Notes from an All-In Foundation President

From the Early Days: A Look Back at 2013.

Introduction to this installment:

This was my first real "President's Letter" from the then-transforming Heron Foundation. I'm not completely sure that this was the final version, i.e., the one that went out to the field, and even if it was, it probably didn’t get wide distribution or readership. It’s pretty nerdy: about business model changes, accounting discussions and data platforms. Possibly the letter was distinctive only because it didn’t tell any heartwarming stories about wonderful grantees. They were present, without a doubt…but I thought that the drama of removing the division between grantmaking and investing in regular foundation operations, and the mechanics of dedicating 100 percent of our assets to mission were also worth recounting. They were rare events, and this version was even, possibly, a “first.”

The eminent historian, Stanley Katz, once told me that he had observed that the foundation business model was singular among all businesses he knew because there was pretty much only one. Foundations, especially the biggest, were unrelentingly uniform! Some described them as, “hedge funds with a small giving program attached.” (I would have amended that to say, “a hedge fund with an expense rationing/tax optimization operation attached.”)

At Heron, we planned to change that model in order to support our belief that true fiduciary duty was to our beneficiaries, not primarily to the money captive in the foundation’s endowment. While funds were instrumental to serving beneficiaries, fiduciary duty to beneficiaries applied to the use of all assets of a charitable foundation, including the investment of the endowment. This entailed a more thoughtful approach, but one well within our power to undertake. To my surprise, foundation leaders and nonprofit folk viewed this idea as revolutionary then and most still do.

I also had observed (in my time at Nonprofit Finance Fund, and then, at Heron) that the underlying business model, regardless of its legal form (nonprofit, for-profit, cooperative, partnership, etc.), is a strict regulator and predictor of most aspects of its operation. All the best will in the world to “take risk” or “meet communities where they are,” (two among many mission-focused goals routinely articulated by foundations) would fall to the strictures of a quietly antagonistic business model. One of my heroes, W. Edwards Deming, put it this way, “a bad system will beat a good person, every time.”

At the time, we at Heron didn’t know whether changing the business model to eliminate the “investing/giving” divide would support our ultimate goal. But we did know that the current one was not getting the job done. Hence, the focus on changes to the model and to operations—and in the process, to culture.

I have provided commentary in bold italics, bracketed throughout the text. I also added some non-bolded bracketed text sections for clarity, which were not part of the original letter.

Dear Friend,

Nearly two years ago now, [I arrived in 2011] we took time to examine and question the relevance of Heron Foundation’s mission: ”to help people and communities help themselves out of poverty.” While we reaffirmed the importance and relevance of the mission, we felt we needed to change our strategy. We found that the world has changed. [The relevant Heron strategy document is the second installment of this “Notes” series, and available here on Substack].

Given the evidence, we had to admit that those we hoped to help had lost ground. American poverty was more widespread and tenacious than in fifty years, the ranks of the unemployed had swelled and their chances to move up and to stay in the middle class had dwindled.

Heron’s strategic focus therefore shifted from an emphasis on asset acquisition by families as the fundamental path forward to one emphasizing jobs, livelihood, and opportunity for those on the economic margins. We now invest not only to solve the specific problem of U.S. employment (i.e., to create job growth, stability, and opportunities for advancement) but to help assure that innovative solutions to individual problems will “stick” by investing broadly in enterprises that epitomize a healthy, balanced and reliable “business as usual” economy where people can find decent jobs and reliable, adequate income.

One of Heron’s social sector heroes, Steve Dawson of Paraprofessional Healthcare Institute, talks about “raising floors and building ladders for workers.” Heron not only invests in helping the highly mission-focused PHIs of the world succeed, we also invest in a broader array of enterprises that assure there will be a reliable, long-term job opportunity when trained and willing workers arrive in the job market.

While 2012’s best-known Heron story was a strategic shift, the more subtle story of 2012 was our realization that if we were really going to make “everything at our disposal…a mission-critical resource,” we would need to make sweeping operational changes at the foundation. Planned changes and those underway include (but are not limited to):

1. expanding from 40 to 100 the percentage of our financial resources invested for mission.

