How Foundations can Help Entrepreneurs Save the American Dream

Last week, the Milstein Commission, a national initiative co-chaired by Steve Case and Carly Fiorina, released a report, Can Startups Save the American Dream? The report  highlighted over how the past quarter-century, startups and small businesses accounted for 65% of net job creation, yet today, job creation among startups is at its lowest point since 1980.

While “entrepreneurship” and “innovation” often mainstream headlines, it’s sometimes difficult to see how innovation can contribute to true economic growth in under-served areas. For example, Facebook’s $2 billion acquisition of Oculus and its $19 billion acquisition of WhatsApp were two of the largest Silicon Valley entrepreneur successes this past year. Yet to Crunchbase, the two companies employed 67 people combined—fewer than the average grocery store.

 While we should applaud the successes of Silicon Valley entrepreneurs and their investors, if we want to utilize entrepreneurship to create economic growth in underserved areas, the Commission outlines, we need to “unlock more sources of Main Street capital.”

The Need for Risk Capital

Risk capital in new businesses—generally considered fuel for economic growth—are concentrated in a subset of industries in a small number of geographies across the world. Almost 50% of venture capital dollars invested globally in 2013 were deployed in three U.S. states—California, New York, and Massachusetts.

And the funding bottlenecks don’t stop with geography. 5% of venture-funded companies are co-founded by women, according to a 2013 EY survey, even though women provide a 35% higher return on investment. And fewer than 1% of venture-backed companies are co-founded by African-American and Latino entrepreneurs.

 Risk capital is highly concentrated in technology industries in Silicon Valley because historically, that’s where the highest reward has come. But for anyone interested in building an inclusive economy, that supports growth not just on Wall Street and in Silicon Valley, but on Main Street, we need to explore alternative sources of capital for entrepreneurs beyond traditional venture capital funds.

Where can philanthropy help? Over the past decade, foundations in our membership at the Council on Foundations have increasingly been asking us to explore “impact investing,” or ways that foundations can explore innovative investment and business tools to achieve the social objectives of the foundations.

Some foundations, such as the McKnight Foundation or the Community Foundation of Louisville, have dedicated investment capital from the foundation to geographic areas—Minnesota and Louisville, specifically. Others, such as the Gary Community Investment Collaborative or the Rockefeller Foundation, have invested in enterprises with target impact objectives—early childhood education and energy/sustainability, respectively. But foundations and philanthropists across the country are already utilizing philanthropic capital to invest where Silicon Valley and Wall Street aren’t.

 Program-Related Investments and Donor-Advised Funds

We see two tools that foundations and philanthropists everywhere can explore to invest alongside their impact objectives. The Milstein Commission report highlights one: Program-Related Investments (PRIs). Fewer than 1% of foundations utilize program-related investments, though it seems like every foundation I speak with wants to learn more about them. PRIs give foundations the opportunity to invest out of their 5% distribution requirement in a business that (a) is aligned with the charitable purpose of the foundation; (b) does not have a political purpose; and (c) profit is not the primary purpose of the investment. Foundations are able to make a profit—and grow their asset base—through Program-Related Investments so long as they can articulate the impact of the specific investment..

We have seen another tool, Donor-Advised Funds, utilized for impact investments as well. A donor-advised fund (DAF) is a vehicle that you can set up at a community foundation or other donor-advised fund manager. While most people utilize DAFs for grantmaking, organizations such as ImpactAssets are increasingly helping individuals use their DAFs for investing. This article talks about how Seth Goldman, founder of Honest Tea, utilizes his donor-advised fund to invest.

Village Capital, which Ross, this post’s co-author, runs, operates an investment fund that invests in for-profit entrepreneurs achieving social outcomes in the U.S. (with a primary focus on the middle of the country) and globally through a unique peer due diligence model. 90% of Village Capital’s investments are the first outside funding companies will get, bringing critical risk capital to Phoenix, Salt Lake City, Louisville, and Atlanta. In December, Village Capital reached nearly $11 million raised for a new investment vehicle for entrepreneurs solving global challenges—with 50% of the capital resulting from donor-advised funds and Program-Related Investments.

 We encourage foundations who believe in how entrepreneurship can contribute to the American Dream—and want to invest in companies aligned with their mission—to look into tools like PRIs and DAFs to build a strong economy.