Using Donor-Advised Funds to Invest in Early-Stage Entrepreneurs
In this Stanford Social Innovation Review article, MIT Solve, an organization supporting early-stage, tech-based social entrepreneurs, explores how donor advised funds (DAFs) can allocate dollars to impact investing, particularly in venture capital, to help fill the funding gap facing early-stage social enterprises.
DAFs, which in 2018 held $110 billion in the United States, have been criticized for lacking transparency and “hoarding” money rather than distributing it to mission-driven organizations. With no required disbursement rates, money can sit in DAFs for years before donors grant it out. (Community foundations managing DAFs might be the exception to this trend: according to the 2018 Columbus survey of community foundations, 39% of the 251 respondents disbursed more from DAFs than they received that year.)
MIT Solve's 18-month analysis of the DAF landscape also found that few DAF sponsors offer impact investing options to their clients at all, let alone the ability to directly invest in social enterprises. For example, most of the $1 billion in assets managed by ImpactAssets, the largest DAF sponsor dedicated to impact investing, is in funds rather than direct deals. Only a few pioneers, such as Blue Haven Initiative, Autodesk Foundation, and the Quality Jobs Fund, invest DAF capital directly in early-stage social enterprises.
This is a lost opportunity because, though impact investing has grown significantly over the last decade, many early-stage social entrepreneurs still struggle to secure funding, especially when they target the most underserved populations. The current impact investing field—most of which is premised on VC and private equity risk/return ratios in specific investment timeframes—isn’t well adapted to early-stage social enterprises, which require patient and flexible capital.
“It’s hard to find impact capital that’s flexible enough to meet local cultural expectations or government requirements, such as long payment terms, temporary contractual limitations, or the willingness to put up with bureaucracy,” says Nicolas Acosta, founder of the online platform Sexperto, which provides Colombian teens with free, straightforward sexual health information and immediate access to birth control appointments in clinics that match their health insurance plans.
Despite filling a critical market need, most of Sexperto’s current funding is from the government. Catalytic investment funding would allow the startup to explore additional revenue streams, such as e-commerce for sexual health needs (like condoms and HIV rapid tests), connections with specialists, and sponsored online sexual education courses—lines of business that would help the enterprise reach sustainability and profitability.
DAFs could ideally fill this role of providing startups catalytic capital because DAF capital is, by definition, philanthropic. Donors don’t need to conform to “market-rate” return expectations or set timeframes, so they can offer flexible terms that allow social enterprises to grow to a stage where they can attract more traditional investing dollars.
Given the need, in May 2019, MIT Solve launched Solve Innovation Future, a dedicated venture fund structured as a DAF. The structure is unique in three ways: 1) It is dedicated entirely to social venture investing, 2) it will re-invest profits in future entrepreneurs, and 3) it uses semi-standard, entrepreneur-friendly term sheets to minimize transaction costs.
For organizations interested in putting DAF dollars to work in impact investments, MIT Solve offers this advice:
Select the right DAF sponsor.
Define your investment thesis.
Think about what additional, non-financial support you can provide.
Work with partners.
Deploying DAF capital is an opportunity for donors to invest in innovation and could unlock significant funding for early-stage social entrepreneurs, as well as help quell DAF critics, the writers conclude.