2. restructuring the staff so that it deploys all capital and incurs all expenses from one department regardless of financial tool, asset class or enterprise type [this entailed the merger of the investing and grantmaking staffs];

3. figuring out how to keep operating costs reasonable while increasing the scope, scale, and complexity of investing activities.

4. credibly tracking mission and financial results together for every investment [mission results, like financial results, vary over time].

5. becoming accustomed to being more market-focused, while operating within the legal and administrative rubric of a private foundation.

Most foundations, understandably, report on their work by recounting inspiring and heartwarming stories related to grants they made, research and policy milestones accomplished and similar program-oriented achievements. We have our share of such stories (stay tuned!), but I’m going to resist the temptation to feature them here and instead tell the story of 2013 through a very different lens: Heron’s changing business model.

Most of our 2013 stories track nearly invisible changes in systems, processes, operations, and data—not to mention culture and philosophy—that will make the achievement of our large-scale ambition possible.

They’re stories about relational, comparable databases with great potential to decrease grantees’ and investees’ reporting load (and potentially freeing up around 50 percent of reporting cost, per organization, potentially hundreds of millions of dollars annually if widely adopted in the sector). [This was a dream that just didn’t pan out…but not for lack of trying! It’s a potentially extremely powerful tool—yet as yet rarely used. While the foundation world has had a number of efforts to create a “common application,” the really revolutionary improvement would be a “common reporting format” for organizations in similar sub-sectors. We made progress, but we’re not fully there]

It’s the heroism of entering 7,700 separate positions into a database so we can track social and financial gains [or losses] in real time in our equity portfolio.

It’s the hard work of walking the talk: “all investing is impact investing.”

To summarize, in 2013 Heron was on a very steep learning curve. One indicator of this was the number of “firsts” we tallied, admittedly set against a host of woulda, shoulda, coulda moments where we fell short. Here’s an explicated list to give you a glimpse of what we have done operationally and why.

2013 FIRSTS

The first year of our integrated “capital deployment” unit—which combines the previously separate investing and granting operations into one, including:

o Design and early execution of our first “pipelined” tracking system for deals, across asset class and across enterprise types with both mission and financial results. While it is quite complex currently, our ambition is to have it tell us the full story—money and mission together—in real time. [this was more like the kind of deal tracking done at a CDFI or bank—going from early contact through analysis, decision-making, document preparation, closing and disbursement—but for all transactions, i.e., both grants and investments. I was familiar with it because we used it at NFF. It’s very different from the ubiquitous “docket” system which is common among foundations, where payout needs and the docket calendar drive operations. Under a pipeline, the impetus comes from the interaction of market needs, grantee/investee readiness and similar market-facing conditions]

o Early design of our first omnibus reporting system, an effort to integrate report results of all assets (debt, equity, and funds) and “enterprise capital grants” on a financial and mission basis, reported on by the integrated unit, “Capital Deployment.” [a rough equivalent in a standard foundation would be having the investment department and the grant program reporting together on an integrated portfolio at a foundation board meeting]

o The first portfolio rating scale that integrates financial and social impact together. [It was a cudgel at first, but surprisingly useful, and improved over time Helpful flagging potential problems, from either a mission or a money point of view]

o Our first market analysis by industry, across legal forms of organization.

Why did we integrate our grant/PRI making and conventional investing staffs?

This was our thinking: once we made the decision to dedicate 100 percent of assets to mission, we then had to be able to track both financial and mission performance for every dollar, credibly, across the entire portfolio—grants, PRIs, loans, bond purchases, equity, everything. What was the best use of a Heron dollar? How do we track integrated financial and mission performance and return over an entire portfolio, in real time? What was the financial performance of a grant? The mission performance of a private equity investment, or a public company holding? To put it bluntly, we needed simplicity of operations (afforded by making two units into one) and most importantly, we needed brain power and input from both sides of the house to make the best investment decisions, whatever our intentions.

