The Endgame on the Hope and Hype of Hybrids—A System of Balanced Benefit

Print Share on LinkedIn More



The fair question being asked around “Hybrids, Hybridity or Hype” is “How does a hybrid organization such as a L3C or B-Corp do ‘better’ (whatever that means) than the current approaches of For- and Not-for-Profit?” When applied to virtually any social challenge, in most cases one or the other of these existing approaches—that is, profit or nonprofit—seems able to address them. Their metrics are known to us, even to the point of being codified globally and taught as doctrine in higher-ed institutions. We can, that is, make qualitative statements as to the value they contribute, and to whom it is contributed.

Moving into this “brave new world” of hybrids—a term I use to mean the new business structures of B-corporation or L3C—might seem to be unnecessary at best, and an expensive and confusing sham at worst. Hybrids draw resources (money, people, time, effort) away from established structures of non- and for-profit, and will do so in increasing amounts as they become further established. So far, however, they’ve been unable to show much of anything positive that hasn’t been shown already via the other forms—when they are showing anything at all. And, not too surprisingly, some of them seem to be taking advantage of the imprecision around what exactly being a hybrid means, and to whom. Same wolf, different sheepskin?

It’s important to say that benefit, social and otherwise, can and does derive from any of the forms. The charitable giving programs of current for-profit organizations have been of tremendous benefit to many millions of people globally at the levels of neighborhood, city, and nation, and some corporations do try to do business in ways that are conscious of the potential sustainability of communities. The same is obviously true of nonprofits. And both of these are fueled, enabled, or extended by generous and increasingly sophisticated philanthropy. So it isn’t that “nothing (good) is happening” with respect to the social challenges that we face everywhere. It’s that “something” has been lacking. “Something” has been causing both of the existing systems to miss their marks to a great enough extent that “something” needs to change.

What needs to change—what hybrids are trying to address—is our fundamental understanding of profit: what it means, how it’s measured, who should share in its various forms, and to what extent. And yet, as I have written elsewhere, to virtually everyone in the business world today, profit means only one thing: cash. How cash flows through a business is pretty much the only critical determinant of that business’s health: how much came in the door; how much went out. And while a thousand qualifications can be made to that measurement, it remains the final arbiter of “success.” The only real question a business needs to answer well is “How can we get more cash in and send less cash out?”

Because, of course, the difference between the cash in and the cash out is the profit, and that’s what every owner, shareholder, and investor is looking to maximize. That’s the deal; that’s the system. With a not-for-profit organization, the terms may be different—fund balance, reserve, excess revenue, or the increasingly popular endowment—but the idea, the trained impulse, is to maximize it. No margin, no mission, and all that. So the piece that’s “missing” is how to expand—to evolve—the imperative that says that, ultimately, only cash has value into one that defines and accommodates ALL benefits an enterprise generates in ways that are equivalent to the value that all systems place on cash.

What is the cash equivalent of social benefit? Currently, “conscious investors” talk about “market rates” and “concessionary rates” of return. That is, within our current system of value, they are conceding (losing) cash return in favor of some nebulous “social return on investment” or SROI. Since the “social” part of the return is not cash, it is viewed as a loss—even if it is a “good” loss, along the lines of “giving back to the community.” Rather than considering social return in this way, hybrids (someday) will be able to show, in cash equivalent terms that are reliable and generally accepted, a “blended” return on investment, or BROI—a fully positive return, rather than a partially “cash negative” one. But until “profit” can be redefined and expanded, this will remain a strong disincentive to investors schooled under current thinking.

(As an aside, I’m constantly infuriated by investors, even enlightened ones, who demand market-rate returns of nonprofits under the guise of “forcing them to operate more efficiently as businesses.” This hogwash is astonishingly rampant.)

However, for- and nonprofit enterprises as currently structured have other shortcomings that hybrids seek to formally and legally address someday. On the for-profit side, no matter how generous or caring an enterprise is or appears to be, the critical fact is that such generosity is strictly voluntary and subject to the whims of markets and tolerances of owners and shareholders. Nothing compels a for-profit enterprise to address social challenges; in fact, it can and has been argued that the operations of for-profit enterprises are what created the need for the nonprofit sector in the first place. To underscore this, I recall about a decade ago a national campaign to convince corporations to “Give 5%”—the maximum amount allowed by the IRS—of their pre-tax profits to nonprofit work. Giving didn’t budge from around the 1%–2% it was, more or less. With individual exceptions, it is simply not their purpose.

