Venture Philanthropy

They reproduce the model of venture capital investors but pursue a social objective instead of maximizing profit.

Author: Austin Anderson
Austin Anderson
Austin Anderson
Consulting | Data Analysis

Austin has been working with Ernst & Young for over four years, starting as a senior consultant before being promoted to a manager. At EY, he focuses on strategy, process and operations improvement, and business transformation consulting services focused on health provider, payer, and public health organizations. Austin specializes in the health industry but supports clients across multiple industries.

Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.

Reviewed By: Manu Lakshmanan
Manu Lakshmanan
Manu Lakshmanan
Management Consulting | Strategy & Operations

Prior to accepting a position as the Director of Operations Strategy at DJO Global, Manu was a management consultant with McKinsey & Company in Houston. He served clients, including presenting directly to C-level executives, in digital, strategy, M&A, and operations projects.

Manu holds a PHD in Biomedical Engineering from Duke University and a BA in Physics from Cornell University.

Last Updated:January 4, 2024

What Is Venture Philanthropy?

If you are new to the world of investment, chances are you have not heard or read the term Venture Philanthropy. This term is a relatively recent phenomenon and is still largely unknown. But it is starting to make a sound in the industry.

But if proven effective, philanthropic venture capital could be the new way of channeling funds in the 21st century for achieving a more significant social impact through new wealth distribution options by making investments that promote social good, like socially responsible investments.

Venture Philanthropy is also revolutionary in how it takes a business and gives it the power to face problems worldwide. So the motivations for both the business and the investors are bigger because they both receive income from the inversions, which makes helping economically sustainable.

The use of standard venture capital (VC) financing concepts to further charitable causes is known as venture philanthropy.

It is frequently used in relation to B corporations, green businesses, or philanthropic enterprises because the venture capitalists that provide investment to these kinds of companies will have the most experience in these fields.

Venture philanthropy is the practice of investing in start-ups, growth, or high-risk social businesses using largely the same concepts as venture capital fundraising.

Its primary focus is on making investments that support social good, such as socially responsible investments (SRI) that satisfy environmental, social, and governance (ESG) standards, rather than on profit.

It's an all-encompassing term that may be used to quickly refer to a wide range of philanthropic investing practices, but it differs significantly from impact investing, which prioritizes making a profit over investing in socially conscious projects.

NOTE

Philanthropic venture capital is a new way of giving to those in need. This new way of giving is characterized by supporting social enterprises whose main objective is to solve a problem that today's society alone cannot solve.

Venture Capital And Philanthropy

Talking about philanthropic venture capital is a contradiction. Venture capital wants to make money, while philanthropy is an altruistic activity that does not seek reward. To understand how both can be related, we must understand the concepts separately. 

Venture Capital

Venture capital is a source of financing for entrepreneurs and business owners through which a financial investor takes a stake in the capital of an enterprise with the aim of over three to five years earning significant capital gains.

From the investor's perspective, venture capital is a financial asset with a high level of risk, so investors expect to make a sizable profit.

Philanthropy

Philanthropy, on the other hand, is the act of donating money or goods to support social and welfare causes with a well-defined objective and without expecting a financial or material reward.

You can also practice philanthropy by giving your time and effort to helping in a retirement home, planting a tree, or engaging in any other volunteer activity that aims to improve lives.

In other words, a philanthropist is a person who exhibits these behaviors, regardless of how many resources (or how few) that person has.

In general, philanthropy encompasses any altruistic activity carried out to promote “good” or improve the standard of living of human beings.

How can philanthropic venture capital exist when it seems contradictory? What is philanthropic venture capital? Where do venture philanthropy investors invest their money? Why does philanthropic venture capital appear?

In this article, we will answer all these questions and we will discuss the following:

  1. What is philanthropic venture capital? 
  2. Key players in venture philanthropy. 
  3. Social Enterprises and Responsible Investment.
  4. Fundamentals of Philanthropic Venture Capital 
  5. Characteristics of social enterprises.  
  6. Why do philanthropic ventures appear?
  7. The philanthropic venture capital model.

This discussion will allow us to understand the new way of channeling funds in the 21st century for achieving a greater social impact through new wealth distribution options by making investments that promote social good.

What is Philanthropic Venture Capital?

Philanthropic venture capital (PVC) is a type of investment that combines traditional venture capital with a focus on social and environmental impact.

It involves investing in for-profit companies that are working to solve social or environmental problems, with the goal of both financial returns and positive societal impact.

PVC can be defined as the application of venture capital techniques and strategies to finance social enterprises with a high potential for social impact. Investors are dedicated to investing funds from different donors or foundations, adding value to the company receiving the funding.

The donor becomes an investor interested in increasing its value in terms of social impact. To do this, it monitors and controls the evolution of the company's business plan and its results and, at the same time, advises it on strategic, financial, and key personnel recruitment issues.

PVC differs from traditional venture capital in that the primary focus is not solely on financial returns but on using business to create positive change. This can include investments in companies working in areas such as clean energy, education, healthcare, and affordable housing.

