To be, or not to be… a not for profit?

Nathan Sowell from Social Ventures Australia tackles one of the big questions tech-for-good businesses face when starting up.

Before raising money, you will have to make a decision about your early stage tech-for-good business. Is it a for-profit or not for profit? The decision comes down to money: how much money does your business need and who is most likely to give it to you? 

How much money do you need? 

To start, you will need enough money to reach break-even, pay yourself and upgrade from ramen to smashed avo. A rule of thumb is at least $1 million revenue to break-even when you have five to eight employees covering development, sales/marketing and operations with minimal overhead. 

Let’s assume that you need $1 million funding to reach $1 million revenue and break-even (before you burn yourself out and update your CV). 

For-profits raise money from investors 

Equity investors ranging from friends/families/fools, angel investors, venture capital (VC) and finally private equity fund the lifecycle of a tech business. 

You can get up to around $100,000 from friends/families/fools and angel investors. They need to believe in you, your idea and its huge potential. Angel networks are the most efficient way to contact these early stage investors. 

That leaves you needing around $900,000 from VC funds. VC funds screen up to 1,000 start-ups each year. That’s four pitch decks per day. They still need time for due diligence, executive investments, managing their portfolio, judging pitch nights and drinking a dozen coffees or green smoothies. Some even have partners and lives outside of work, so they have no time to spare. 

To make their life easier, most VC funds use metrics to filter out pitch decks. The metrics are nearly impossible to meet. You cannot blame the VC funds – the vast majority of their investments fail. They plan to make their money from a few start-ups that do incredibly well. Therefore, every investment needs to meet the tough metrics to show that they have the potential to be a “unicorn”. 

Metrics vary by industry. For the most common tech business, software-as-a-service, the VC metrics are: 

• 3x year-on-year revenue growth;
• $1 billion market size (in Australia, this generally means you plan to be a global company from day one); and
• greater than 4 ratio of lifetime value of customer over customer acquisition cost (LTV/CAC).

If your business does not meet these metrics, it will be hard for you to raise money from VC funds. Plan for over 100 emails/calls plus follow on meetings to try to secure the money (no guarantee of success).

There are other investors who do not use these metrics. Most impact investors, such as Social Ventures Australia and Social Enterprise Finance Australia, and cash-flow lenders (who provide debt) invest when a business is closer to break-even. They assess the risk that their investment will get you to break-even and you’ll be able to repay the investment over two to five years. Therefore, your revenue will need to be over $500,000 and approaching $1 million before they will give you the money you need. Can you bootstrap for that long? 

Note that investors, aside from impact investors, are finance first, so expect tension between your mission as a tech-for-good and your financial performance.  

Not-for-profit organisations receive grants from philanthropists and government 

Grant providers focus on social outcomes. They are mission-aligned and support your pursuit of change. 

There are various grants available to early stage not for profits for up to a few tens of thousands of dollars (Social Change Central has a listing, among other resources).

The larger foundations offer grants over $100,000. These are highly competitive. Most ask for evidence of social outcomes (e.g. surveys and quantitative data), or at least external endorsement of the theory of change. Many foundations are starting to assess “systems change” potential. Each foundation has specific impact areas that they focus on. 

There are more grants available if you have deductible gift recipient status (DGR). Some foundations only give grants to DGR-1 organisations. Getting your DGR status requires legal fees and takes several months. 

Only the few most exciting not for profits with a clear link or evidence to influencing systems change and a strong team to pull it off could expect to raise $1 million in their first years. 

Where’s the most money available?

The final consideration is how much money is available. There is more private investment accessible than philanthropy. Private equity and venture capital funds in Australia make over $2.2 billion investments each year. Philanthropy provides over $1.5 billion each year. 

However, without data, my impression is that there is significantly more money available to early stage tech-for-good businesses from investors than philanthropy where most of the big checks are for later stage not for profits. 

So what is right for your business?