[I think it’s fair to say that this wasn’t the only reason. Banks and CDFIs and nonprofits, for-profits (social enterprises, and beyond) and others swam in the same philosophic seas. Understanding enterprises and financial tools as an interconnected whole was very helpful to the success of both segments of the portfolio

· A number of “first” initiatives on data and reporting, across the foundation and in the form of grants, including:

o First use of an outside cooperative data warehouse as a reporting unit for Heron grantees, investees, and others. Coop Metrics now tracks cooperatives, nonprofits, and small for-profits for self-reported, real-time financial data in an auditable and comparable format.

o First investment into an organization leading data standards development (SASB) for ESG data reporting by public companies in SEC “10K” filings.

o First full year without any special reports on grants, having put a stop to all specialized grant reporting to Heron in 2012 (we do ask for annual reports on whole enterprises and reporting as per financial/mission tracking agreement from all exposures in our portfolio, nonprofit, for-profit, and cooperatives). [Our view on special reports on “our” grant was that it was a waste of time and money for grantees. Most grants were unrestricted anyway, so apart from something like a commissioned report—which itself was the “report”—looking at how the whole enterprise is performing was enough]

o First Bloomberg data terminal.

Why the interest in data and data infrastructure building? Why would we stop asking for specialized grant reporting to Heron? And why the Bloomberg terminal?

We know that given our ambition, we will need a large volume of diverse data that will allow us to track our mission results together with our financial results. We expect to buy research and analysis from specialized sources as needed. We also want to track our entire portfolio of grants, loans, private equity deals, bond purchases, public equities, etc. against our investees’ own goals and against other peer enterprises. A shared data “utility” will help us do that. And finally, we want to simplify compliance and reporting for our investees and ourselves.

On the SASB and Bloomberg terminal front, we found that while financial data is readily available, there is a dearth of credible mission and ESG data for for-profit companies, including public companies. We, with a number of others who are already working on this need, would like to contribute to the development of rigorous, credible, standardized, and auditable evidence for net contribution to society by these companies. [At this point we had just made a large “enterprise capital” grant (see below) to the Sustainability Accounting Standards Board (SASB). The grant was “Enterprise Capital” to fund SASB’s growth, which was start up at this point]

· Some notable investment (including grantmaking and PRI) “firsts,” reflecting our new market posture.

o Our first $1.5 million and $2 million grants to nonprofits as enterprise capital grants (also called philanthropic equity and growth capital) in campaigns reflecting our financial role as a capital investor rather than a purchaser of services. Our average capital grant size is around $1,000,000, and the campaigns are typically between $5 and $15 million, so our funds are only part of the story.

o First $5 million program related investment (PRI). Having invested in the growth of the CDFI industry in the last 10 years, we are in a great position to provide capital to the resulting larger scale, such as our investment of this size in Craft 3, a small business lender in the Pacific Northwest.

o First direct private equity into a for-profit manufacturing company which manufactures innovative “green” packaging and will create jobs. [We were enthused about this, but it didn’t pan out, was expensive to underwrite and track, and reinforced our inclination to use intermediary funds. Live and learn!]

Why the big grants and PRIs?

We have taken on the role of a growth stage capital investor. Our view is that the greatest increases in stable jobs and employment are likely to exist in growing, early-stage enterprises. [Later, we found that this wasn’t necessarily true. More on that in future letters] We have also embraced “enterprise” as our primary unit of investment (rather than programs, individuals, or similar alternatives). On the equity grant front—for nonprofits—we look for organizations that are poised for healthy growth and can identify reliable revenue that a capital infusion can help attract. We then collaborate with them to organize and run campaigns to raise growth capital funding. We invest in mission aligned private equity firms to similar ends. [This was a big departure from foundation-business-as usual: the selection of a financial role—routine among financiers. The “grant” isn’t really a financial instrument but a term of art for tax compliance. Most foundations are not investors with their grants, but purchasers, that is, buying services for a third party, buying research from a grantee, even simply “buying” what an organization is doing, with unrestricted support—mainly used as revenue.]

