Tuesday, 5 February 2013
Should Your Business Be Nonprofit or For-Profit?
Social entrepreneurs often grapple with the decision of whether to establish their organizations as nonprofit or for-profit in order to reach their goals. But what if you don't know which model to use, or which would best suit your mission? I've stood at this crossroads myself, and share my own experience here in the hopes that it will help inform other social entrepreneurs facing the same decision.
When I was a graduate student at Stanford University in 2007, a team of students and I first conceptualized the Embrace Infant Warmer — a low cost way to regulate the temperature of vulnerable newborns, without the need for constant electricity, and at a fraction of the cost of existing solutions. We were eager to take this product to the disadvantaged communities who desperately needed it. We needed to build an organization by which we could carry out this vision, and inevitably, the question arose: Should we be a for-profit or a nonprofit entity?
We debated at length the merits of each type of structure, and came to the conclusion that the fundamental difference between a for-profit and a nonprofit organization is where it can source capital. A for-profit can raise money from private investors, for which it must give equity or dividends to shareholders; ultimately, a return on investment is expected. A nonprofit, on the other hand, can seek donations from individuals, foundations and corporations. Such stakeholders generally expect a "social return" on capital.
Given the inherent risk associated with what we were attempting to do (an untested management team bringing to market an unprecedented medical device) and the uncertainty of the commercial viability of the product, and given the type of customers we wanted to serve, we decided the best option was to go down the nonprofit route and created a 501(c)(3). However, even as a nonprofit, we believed in running the organization as a business; we would sell the product at a margin, and any "profits" would be reinvested back into the company to fulfil our longer term goal: to create a line of affordable medical devices that could save the lives of millions of at-risk babies.
I believe that to be an entrepreneur, one must be truly idealistic — almost naïve — and even more so to be a social entrepreneur. We started Embrace with a bold vision, ready to change the world in our own way. Little did we know the time and capital it would require for us to get from a concept to a manufactured and clinically tested product — not to mention what it would take to build a distribution channel to sell our product. Nor did we realize the amount of management time it would require for us to raise this capital as a non-profit organization; precious time that would be taken away from building the product and the infrastructure needed to deliver the product, and to make impact at the scale we had envisioned.
In order to raise the capital that was needed to achieve our mission to save as many babies as possible, we decided to spin off a for-profit arm of the company. We would run two separate organizations: the nonprofit arm, Embrace, would own the intellectual property for the technology, take philanthropic contributions to donate the product to the poorest communities through NGO partners, and build an eco-system around which we could help promote newborn health, through things beyond the technology, like education.
The for-profit arm, Embrace Innovations, would raise money from venture capitalists — though our first screening criteria would be investors who were aligned with our social mission. It would license the technology by paying a royalty for every product sold. The for-profit arm would be responsible for the capital-intensive aspects of the work, including manufacturing, clinical testing and R&D. And, importantly, it would set up the sales and distribution infrastructure to sell the product to those who could afford to pay for it, while still focusing on bottom of the pyramid markets.
Our hope is that these two organizations, together, will most effectively meet the goals of Embrace: in the short run, to give every child a chance for a healthy life with our infant warmer, and in the long run, to empower the disadvantaged to improve their lives through a line of affordable healthcare technologies. Having both a for-profit and a nonprofit organization working side by side allows us to leverage private capital, in addition to philanthropy, to ultimately serve all segments of the market with our product.
Furthermore, this allows the for-profit entity to develop and focus its competencies to sell and distribute products, as well as to conduct research and development. At the same time, the nonprofit is able to focus on broader issues around newborn health, through training, education, and monitoring and evaluation. Early last year, we were able to close a Series A round of financing from Khosla Impact Fund and Capricorn Investment Group, giving us a launchpad by which to try this new structure. Thus far, through this approach, Embrace and Embrace Innovations have helped over 3,000 babies with our product. While our primary focus is in India, Embrace is doing pilot projects with NGO partners in 10 countries, and we hope to further scale this year.
Making social impact requires innovative thinking, not just in terms of developing a new product or service, but also in terms of organizational structures and mechanisms for raising capital. The challenges that social entrepreneurs are trying to solve are some of the most formidable problems in the world, in areas with significant market failures, poor governance, and a complete lack of infrastructure. Effectively tackling problems in this environment may require leveraging both capital and expertise from grant makers and private investors alike. Ultimately, social enterprises should not be confined to a single type of legal structure. The most important part of choosing the right structure is starting with your mission, and then adopting a structure that allows you to best achieve it.
Words by Jane Chen via: HBR
Posted by Kamau Koigi