Thinking On: Frequently Overheard Grumblings

When we began to reinvent Heron’s operating model, we failed to predict the degree of confusion about our intentions, operations, and philosophy in the field. We had created a set of “frequently asked questions,” spoken and written frequently about our work, and posted copious information on our approach and holdings on our website.

But that didn’t do the trick. So here I address a set of “frequently overheard grumblings” (FOGs) that have popped up from time to time. They tell us that we have to do a better job communicating to our broad variety of communities, so here’s a start:

FOG #1: “Heron thinks that for-profit companies can do all the things the nonprofit sector is doing — better and faster.”

I was taken off guard by this one, having spent 30 years at Nonprofit Finance Fund working for the extraordinary people and organizations in the nonprofit sector.

I must say that it’s true that for-profit companies can and should do most things. But by definition, nonprofits provide social value where for-profit enterprise and markets have failed to do so.[1] From Heron’s point of view, it is not now and has never been an “either/or.” We need to strengthen nonprofits that are effectively “helping people and communities help themselves out of poverty” and to give rise to a mainstream economy that works for and welcomes people not now benefitting from it.

The social sector, health and advocacy nonprofit triumphs when there is a declining need for its services because the problem it addresses ceases to exist or is minimized. Despite this commercial ambivalence (and in part, because of it) these organizations, like their for-profit cousins, require a range of types of financing to have a chance of success. We are taking a swing at providing one particular type of financing — philanthropic equity, or enterprise capital grants– that we think is in short supply and allows such organizations to achieve strength and staying power so they can do so.

FOG #2: “Heron doesn’t identify as a grant-maker anymore, and has actually stopped making grants to nonprofits. They have essentially abandoned nonprofits and the nonprofit sector.”

We disburse the same amount in grants that we have historically, and that is about the same percentage as most private foundations. Unlike most foundations, however, we have chosen a distinct financial role (capital provider) and make larger (on average $1.5 million) and fewer (approximately three per year) Enterprise Capital Grants (ECGs). It is true that we do not identify principally as a grant-maker since we view all our spending and investing through a mission lens.

And as noted above in FOG #1, we have not abandoned the nonprofit sector, but it is not our singular focus. We simply approach nonprofits in the context of the multiple enterprise types that all foundations (ourselves included) already invest in: public and private for-profit companies; government entities; cooperatives; and others. We think the division among various types of enterprises on the basis of tax status (or financial instruments, such as PRIs or MRIs) is about tax compliance, not mission.

FOG #3: “Heron doesn’t have program officers, and sees program knowledge as irrelevant to its work. It doesn’t even do its own due diligence on programs.”

The first part of the grumbling is true (no program officers), the second is not true, and the third is mostly true and we’re happy about it. We do not have programs or program officers, and we don’t have a program side and an investment side. We work as one team to deploy and attract the various forms of capital that can help achieve our mission. And we consult experts in program areas or industry groups — healthcare, housing, financial inclusion, accounting, and communities — to inform our work.

We think that any sector can have positive (or negative) impact on employment, systems, and the people we serve. We have found that our current approach is, thus far, more complex and expensive than the bifurcated, largely hierarchical model:  making grants with little connection to finance on the one hand and investing conventionally with little connection to mission on the other. Applying this broad approach to the market necessitates a diversity and breadth of expertise that we (and most foundations) cannot afford to keep on staff all the time.

Therefore, we bolster our own expertise by relying on the generosity and expertise of many friends and colleagues. Among those we have relied on for expertise in recent years have been the Robert Wood Johnson Foundation, New Profit, Surdna Foundation, Ford Foundation, Kresge Foundation, Lumina Foundation, John R. Oishei Foundation, MacArthur Foundation, Mary Reynolds Babcock Foundation, Rutgers University, Mission Point, Hitachi Foundation, to name just a few—and naming none of our for-profit partners. We think deep subject knowledge is critical — we just don’t think we will add value by replicating what others are already doing better than we could.

FOG #4: “Heron only invests in Social Impact Bonds (SIBs). How can they make any money doing that?“

This was a real head-scratcher. We committed to one SIB through REDF because we thought that (unlike some SIB opportunities we saw) it did a good job of balancing the interests of the nonprofit provider, the investors, the government, and, most importantly, the beneficiaries. But that SIB did not ultimately go forward. And even if it had, the SIB didn’t project high financial returns and we never expected it to be a big money-maker.

We consider and employ any and all financial instruments based on their “fit” with a purpose — including debt, equity, performance contracts, royalties, cooperative shares, guarantees, etc. SIBs are one of many in that toolkit, but we don’t favor them over other financial instruments any more than we would favor a fork over a knife.

For a sense of what Heron actually has invested in over the past five years, please browse our website. Whether it’s a SIB or an Enterprise Capital Grant, a bond or a private equity fund, we have cataloged all of our current holdings (including their size, vintage, enterprise type, and financial tool). The site is interactive, so it’s possible to click through our progress portal to see how these assets have grown, changed, and performed since inception.

FOG #5: “Heron recommends that foundations spend more than five percent per year in grants for payout” and “Heron is a spend-down foundation.”

We are agnostic about five percent “payout” — it’s an Internal Revenue Service (IRS) rule, so it’s a tax compliance necessity and an operating data point, not a relevant strategic element. If we have many opportunities among nonprofits to make “qualifying distributions” in a given year, we might exceed payout. Or if we have fewer, we might be below it.

Grants are one among many tools, so making more or fewer grants hinges on their quality relative to other investment opportunities. We do believe that foundations should invest (though not necessarily spend) 100 percent of their assets in alignment with their missions. But the decision on financial instrument, size of disbursement, and legal form of investee should be guided first and foremost by mission and pragmatic considerations.

Similarly, we are neither a “spend-down” foundation nor a “perpetual” foundation — we think it’s a false dichotomy. Instead, we prefer to tie our longevity to our usefulness to society. Mission effectiveness should be the most important determinant of time horizon, and many spend-down proponents imply that “spending” is always the most effective way to accomplish mission, as opposed to investing or other ways of deploying capital. We think that both options are powerful in different circumstances.

We have been on the path to our current status of 100 percent of assets aligned with mission for 20 years, have during that time (and now) retained purchasing power and complied with IRS regulation. At this point, that continues to be our plan.

FOG #6: “Heron is in breach of its fiduciary duty. The IRS will shut them down.”

This was a more frequent comment earlier (c. 2012) than now. I confess that I was attracted by the dramatic possibilities at the time: “Foundation president taken away in chains by IRS agents!” But we were skeptical. After all, nobody got in trouble for putting their endowments in the hands of Bernie Madoff, so the standard must be pretty low. But we checked our 2012 Investment Policy Statement (IPS) with our law firm (Milbank, Tweed, Hadley & McCloy) and some legal mavens who sat on foundation boards. They saw no problem.

Heron’s view is that philanthropic institutions that aren’t investing their endowments in alignment with their missions are in breach of their philanthropic duty of obedience to mission. And while we might be lulled into the idea that this is somehow radical, those less familiar with the wonderful world of private foundations almost universally have a single reaction after hearing about Heron’s stance: “Isn’t this what all private foundations do?” And so they should.