It is exceedingly easy to demonstrate this schizophrenia of for-profits. Many maintain highly visible environmental or low-income charitable programs while at the same time contributing negatively to those issues in their everyday operations. Others evade taxes while pointing to corporate giving programs as evidence of their giving back. In all too many cases, it would seem to be far better for communities if corporations redirected their charitable giving inward to things like living wages and environmental sustainability programs. To address this, hybrids seek to change the very articles of incorporation, the “corporate DNA,” to address this shortcoming by requiring a balanced disposition of the enterprise in all respects—before profits are calculated, regardless of who’s in charge, and whether or not the markets have been kind.

If long-term social change is to be achieved and sustained, Corporate Social Responsibility (CSR) is not something that ought to be voluntary, or cancellable, or changeable at the whim of a new leader or downturn of the market or the rise of a new “social challenge du jour.” It shouldn’t be something that is done in one department of the enterprise while other departments work in direct opposition to what CSR claims to want to address. At the same time, any idea that the hybrid or social enterprise movement will cause existing corporations to suddenly “get right” is ludicrous. The social enterprise movement is actually not aimed at them, although they are doing everything they can to make it look like they’re already doing social enterprise work—and the most offensive of these efforts is the push to equivocate all enterprise as social. Any job is a good job, and all that. This movement, like any movement, is operating on a very long arc and will only succeed with a series of blank slates. It will be impossible, I believe, to convince the vast majority of current (large) for-profit enterprise of anything approaching “blended value” or cash-equivalent benefit. To steal a popular line from sci-fi TV: “It does not compute” and then the computers explode.

But what about the nonprofit sector? What are the shortcomings there that lead to the need to create a new corporate structure?

I’m going to bypass the emotional heart of the matter—with nods of affirmation  regarding mission and vision and storytelling and all that—and cut to the structural heart of the matter in the context of this essay: Current nonprofit corporate structure prohibits a nonprofit enterprise from assigning cash value to its work. Even if (or when) it is allowed, the nonprofit does not control how cash flows through it. That is, a nonprofit provides a service to a second party and a third party or parties decides the value of that service and reimburses the nonprofit on a schedule having nothing to do with the timing of the provision of the service.

As the saying goes, “That ain’t no way to run a railroad.” This structure leads to any number of perversions of the operations of enterprises, many of which have been documented almost ad nauseam. I’ll cover a few of what I consider to be the more important ones—again, in the context of this essay.

It is a system that is rampant with disincentives, and the nonprofit sector has survived in spite of its own corporate structure, not in any way because of it. Chief among these disincentives is any financial reason to be efficient. A nonprofit is paid what someone else determines it should be paid. Certainly, the nonprofit goes through the exercise of establishing a budget and submitting it with a proposal. But the funding source accepts, rejects, or modifies the budget based on the funder’s internal logic and priority, not the nonprofit’s. Most nonprofits seek and receive funding from any number of sources, and each of these has any number of wrenches to toss in. And each of them wants to know exactly how their funds were used, and whether there was any left over. And when there’s any left over, that’s seen as some sort of failure on the part of the nonprofit in achieving the goals set forth, and thus, the excess funds can be (and often are) reclaimed by that particular funder. Thus, finding ways of achieving goals for less than anticipated is far too often viewed as much more trouble than it’s worth.

That means that a manager of a nonprofit who seeks to offer incentives to employees to do better, or be creative, or actually think about what they’re doing in any critical way can literally cost that manager money. It means that managers must make adjustments within their organizations that are often completely illogical or unnecessary; they must “innovate” to get new funds whether or not innovation is called for or needed; they must undervalue themselves and their employees; and perhaps worst, they must justify their managerial decisions to a large number of people who are, quite literally, exceedingly small players in what they’re trying to accomplish. The value of a funder’s contribution is more often than not virtually negligible in the overall operation of the nonprofit, and yet they—and their colleagues who also contribute—can often change its course almost whimsically.

The hybrid structure, which is fundamentally FOR-profit, addresses this directly by returning most—but NOT all—control of the valuation of services and cash flow to the enterprise, not the collection of funders it relies on. It also assures the “social enterprise” the ability to meet its intentions around issues such as equitable pay and benefits, environmental stewardship, and the like by making these preconditions for the investments of funders or any sort.

We may need to see the outputs of social enterprise hybrids not as concessions to profit, but as additional forms of it. The hybrid offers multiple valuable benefits to the communities in which it works and to the employees who work for it because it must absolutely be stated that people who engage in social enterprise have every reason to expect to actually achieve the exhortation to “do well by doing good.” Other-than-cash benefits to employees in social enterprises might include things like cooperative housing, shared transportation, collective childcare, and enterprise-funded, cafeteria-style benefits. Not because these are good things to do, but because these are things the enterprise exists to do, in addition to earning an excess of revenue over expense. All these activities are required to the greatest extent the enterprise can achieve them. They are not voluntary. Shareholders cannot eliminate or curtail them. Will these activities reduce the cash available to shareholders or investors for dividends? Yes. Does that mean it is an unsustainable business model? No.

