Conducting Due Diligence On Initiatives That Are Scaling: How Does It Really Work?

Social Impact Exchange staff
Posted: January 22, 2014

Last month, eight nonprofit investment opportunities “went out to market” for distribution to a broad funder audience as part of the launch of the Social Impact Exchange’s Scaling Marketplace. The marketplace provides a much-needed new infrastructure for aggregating capital from hundreds of co-funders to finance the scaling of dozens of effective initiatives on an annual basis. It enables funders across the country to join forces and connect easily with one another, and to evidence-based, game-changing nonprofits with the potential to have a major impact in health and education.

The Exchange’s Funder Working Groups serve as anchors for the Scaling Marketplace and play a key role in nominating nonprofit organizations for review, and then participating alongside Exchange staff in a multi-layered due diligence process on those nominees. Their due diligence focuses on concrete evidence of impact, scalability and financial sustainability, based on evaluation studies and a growth business plan. 

The teams are staffed by the Exchange and include several funders from each Working Group who bring specific expertise – for example aging or teacher professional development – adding authority and knowledge to the discussion.

“This rigorous due diligence process, which vets nonprofits’ growth plans and audits their capacity to scale, is the hallmark of the marketplace and ultimately determines which nonprofits are ready to go to market,” said Lauren LeRoy, Exchange advisor and facilitator of the Health Working Group.  This process is critical, since multiple Working Group members must ultimately provide significant funds for each nonprofit’s growth capital campaign in order for it to advance to the Scaling Marketplace.”

While the overall review is extensive, evidence of impact and an organization’s business plan – its business model, market analysis and marketing plan – are looked at most carefully.  “Conducting due diligence on scaling carries a particular set of expectations,” noted Robert Sherman, Exchange staff director of the Education Working Group. “The funders in our Working Groups care about the viability of a scaling strategy, particularly in terms of financial planning and staff capacity, and want to ensure that the nonprofit understands what it takes to scale and what its vision for sustainability is, both at the national and local levels.”

Due diligence teams will assess an organization’s scaling mechanism and aspects of the model that will inevitably change with its scaling plan, key success factors, market demand including the potential for new market entry, and capacity needs for scaling (e.g., staffing model and investment in systems and revenue generation). Equally important in the teams’ review is the organization’s track record, understanding how this is a transformative opportunity for making significant social progress, and how the sales and marketing component are addressed.

Business Model.  As part of the nomination and review process, the Exchange asks each nonprofit for a business plan, with 2-3 years worth of projections. “Basically what we’re trying to determine is if the organization has thought through expenses and revenues over the life of the plan in a way that fits with its stated goals,” said Anne Sherman, vice president for Nonprofit Strategy at the Exchange. “Do the expenses seem reasonable, appropriate, and adequate to do what they want to do? Will the expenses cover the growth they hope to achieve, both in terms of their scaling goals – for example, increases in numbers served, new sites, new policy initiatives – as well as the infrastructure they’ll need to build to be able to do the work – for example IT capacity, internal communications, knowledge management, and so on.”

While there’s no particular recipe for the revenue side of the ledger, the due diligence process involves evaluating whether the organization is building a funding base that is appropriately diversified and sustainable. What role, if any, does government funding play, and how does that suit the mix? Is the organization taking advantage of new policy changes and expanding accordingly (e.g., the Affordable Care Act makes some things reimbursable under Medicare or Medicaid that previously were not)?  Is there a reliable earned income stream? Most organizations planning significant and sustained growth achieve some level of steady earned income. Many organizations nominated by Working Group members are able to sell products and services: curricula, training, membership, or technical assistance. Though funders expect that most or all organizations will continue to rely on philanthropic investment, a business plan expresses the organization’s expectations around funding source balance, over time.

Market Analysis.  Evidence of impact is another key component of the due diligence process. What is the degree of impact of the organization’s work, the strength of evidence, and rigor of evaluation studies conducted? What is the research base for the intervention? Are additional evidence studies needed and planned?

Other strategic considerations are taken up in the vetting. Due diligence teams want to know about an organization’s positioning in the marketplace in which it operates, attributes that differentiate it from others, and how its outcomes compare with others’ in its field. Macro factors are important too, such as new laws that may have an impact on the initiative and its plan to scale.

Marketing Plan. Organizations nominated for a potential spot on the Scaling Marketplace must provide a full description of their initiative and scaling strategy. A nonprofit must demonstrate that it has strong leadership, strength of operations, and quality control systems in place – that it has identified the core program elements that make the program work and a process for maintaining fidelity to the model. A data collection system that tracks and analyzes performance and outcomes is also critical to effective growth and scaling.  

The Exchange expects there to be big “payoffs” for both nonprofits and funders participating in the due diligence process, which has built in a healthy and frequent back-and-forth conversation between funders and nonprofits. “Besides being considered for a place on the Scaling Marketplace, with potential access to hundreds of funders, the due diligence process benefits nonprofits by ultimately helping them strengthen their plans and prepare for questions that other funders will ask,” said LeRoy. For funders, Sherman adds that  “Each brings its own set of priorities and particular ‘sweet spots’ of expertise and knowledge, and also its own constraints and ways of doing business. Highly different perspectives make for a very informed and productive collaboration.”