Seed funding nonprofits: a high-risk, high-reward approach (Founders Pledge)

By KarolinaSarek🔸 @ 2020-08-31T15:25 (+49)

This is a linkpost for https://founderspledge.com/stories/seed-funding-nonprofits-a-high-risk-high-reward-approach

"Seed funding a new nonprofit could be the difference between an impactful organisation existing or failing. In our latest blog, we discuss early-stage nonprofits, the benefits and challenges to funding them, and explore examples of this approach in action." ~ Founders Pledge

Given their backgrounds as company founders and VC investors, our members tend to be familiar with a for-profit investing approach based on funding companies with high growth-potential at a very early stage. This is an approach a donor could also take in the nonprofit world, and many of our members find this idea intuitively appealing.

Traditionally, our research hasn’t taken this approach and Founders Pledge’s recommended charities have tended to be established organisations with a proven track record. This is, in part, because they are easier to find and evaluate, and can absorb large amounts of funding. These recommendations are the very best giving opportunities we’ve come across, and we believe they represent incredible opportunities for our members to do good.

But we also think that making grants to early-stage nonprofits can be impactful, because grants have the potential to be the difference between an impactful organisation existing or failing. The early donors who helped get Against Malaria Foundation off the ground, for instance, have had a huge impact; the charity has gone on to distribute tens of millions of life-saving nets to those at risk of malaria.

We are interested in how a seed-funding approach could translate to the nonprofit world, and so we’ve taken a look into the area. Below we outline what exactly we mean by early-stage nonprofits, the case for funding them, and some examples of this approach in action.

What do we mean by early-stage nonprofits?

In this post, we are broadly referring to nonprofits that have the potential to be very impactful at scale, but are currently a long way from it. For example, this would include organisations developing a new intervention, or testing core components of their model before they begin to scale it up. We’d usually expect them to have a budget of less than $500,000 and an idea that is yet to be proven to work at scale.

We’re also talking primarily (though not exclusively) about organisations that are looking to scale up direct implementation of programmes, rather than organisations that may be ‘catalytic’ in other ways (such as established research and policy organisations, or grants to individuals).

What’s the case for funding early-stage nonprofits?

Say you have $10,000 to donate to help children living in poverty. You could either give it to an established charity, such as Against Malaria Foundation (AMF), to fund direct bednet distribution, or you could give it to a new organisation to scale up a promising new intervention like a malaria vaccine. How do these compare?

On the one hand, funding early-stage organisations benefits from:

• Leverage - The basic case for funding nonprofits at an early stage is that our money may not directly fund implementation today, but it has the potential to help an organisation that might not otherwise exist to reach millions of people in the future. Donations of this type, therefore, have the potential to affect, or ‘unlock’, a much larger pot of funding down the line. This means that when we’re looking for promising early-stage opportunities, a project’s potential scale is very important.
• Neglectedness - These opportunities seem more likely to be neglected, because most donors are not in a position to identify and fund completely new organisations that aren’t as prominent as large, established ones. We’re not completely confident in this, because there are also reasons that point in the other direction. For example, social impact investors sometimes refer to a 'missing middle', and some donors find the catalytic nature of seed-funding really exciting.

On the other hand, some challenges of funding early-stage nonprofits are:

• Uncertainty - Not all nonprofits that aim to reach scale succeed. Scaling up an intervention to reach millions of people is very challenging, and not all ideas that seem promising at first survive the test of scale-up. The closer we look at a promising idea, the more likely it is we’ll find reasons it isn’t as great as we'd first hoped. So, while early-stage funding may leverage a lot of future funding, it may also go to waste if the organisation fails, or if its intervention ends up not being very impactful.
• At-scale funding has an opportunity cost - If a young organisation successfully reaches scale, the funding it will go on to receive would likely be spent on other valuable work if the new organisation didn’t exist. Therefore, it’s important that the activities being funded are really promising, relative to the existing programmes working in the same space. If the at-scale funding would come from another activity that is just as effective as the new intervention promises to be, then it is not worth funding an entirely new organisation -- it would simply be displacing other equally important and effective work. Analogously, when someone starts a new company that goes on to become very large, they are making a decision about how vast amounts of effort and resources will be used in the future.
• Longer timeframe - You may not know whether what you’re doing is working for multiple years, so you have much less to go on to evaluate grant opportunities.

To put it simply, funding nonprofits at an early stage is high-risk, high-reward. What’s more, a new idea needs to improve on the best existing solutions to be impactful.

What already exists in the space?

To build up a sense of how a donor could go about funding early-stage nonprofits, it’s useful to look at examples of this approach in action. Examples of groups that follow an early-stage funding approach include:

• Standalone nonprofit incubators, such as Evidence Action, Echoing Green and Charity Entrepreneurship
• Government programmes, such as USAID’s Development Innovation Ventures
• Foundations focused on entrepreneurship, such as The DRK foundation, Skoll Foundation and Schmidt Futures
• ‘Low-burden’ funding for projects by individuals, such as Helium Grants and Emergent Ventures
• Many others, including GiveWell’s incubation grants, D-Prize, Global Innovation Fund and YC’s nonprofit programme.

As you can see, the types of groups that work in this area vary widely, ranging from individuals to governments, and this is reflected in the range of methods used. Prominent ways in which these groups vary in their approach include:

• The types of support they provide - some operate as full incubation programmes and provide a lot of additional support outside of financing.
• What they look for in projects - some focus on finding great founders and don’t worry too much about the idea itself, whereas others want to fund very specific interventions, or understand the idea in-depth
• How selective they are - some of the organisations have very narrow criteria for the interventions or projects they will fund. For example, GiveWell is focused on funding organisations that could become top recommendations in the future, which means it is highly selective when choosing the types of interventions it will fund. D-Prize looks for organisations implementing specific activities that have evidence behind their effectiveness. Others will accept applications without defining specific interventions. This also applies to the cause areas donors will fund too.
• Stage of projects - some, such as D-Prize, fund organisations only at the pilot stage (and so provide relatively small grants), whereas others, such as DIV, fund organisations at any stage from pilot (grants of up to $200k) to scale-up (upwards of $1.5m). In general, those making smaller grants appear to have faster processes than those that make large grants.

In our next post on early-stage funding, we’ll lay out our search for recommendations in this area so far, the challenges we’ve faced in that search and our future plans in this area.

If you're a member of Founders Pledge and are interested in this area, we'd love to hear from you! Please contact Callum at callum@founderspledge.com.

Callum Calvert

AUTHOR

Callum joined the research team in spring 2018. Before joining Founders Pledge, Callum worked as a quantitative analyst at a hedge fund. He holds a First Class MMath in Mathematics from the University of Warwick.