How nonprofits could access needed capital.

Who's giving, who's getting.
Nov. 13 2006 7:28 AM

Market Magic

Nonprofits could access needed capital by turning donors into investors.

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Today, capital-market firms advise private-sector companies about when to issue stock and they advise investors on when to buy and sell. In return, the professionals are paid fees or commissions. They would stand to earn similar fees and commissions for applying their know-how to the new market for DD shares, and they'd learn the ropes because it would be a growth opportunity for them. Over time, the professionals would help investors evaluate nonprofits' current and future performance. Relevant factors include cash flow; balance-sheet strength; the size and growth of the market in which the nonprofit competes; the nonprofit's share of that market; what the nonprofit is really good at; the talent, skill, and even celebrity of top management; the nonprofit's strategic alliances; products, services, and distribution channels; brand strength; and use of technology. Different investors and advisors would draw various conclusions about a nonprofit's prospects based on these factors, just as they do with for-profit companies. These judgments would be based on information provided by the company (like annual reports) and analysis by professionals who follow the company (like an analyst's reports and recommendations).

The capital market for nonprofits will fluctuate for all the same reasons there are fluctuations in private-sector capital markets. Nonprofits with hot solutions to major challenges—for example, Habitat for Humanity's volunteer home building and repair—will see their DD shares bid up quickly. The DD shares of stodgy nonprofits that are slow to respond to market shifts will plateau and decline. Some nonprofits might overextend their reach by issuing too many DD shares and diluting value. Others might make the opposite mistake by issuing too few DD shares that remain too thinly traded to attract much interest. All the relevant choices, by nonprofits and by investors, would happen within the regulatory framework of information disclosure and fraud prevention that also already exists for other securities.

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DD shares would be the latest in a string of capital-market innovations that allows investors to trade different instruments with various characteristics of risk and return. Investors can trade stocks that offer rights of ownership in companies, or they can trade options representing the right to buy or sell such stock. Investors can buy commercial paper—the rights to trade interest payments due from the borrowing corporations—or they can buy junk bonds, which blend interest payments and contingency ownership. DD shares, for their part, give investors the chance to trade in the right to the size and timing of charitable deductions rather than the rights of ownership in a nonprofit. Like other capital-market innovations, DD shares strengthen the economy—in this case, by establishing the missing link from high-performing nonprofits to the capital they need for growth.

Dynamic deductibility is a win for everyone. It is a win for nonprofits with the capabilities—but not the capital—to meet burgeoning needs. It is a win for the people and causes that increasingly depend on the nonprofit sector. It is a win for the capital-market firms and professionals whose business will increase. It is a win for legislators who believe in betting on markets to solve problems. And it is a win for investors: By taking smart risks on a better future, they'll be able to realize the elusive goal of doing good and doing well.

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