PVC can be a powerful tool for addressing pressing social and environmental challenges, as it allows investors to support companies working to address these issues while potentially earning a financial return. 

NOTE

PVC can also help attract and retain top talent who are motivated by a sense of purpose and the opportunity to make a difference.

Key Players in Venture Philanthropy

When we think of Venture philanthropy, We think of the investors and the enterprises as the two key players. Venture philanthropy needs investors to invest in social projects, and investors want money from their inversions to grow their wealth.

But then, what is the difference between venture philanthropy and Venture Capital? Aren’t Investors and enterprises the same key players in venture capital?

We know both have investors and enterprises. However, in venture philanthropy, Social purpose Organizations and beneficiaries are also a critical part of the venture Philanthropy ecosystem.

Here’s a little bit about the different players and the roles they play:

1. Social Purpose Organizations (SPOs) 

SPOs are non-profits, charities, co-operatives, or social enterprises. They also can be profitable enterprises with a social mission. SPOs suggest solutions for improving the standard of living of humans and their environment.

2. Investors

Investors are the source of money; they play the key role in keeping the cash flow in the business, which is most likely to succeed monetarily and philanthropically. They are willing to take a risk to support SPOs through monetary investments.

3. The “ Beneficiaries.”

These individuals/firms are those benefiting from the SPO’s services or products; It could be any person that has a disability, is a minority, or is facing difficulties with mental health or health issues.

Social Enterprises and Responsible Investments

The big difference between philanthropic venture capital and traditional philanthropy is that it supports a company or social entrepreneur instead of focusing on projects. To understand better the difference between traditional philanthropy it is ideal to understand its ecosystem.

Social enterprises are revenue-generating organizations whose objective is to have a social impact and to acquire capital; they sell a part of the company's shares. Some examples of social enterprises are:

  1. Sustainable Water: Companies that place small water purification stations in communities in developing countries.
  2. Schools: Schools for children who need special education but whose parents cannot pay.
  3. Hospitals: Hospitals for people without resources in countries with no social security, such as the United States.

In other words, social enterprises are not necessarily aimed at solving a problem in a developing country. Still, in many cases, they have to solve problems that the current systems of the developed world do not solve.

Responsible Investment 

It is also vital to distinguish philanthropic venture capital from socially responsible investment, which is so fashionable nowadays.

These are some differences:

  1. The socially responsible investment seeks to obtain a profit, so the shareholder's objective is to maximize profitability, as in any other company.
  2. The difference is that socially responsible investment aims to put money into projects that benefit society. In exchange for this, the investor can give up a higher return in exchange for knowing that what you are doing is good for humanity.
  3. Examples of socially responsible investment include clean energy, companies whose codes of conduct in social responsibility are of the highest standards, or those with social programs for the less favored.

Fundamentals of Philanthropic Venture Capital

The best way to understand what philanthropic venture capital is and how it differs from other forms of philanthropy or social investment is to pay attention to its general characteristics:

  1. Medium/long-term perspective. Normally we work with business plans of between three and six years, which encourages the development of the organization and its capabilities.
  2. Management and risk control practices are implemented. Foundations are generally not involved in risk management or control. Once an amount of money has been assigned to a project, they usually wait for a final report detailing the results obtained.
  3. Philanthropic venture capital invests in a few companies rather than a large number of projects, so the money invested per company is generally higher. This characteristic is one of the main differences from a traditional foundation, which normally finances multiple projects.
  4. The philanthropic venture capital investor becomes, in many cases, a shareholder of the social enterprise; it is necessary to think about an exit of the investor so that he can focus on supporting new initiatives of other social entrepreneurs.
  5. A partner relationship is established between philanthropic investors and the financed company. In many cases, the philanthropic venture capital investor sits on the investor's board of directors.
  6. Dominate the results-oriented process. The philanthropic venture capital investor offers support on strategic issues and hiring key personnel and seeks to maximize social impact.

In the case of more traditional philanthropy, these are projects, in many cases annual, that seek to provide a solution at that specific moment and that, therefore, are not based on the construction of an organization.

These characteristics do not occur in all cases, but in general, there are several. The key is that they support social enterprises, not individual projects, and the philanthropic investor-company relationship goes beyond pure financial contribution.

Characteristics of social enterprises

For many, it is difficult to distinguish between a social and a commercial enterprise. You can always raise the debate that, for example, a company like Apple is both commercial and social since, thanks to advances in the world of technology, many people have access to information and communication.

That was previously unthinkable. Where is the line? How do we distinguish? Although the debate is still open, four characteristics can help us distinguish between the two:

Focus On Social Good 

The social entrepreneurial initiative seeks to create and maximize social value as a public good. The commercial enterprise focuses on maximizing shareholder value and seeking private profit.

In some cases, social enterprises can profit, but these will be reinvested to achieve more social good.

Limited Access To Usual Funding Sources

The fact of not distributing profits – if any – and its corporate purpose mean that traditional capital markets are restricted, in general, for social entrepreneurs.

