Unlikely Takeover: A Third Way to Scale Social Enterprise

| No responses | Posted by: Jon Huggett | Theme: Social Innovation & Investment, Youth & Education

When we try to scale social enterprise, we usually try one of two paths: growing small organizations or spreading ideas across a range of organizations to scale impact. One path less traveled is to leapfrog through converting a large business into a nonprofit social enterprise, which can more easily and effectively thrive and grow at a larger scale.

There is no practical reason why such a strategy should not be considered more regularly. Large social enterprises are not new, especially in distributed businesses; consider the Cooperative in the UK or Mondragon in Spain, each with US$19B revenue. In the developing world, microfinance has spawned brawny social enterprises like BRAC of Bangladesh, with its half-billion dollars in revenue.

Here’s the story of how Social Ventures Australia led a consortium of nonprofits to create a scale social enterprise out of the wreckage of a bankrupt business, and what lessons can be learned from their efforts.

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When Evan Thornley, a businessman and member of the state parliament of Victoria, Australia, heard that ABC Learning, a for-profit business with $600M in revenue, was floundering, he saw a “once-in-a-generation opportunity.” Could the chain of day-care centers serving over 70,000 children across Australia—a full 15 percent of the market—also deliver early learning under new ownership?

Michael Traill, the head of Social Ventures Australia, a $10M non-profit, saw a chance to leapfrog to scale while improving the quality of what was being offered. SVA nurtures small social enterprises, and acquiring ABC would be the largest takeover yet of a for-profit by a non-profit. But Traill had an eye for the task; he was no stranger to M&A. Before founding SVA, he had spent 15 years leading private equity at Macquarie Bank.

The Social Context

In international comparisons, Australian education performs well for the average child, but poorly for the disadvantaged. According to the Program for International Student Assessment (PISA) statistics from the Organization for Economic Cooperation and Development (OECD), the average 15-year-old Australian scores better than the average OECD, American, German, or British child in reading literacy and mathematics. The only large nations with better scores for the average 15-year old are Canada and Japan. Scores for disadvantaged 15-year-old Australians, though, are closer to their disadvantaged peers in the U.S. and the U.K.

Australia spends less on preschool education than its peers: less than a quarter of OECD average percentage of GDP. In 2010, with only 51% of children enrolled in early childhood education, Australia ranked 34th out of 38 OECD and partner countries, and well behind the OECD average of 79%. Could focused, for-purpose early learning help disadvantaged Australian children catch up to the impressive results achieved by most Australian school students?

The Challenge

On November 6, 2008, ABC Learning went into “voluntary administration,” which U.S. readers will find more familiar as “Chapter 11.” Its assets were for sale. Traill believed that the early learning centers would be more effective, more sustainable, and happier with a nonprofit parent that could focus on social impact, and cut costs, too.

There is a good deal of research that suggests that, in some fields, nonprofits perform better than for-profits both in terms of programmatic outcomes and cost containment. In the field of education, Canadian research shows that childcare is likely to be better run by a nonprofit than a for-profit, finding “strong patterns of non-profit superiority in producing quality child care services” (Cleveland, Forer, Hyatt, Japel and Krashinsky; 2007) and a 2013 study of charter schools from the U.S. National Education Policy Center found nonprofits more likely than for-profits to meet federal Adequate Yearly Progress benchmarks.

Without access to equity capital, though, non-profits have a harder time raising cash for investment. Acquiring ABC Learning Centers would require a lot of money, quickly. While SVA is Australia’s leading venture philanthropist, it was too small to swallow ABC Learning. It needed partners large enough to raise the capital, with leaders decisive enough to run at the pace of an acquisition. Traill pulled together a consortium of four non-profits to buy the assets of ABC Learning, take them into the nonprofit sector, and refocus the organization around a social purpose.

The Consortium

Goodstart is a coalition of SVA and three large Australian nonprofits: The Benevolent Society (with $76M of revenue), the Brotherhood of St Laurence ($61M), and Mission Australia ($295M). The combined revenue of over $400M and solid balance sheets gave the group the credibility to borrow the funds needed to buy the assets of ABC. Keeping the consortium to just four nonprofits with excellent administrative capacities meant that Goodstart could move quickly.

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The team that SVA assembled to create Goodstart learned four lessons that may help other consortia of nonprofits trying to buy for-profits.

Lesson 1: Pick a hard goal to tighten collaboration among nonprofits

Even among four handpicked nonprofits, collaboration was hard. There was the risk that profit could trump purpose. The finances of any deal would be demanding. To keep the consortium together, the team strove to agree exactly what they wanted to do for children. If they shared a purpose, it would help them surmount differences—for example, over money. The team wanted a well-defined goal as a tool for making decisions.

Together, they iteratively developed a foundation document, titled “Connecting Head and Heart: A framework for how Goodstart Childcare Centres will drive improved early childhood educational and social inclusion outcomes in Australia.” Its ten pages of facts and figures detailed how Goodstart could help children.

The process of writing the document and agreeing upon purpose brought the four nonprofits together. “It made it easier to have the fierce conversations,” Traill commented. “Communication was important because the decision-making process of each member was different.” U.S. research into nonprofit mergers stresses the importance of “strong working relationships between executives prior to merger” in delivering good outcomes after the merger (MAP for Nonprofits and Wilder Research; 2012).

