February 1, 2013
Accelerating Nonprofit Start-Ups
From Monday's The Wall Street Journal comes this story on the acceptance of a nonprofit start-up into the accelerator program of Y Combinator out of California.
Wait, this is a nonprofit blog! Accelerator programs??
Accelerator and incubator programs are all the rage in the entreprenurial business world. In general, they are places where an entreprenur with a good idea - but not much more - can find support and advice in growing a new business. In the case of incubators, that typically means a hub for shared space, networking, and professional resources. An accelerator program, essentially, is an incubator on steroids. An accelerator often provides a structured program that is designed to help in a concrete way the limited number of businesses that are accepted into the program. The goal is for those participants to be market-ready on an expedited basis (think three to six months). The program often concludes with an event that brings together the participant startups and local equity investors ("Demo Day" in the article). In return for this assistance, the accelerator typically takes a small equity stake in the business. The growth of the business obviously rewards the startup's founders and the outside investors that come to the table, but also it also funds the operations and future investments of the accelerator itself through its equity stake. Y Combinator is one of the most innovative accelerator programs out there, the former home of success stories Scribd, Reddit, and DropBox.
Wait, this a nonprofit blog! What is this equity investing of which you speak??
That's what makes the notion of Y Combinator accepting a nonprofit so interesting! As we know from Prof. Hansmann and others, one of the hallmarks of a nonprofit is the "nondistribution contstraint." Under both state law and federal tax law, a nonprofit can't have equity investors. The net earnings of the organization don't get distributed as income; rather, they are retained by the nonprofit to be devoted to its mission. At the end of the day, neither the local investors nor the accelerator program itself can take a cut of the accelerated nonprofit's earnings - by definition!
I curious about how the admission of nonprofits to an accelerator impacts the accelerator's business model. Undoubtedly, even with only for-profits involved, the accelerator assumes that for every Reddit, there are a handful of organizations that don't provide any meaningful return on the accelerator's investment. As the accelerator can't take an equity interest in a nonprofit participant, does it just assume that the nonprofit is one of the losers (with an internal rate of return of, well, zero) and hope the others will balance out accordingly? (That is what I gather from the article, by the way.) Or could it mitigate this risk by essentially charging an alternative fee schedule - for example, providing mentoring and facilities at cost, which means nothing out-of-pocket for the accelerator other than the opportunity cost of admitting an additional for-profit startup.
I'm also curious about this as yet another manifestation of the social entreprenuership movement. In the article, Paul Graham, the founder of Y Combinator, says:
I was talking to a friend who wanted to do a nonprofit project and I realized that i was giving exactly the same advice I'd be giving to a startup.
To some degree, that has to be undoubtly true and right. Every new venture, for-profit or not, has similar concerns: where do I get my money? what space am I going to use (if any)? how many employees will I have. And yet, there are fundamental differences in goals and methods of the organization - as much as nonprofits can (and to some degree should) adopt business ideas for the purpose of serving the organization's mission more efficiently, a nonprofit is, at its core, a very different animal with a very different mission. Can a nonprofit successfully co-exist in a private equity environment driven by return?
We shall see - certainly, something to follow!
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