· Two major “firsts” in financial planning and reporting.

o First functioning prototype of a fully integrated foundation-as-enterprise model reflected in financial statements. We used to know [the destination of] as much as 90 percent of the grants we were likely to make at the beginning of any given year. This had some positives (our grantees could rely on their operating grants in advance) and some negatives (we were bound to private foundation payout requirements as our primary “market signal,” [which of course it’s not, it’s a regulatory requirement]) We have begun to operate in a more market-facing way. Now, we are pipelining all investment (including grant-making) opportunities and trying to respond to the needs of investees in real time while still complying with payout regulations. This requires that we understand and plan for our liquidity, target returns, asset mix and similar with a new kind of financial model. Our vice president of finance and administration, Ian Magee, completed a first prototype of such a model, which we expect to use in 2014.

o First new audit format for a “fully mission/impact invested foundation” negotiated by board member Bill McCalpin and me with our fairly conventional (yet flexible) auditor. Since our ambition is “all assets for mission,” Bill McCalpin, our lead partner for audit, and I wanted a category of assets that reflected that ambition. I suggested on called “not examined for mission,” for those assets (primarily public company stock positions) that had yet to be rated for “social contribution.” Our auditor looked at me pleadingly: “Clara, I’m an auditor. I can’t have ‘unexamined assets’ listed in an audit.” However, we were able to work things out, and now we are moving in the direction of having the mission performance as well as the financial performance of our entire investment portfolio appear in our audited financial statements. [This was early stage, to say the least, and to this day we are stymied by the lack of a system that approximates the FASB accounting standards and that corporations routinely use as part of SEC reporting compliance). This issue continues, with some small steps forward.]

· A few firsts in developing social and knowledge capital. “All available capital” means being intentional about learning from others, sharing our own experience and knowledge and looking for “deals” that others have underwritten (as well as sharing our own underwriting). We view this as a critical part of the evolution of our business model. Thus, some baby steps in that direction:

o We housed our first Heron/NFF Fellow (Rodney Christopher) and first Kresge Fellow (Tania Das) to help us move closer to two long-time friends.

o As one fan put it, those “brilliant weekly emails (i.e., ‘In Case You Missed It’)” the first Heron newsletter, courtesy of Toni Johnson VP, Knowledge and Influence.

o First Heron-sponsored national convening (on “big data” for impact investing) at Pocantico Hills, courtesy of the Rockefellers Brothers Fund, followed by

o First You-tube videos of conference highlights and curated conversation among participants on social media following same.

I hope you will excuse my somewhat breathless air. And please overlook the absence of any reporting on our social goals and impact (this will be ongoing and coming soon). I realize that none of these mostly “build” tasks is what most of us care deeply about when we do this work (I mean really… “new audit format”? Pu-leeze).

We do know that if we don’t have the systems to monitor real, standardized data, over time, our plucky talk about systemic change in the economy will be just glib bravado. Mission and impact results will be fundamentally unexamined, non-rigorous and over time, they won’t stand up to the scrutiny of the larger market. Most importantly, we won’t learn anything.

These systems won’t reduce our risk of failure; they will simply make it possible for us to know how we are faring against our goals. And as for failure, these systems will make it more obvious—to ourselves and others—when we are succeeding and failing. The investments to build our platform are pre-requisites, not destinations. They will only get us to the base of the mountain; they will not assure that we are able to climb it. We are simply building the capacity to try.

This work requires trust, a little risk taking (although the risk is mainly our own bruised egos) and negotiating the “grey,” instead of the black and white. In the coming months and years, we will be inviting others into our decision processes and exchanging “deals” for the promise of more social good. And in some cases, we will be ceding control of when and how we deploy capital in exchange for being the early money, attracting more capital, and working with investees to raise it. These practices are likely to be unsettling because they open us to public failure and a new form of practice for ourselves, our traditional partners, and the philanthropic field as a whole.

We think, however, that the potential gain will outweigh these perils, and that the price of business as usual would be acceptance of a kind of cowardice: that we hadn’t even tried to take the steps we need to be able to succeed at something new. Heron 2013’s biggest story was that despite some mistakes and missteps, we made pretty good progress building an alternative model of a private foundation that operates outside its protective “terrarium.” With a bit of luck, 2014’s report will carry many more stories about how our full range of investments—and our mission—are faring with this approach .

Warmest regards,

Clara