The Goodstart team set three clear overriding goals, to which it now manages the business:

  • Raise the quality of early learning
  • Enable all children’s access to, and inclusion in, early childhood programs
  • Ensure financial stability to generate a surplus to reinvest

Lesson 2: Pick the board to “move and shake,” not “represent interests”

With the social purpose embedded in shared goals, not the representatives’ roles, the team could move just quickly enough to secure the capital. Traill recalled, “Communication was critical, and we connected weekly, if not more often. At one point deciding the governance structure was hard. We made speed of decision-making a gating factor.”

Research into other nonprofit mergers echoes the importance of prior “strong board involvement.” For Goodstart to function well, it needed a board that could be an effective decision-making service. It was not enough that “‘stakeholders’ were ‘represented’”; the board needed a range of skills to guide Goodstart, both to do good and to do well. Along with expertise in education, it needed the experience of running distributed networks sustainably.

Assembled, the board was bicultural: comfortable in both for-profit and nonprofit worlds. Michael Traill himself had been a successful leader in both for-profit and nonprofit worlds. Robin Crawford, the chair, was a successful banker with years of consistent engagement with nonprofits. Tony Nicholson, head of Brotherhood of St. Laurence, and Toby Hall, head of Mission Australia, had each run a large business.Two of the member non-profits did not put their own CEOs on the board, but an Early Learning Reference Committee advised the board.

Lesson 3: To secure the deal, use the most robust M&A skills from business

If M&A is hard in business, it is harder in the third sector. Studies have shown that most business mergers and acquisitions actually destroy value. To deliver value, they must drive costs down, squeeze more from customers, or push the share price up. It is even harder for nonprofits, as overheads are already usually lean, there are few chances to raise prices, and capital can dry up if donors do not transfer their loyalty from the old organization to the newly merged one.

The M&A skills that Traill learned during his years in private equity were tested. It was not clear how to structure this deal. Few like it had closed before. Robin Crawford, a senior banker at Macquarie and a long-time supporter of SVA, attracted the attention of Michael Ullmer, Deputy-Chair of the National Australia Bank, and other heavy hitters. Traill and Crawford were also able to drum up such platinum-quality advisors as Gilbert & Tobin and Champ/PEP, who put fees at risk and worked pro-bono to complete the transaction. The firms agreed to a total fee cap of $750,000 for work worth $2M.

Traill’s view was that “We really needed contributions in terms of deeply discounted fees. We used the moral high ground to squeeze rates down, asking whether or not they wanted to be part of this once-in-a-lifetime opportunity to help the children of Australia.” Merger expertise is critical, and U.S. research also shows that most successful combinations required consultants with specific merger skills.

On December 9, 2009, Goodstart was announced as the preferred bidder, and in April 2011 it took over the last of the centers. It bought 660 centers for $95M in a carefully layered deal. The members invested $7.5M, angels bought $22.5M of Social Capital Notes, National Australia Bank bought $50M of senior debt, and the Australian government chipped in $15M of subordinated debt. (The Social Capital Notes were a new unsecured debt instrument bought by 41 social investors.)

Lesson 4: Manage toward hard goals

Completing the acquisition was a notable accomplishment, but the bigger challenge was the road ahead. With 15,000 staff, Goodstart wanted both to improve outcomes for children and to stabilize the finances. These two goals do not always sit well together. While most sites in poorer areas are financially sustainable, some are not yet. Goodstart has explicitly cross-subsidized some less financially sustainable sites in areas with great opportunity for social returns.

It was hard to squeeze costs, as economies of scale are hard to extract. But Goodstart is making a good start on the road. In its first year, it managed to improve occupancy and trim costs enough to repay $21M of debt on time and deliver a net surplus of $5.6m. In 2012, Goodstart increased its surplus to $8.3M, and strengthened its balance sheet with an accumulated surplus of $21M. It has now managed to repay $66M of the $110M borrowed at the time of acquisition.

Now that Goodstart is proving financially sustainable, it has been able to invest in early learning beyond simple childcare. It has invested $51M in extra staff, including 100 teachers, who can work in each center. It has invested $10M in professional development with its own training college. Leading its professional practice is a professor splitting her time 50/50 with Australian Catholic University.

Monika Henry, Director of the Goodstart Early Learning Center on Hercules Street in Tamworth, NSW, said, “Watching a child learn something new is a special wonder of my job, and it is a great pleasure to be part of children, families and educator’s learning journeys.”

The Hopeful Conclusion: For-Purpose Can Work Well at Scale

CEO Julia Davison commented, “I am proud of the positive impact our early-learning programs are having on the 73,000 children who attend our centers.” The chairman of Goodstart, Robin Crawford, commented, “The next stage of our journey presents us with significant opportunities to lift the quality of our early learning, do more for disadvantaged children, and engage with the sector and other relevant stakeholders to deliver our vision for all Australia’s children to have the best achievable start in life.”

Being a social enterprise does lend credibility with both parents and the government, who both need to support early education if Goodstart is to have the impact it intends for disadvantaged children in Australia. As a nonprofit, Goodstart may have greater ability than a for-profit to deliver both fair financial returns and good social returns. In education, many parents prefer nonprofits to for-profits, as evinced by the suspicion cast on for-profit schools in the U.S., the U.K., and Australia.

This restructuring may strike some as odd or counterintuitive, but it should make more people in all three sectors think. Are there enterprises that could function better as nonprofits, saving taxpayer dollars and providing better service? It may be that blanket assumptions about the relative competence of one sector over another need to be dispensed with, so that we can look with clear eyes at the comparative advantage achieved by placing an endeavor in one sector over the other.

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Read the original article in Nonprofit Quarterly.

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