Coverage of social needs 

The social entrepreneur appears when the commercial market forces do not cover a social need. This is called “social market failure.”

Difficulty In Measuring Results 

In commercial companies, the results are easily quantifiable and comparable; normally, they are financial ratios, market share, or customer satisfaction indicators. In social companies, quantification is much more complicated, and each company applies its tools.

In conclusion, although some commercial companies could have some social purpose or have important corporate social responsibility programs, their final objective is not the social problem; therefore, they would not be part of this group.

An example of a successful social enterprise is the Wall Street Oasis Internship. Wall Street Oasis is the largest and most entertaining finance community online, whose objective is to foster finance and entrepreneurial skills in individuals through several program offerings.

Their Internship program offers on-demand curated training and up to four months of paid work.

why does philanthropic venture capital Exist?

In the era of capitalization, stakeholders, and ETFs, it was not going to take long for philanthropy to enter the game.

These are some reasons why venture philanthropy exists: 

  1. Measuring social impact is complicated and different. Philanthropic investors use different systems.
  2. Social enterprises aim to maximize social impact. 
  3. To maximize this social impact, entrepreneurs need access to financing.
    • In most cases, traditional financing from banks and savings banks is unavailable, as they are companies that will not necessarily obtain positive cash flows, especially during the first few years.
    • Traditionally, the providers of capital in the social sphere have been the foundations, but these are not the best source of financing for the social entrepreneur for various reasons
  4. Foundations do not usually invest in an entire organization but in specific programs or projects. For this reason, long-term investment in a social entrepreneur, where the results are not obtained in the short term, does not usually fit with its founding mission. 
  5. Shortage of funds. Taking into account the number of projects that seek funding, especially NGOs that support the most disadvantaged countries, in many cases, humanitarian emergencies, it is difficult for social entrepreneurs to obtain all the necessary resources. 
  6. Allocation of funds is based on the greatest need rather than the social impact. Therefore, long-term results are not always considered, considering who urgently needs the money.
  7. Lack of management support. The foundations do not get involved in hiring the best managers or helping entrepreneurs improve their management practices. This aspect is essential for the long-term viability of the social enterprise.

NOTE

These reasons and some others, such as the existence of a highly fragmented system when applying for grants or funds for social enterprises, make philanthropic venture capital emerge as a possible solution to the problems that social entrepreneurs face and as an innovative solution to help the possible beneficiaries.

Philanthropic Venture Capital Model

The philanthropic venture capital model is based on applying techniques used by venture capital investors. Three well-differentiated phases characterize the traditional venture capital model:

  1. Fundraising 
  2. Investment
  3. Exit.

This model is called the “venture capital cycle” and was presented by Gompers and Lerner, Harvard professors, in 2001.

Fundraising 

Refers to how venture capitalists raise money to be able to carry out their functions. In the case of philanthropic venture capital, it involves donations, so the fundraising process is quite different.

Investment

The investment processes are divided into different stages:

  • The selection process
  • The investment process

Philanthropic venture capital funds share how they select and manage investments with traditional venture capital funds.

  1. The selection process is the analysis of the social enterprise, its strategy, the market in which it operates, and the analysis of company results, with particular emphasis on social impact.
    • Once the company has been selected, the investor completes a close follow-up to detect deviations and add value, especially in strategic and financial aspects.
  2. In the investment process, instead of covering the entire financial need at once, philanthropic venture capitalists invest the money in stages to ensure that certain key milestones are met before the next round of funding.
  3. How philanthropic venture capitalists exit investee companies and divest is unclear. This is because this form of investment is still very recent, and there is not enough data about the exit forms.
    • In general, philanthropic venture capitalists will divest once the company can be sustainable in the long term and will invest in the early stages of the company once the company is stabilized and the selection process is strategized. 

Conclusion

Philanthropic venture capital is a new way of giving to those in need. This new way of giving is characterized by supporting social enterprises, whose main objective is to solve a problem that today's society alone cannot solve, such as education or health for the neediest or the weakest classes.

In traditional philanthropy, support is given to specific projects, with certain durations and generally annual. Furthermore, in philanthropic venture capital, the donor acts as an investor simultaneously, taking an interest beyond the pure donation.

Some of the actions carried out by philanthropic venture capital investors include:

  • Being part of the board of directors
  • Taking shares in the company's share capital
  • Advising the management
  • Helping with personnel selection and strategy
  • Putting their network of contacts at the service of the social entrepreneur.

In other words, they reproduce the model of venture capital investors but pursue a social objective instead of maximizing profit.

This way of giving is quite recent, most of the funds are young, and today, there are less than a hundred philanthropic investors.

However, suppose this way of supporting the resolution of social problems proves more efficient than it seems to be by providing support beyond financing. In that case, it could be the new way of channeling funds in the twentieth century to achieve a greater social impact.

Researched and authored by Sebastian Girault | LinkedIn 

Reviewed and edited by Rohan Joseph | LinkedIn

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