. Interested in how his new venture was going, I've long since learned that if you want the straight scoop from an entrepreneur, you don't ask "how are you doing." They are simply too optimistic to ever provide a meaningful answer.  Instead, I asked Sammy about his greatest challenge in his new SMS technology business. His two word answer?  The "NGO economy."

Sammy noted what should have been intuitive to me after so many trips to Africa, that Africans are naturally entrepreneurial -- many have been making something from nothing all their lives, just to stay alive. But what Sammy said next rocked my world.

"Africans don't see a reward system in place for being entrepreneurial. In fact, they view it as a matter of survival, not an opportunity to lift themselves out of poverty.  Rather, what they learn at a very early age, is to make good money, they should learn to speak English incredibly well and then maybe, just maybe, they can get a job driving for an NGO. In a few years, if they play their cards right, they might be able to land an NGO job as a project manager and even advance further."

Sammy's point was simply this. As a struggling businessman creating new start-ups, he could not compete with what NGO's were paying for some of the best and brightest. And even worse, he said, "by the time the NGO's are done with them, there isn't an ounce of entrepreneur left."

Add to that, the typical underpaying of talent in the developed world, creating non-sustainable NGO economies in the developing world, and the brain drain that NGO’s create by attracting the best and the brightest away from business to work for NGO’s, you can begin to see some of the dysfunctions that arise from our philanthropic dollars.

And Overburdened Public Funds

In the interest of full disclosure, I'm also not sure that our tax subsidy for philanthropy represents wisdom, in terms of public policy priorities.  I’m not particularly interested in foreign government-funded solutions for the developing world. Long-term, that’s a complete dead-end, partly because it can never happen without the taint of policy and bias based upon other policy priorities (just look at how our food subsidy programs have killed agriculture in parts of the developing world), but has anyone asked the question of whether that kind of aid is sustainable?

Now don’t get me wrong. I’m not saying that governments cannot play important roles. Governments can be good initiators, but there always exists the risk they become a “stakeholder,” at which point the initiative will become corrupted from an entrepreneurial perspective.

Not because governments are bad, but because the people who work in government are conditioned to pursue one thing and one thing only – the avoidance of risks. Performance, promotion, and success within government require that government dollars be spent in a manner that avoids the risk of criticism. This, in turn, means that the traits of a good government employee would be exactly opposite the trait of a good entrepreneur, who sees opportunity and is willing to take risks (sometimes great risks) to seek the opportunity, even if that means total and utter failure as a distinct possibility.

Sure, there are a few examples that buck this construct, but by and large, I believe this generalization holds true.

Finally, government is a dead end (at least in the developed world) because the economies of the developed world are beginning a trending slide that, unless drastic action is taken soon (something that will either require incredible political guts, or a mass awakening), dollars will become an ever-greater resource constraint.

If you are quick to dispute this point, consider the following:

· The U.S. Department of Defense budget is over $750 billion. That’s larger than the military budgets of all the other countries in the rest of the world combined. (Some of you might rightly ask, “against what are we defending other than the fear that our standard of living is sliding?”  And if that's really your attitude, then the obvious question is whether we would fight the developing world to defend our right to over-consume the world's resources.)

· In 30 short years, if we don't change priorities, the U.S. budget will be consumed by five line items -- Medicare, Medicaid, Social Security, Military spending and interest on our debt -- assuming nothing else changes. That means no FDA, EPA, DOE, Justice Department, and Homeland Security, not to mention, Interior, National Park Service, Postal Service and IRS.

· But to mention the DoD budget and other government spending really misses the point. The global economy is some 79 times the size of our military spending. The capital markets circulate $3 trillion dollars a day in funds and generate $59 trillion dollars each year, calculated based upon aggregate global GDP.

My Ultimate Disclaimer

So, personally, I come to the table with some distinct biases.

I suggest social entrepreneurs run as fast as possible from the pursuit of government funding or subsidy and pursue, instead, investment capital. Granted, it requires a business-focused approach, but capital is beginning to flow to those who are trying to do well and do good at the same time.

Ultimately, the only limiting factor is the creativity of the social entrepreneur.

Which brings me (fervently), to the point of trying to figure out (wherever possible), how to make the goals of a social entrepreneur work within a “for-profit” model. For me, that means we must answer the following questions:

· How can we help social entrepreneurs seek investment funding by being sure they are prepared to put forward a strong business case of how those funds will be used, BOTH to further the business and the mission?

· By what measure will the business be measuring impact on the mission?

· Is there a tension between the mission and the its measure of impact (on the one hand), and the financial return expectations of the investor?

· If a tension exists, are their ways to smooth out that tension to make it plausible to both parties (or not)?

· If there are ways to smooth out the tensions, then what will be the mechanisms for monitoring both (and the process for smoothing) to ensure that no imbalance occurs at a later time?

Ultimately, to be involved in healing the long-term issues in the developing world requires sustainable solutions of scale. For me, I want a vehicle where I go on a long drive that doesn’t require stopping every few miles and seeking fuel (the way a non-profit does). Instead, I'd always choose the vehicle that can fuel up once or twice and then drive forever thereafter because it generates its own fuel (or can charge during any potty break).

I want a real, honest to goodness, sustainable solution. And so do investors.

At the end of the day, money and mission impact need not present opposite ideas, nor do they need to create an unresolvable tension. But sorting out the need of each and how to make them work together for maximum impact for both (which may include telling the social entrepreneur that, “no,” he/she cannot have more money) is a goal that can only be accomplished when the right questions are asked.

I want to ask the right questions and explore the best answers.

Want to join along?

*Todd is a partner at the law firm of Jones Day, where he founded their Silicon Valley Office and runs their Renewable Energy and Sustainability Practice. The views expressed in this column are solely Todd’s personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.

© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are the property of R. Todd Johnson and may not be otherwise used or reprinted without express permission from Todd.