Those who invest in and work for these enterprises will continually upgrade their expectations for what “return on investment” actually can mean, across a broad spectrum of outcomes. There is still a lot of “someday” in what is beginning to happen in this evolution of the capitalist system of business and finance, but evolution is a slow, staggering process.

And it needs to be said that this “social enterprise” movement is not intended to be a universal change that can or will include the existing systems. Long-standing corporations and organizations will not fully capitulate to this new method of operation, nor should they. The genuflections that the for-profit sector makes through activities like CSR, and the nonprofit sector makes through “unrelated business income” or separate revenue generation activities to supplement income are ultimately more harbingers of change than the change itself. These will need to continue and to be refined by the knowledge gained as social enterprise becomes more established and understood and measured.

Social enterprise—the hybrid—must be built on a new platform, a new understanding. Perhaps it can be called Capitalism 2.0 or something spiffy like that. (“The Fourth Sector” is totally inadequate to capturing the level of change we’re talking about here, and is, thankfully, fading quickly from use.)  

Social enterprise has real, deep, significant meaning. But, right now that larger meaning and need is being jumbled, misconstrued, misinterpreted, and misused in many ways. That is to be expected. That is what happens with ALL significant changes in understanding by large numbers of people. There are vested interests that desperately want the model to remain a marginalized, boutique kind of endeavor because there is much for many people to lose as it takes hold and succeeds. The germ of this hybrid movement must be protected because, ultimately, it will evolve into the core of the change that many of us have wished to see and have spent much of our lives pursuing.

Paul T. Hogan is the executive vice president of the John R. Oishei Foundation.

  • Jan Masaoka

    The puzzle is why hybrid types are being portrayed and promoted as responses to the failure of nonprofits. In reality, they are responses to the failure of the FOR-PROFIT structure to provide the frameworks that entrepreneurs are seeking. Jan Masaoka

  • Eve Tulbert

    Very helpful article, Mr. Hogan! I am a Buffalo native, and now founder of Freedom Games–a social enterprise dedicated to educational toy and game development. We have a triple bottom line–improving the education system, creating youth employment, and advocating for fair trade and sustainability in the toy and game industry. It would be great to get your take on our financial model next time I’m in town! We get a lot of questions about being a “hybrid”–and I’m looking for advice on how to educate our stakeholders about this question.

  • Sy Rotter

    The basic distinction of the L3C as a “limited profit” business has been for me during the past three years of encouraging its adoption, the most difficult hurdle to jump. First impressions, unfortunately or not, are often the door openers or closers to a discussion of a new concept and no amount of explanation can change that impression. In fact, the L3C is not a “limited profit” business, it is a “for profit” business in which its investors accept the limiting of their dividends, and thus their profit on their investment. It may be considered by some to be a meaningless turn of words, but ever since I began to speak of the L3C as an L3D, a “limited liability,limited dividend company”, the hurdle has disappeared.

  • Cass Brewer

    Mr. Hogan–

    Great essay. I generally agree with your comments–especially concerning the need to redefine “profit” and a more conscientious form or “capitalism.” For a similar perspective on the developing law of social enterprise, I invite you to read my article here:

    If you are aware of other essays, articles, or similar works that express the same general viewpoint, I would be very grateful for pointing me to them.


    Cass Brewer
    Asst Professor GSU College of Law

  • Laura Cafiso

    Thank you for this thoughtfully written article, Paul, especially coming from the perspective of someone working at a foundation. One of my Master’s projects was on the B-corp/hybrid model & I have also worked extensively in the nonprofit world. In the big picture, I think the general public needs to be schooled better on how nonprofits actually work – yes they have to make a “profit” in order to run, etc. – & those of us at nonprofits need to be responsible for that.

    As far as hybrid models, it is exciting to see people trying to do things better and different, with more accountability and transparency while having the triple bottom line of people/planet/profit. I applaud for-profits for their generosity/CSR but think the tough part about that scenario is the reality of how their business operates as a whole. They may be giving funds/resources to a local nonprofit but at the same time, manufacturing their products some other place where they’re dumping the waste products into the local water. One hand strongly promotes their “CSR,” while the other hides CSD (corporate social damage!) they are also doing.
    I totally agree with your final statement, as this is the breeding grounds for better ways to make transformative social change. As we say in my circle,the day some of our nonprofits become obsolete – we’re talking about finding the cure for AIDS, cancer,etc. – will be the day our nonprofits achieve true success. Until then…we need to keep brainstorming!