In our 2011 Stanford Social Innovation Review article, “Journey into Brazil’s Social Sector,” we looked at challenges that Brazilian social organizations face in accessing financial services, including opening a bank account, high interest rates and collateral requirements, and the potential for catch-22’s where a late government contract payment means a nonprofit falls behind on payroll taxes, with the consequence that government is obliged to freeze further payments.

We believe that our work at SITAWI helps resolve some of these problems; we have developed our product offering to expand the amount and types of capital available to Brazilian social organizations, enabling us in 5 years to put nearly $1.5 million into 15 socially focused organizations and reach nearly 24,000 people. As we knew would inevitably happen, we also saw our first social loan default, and feel it is important to share the experience and identify lessons for the social sector and wider social impact community.

In November 2009, SITAWI granted a $85,000 working capital loan to Caspiedade, an organization that provides nutritionally balanced meals, after-school care, and workshops to discourage gang membership to vulnerable children in the north of São Paulo. In several cases, there were no similar organizations in the area and, consequently, the government awarded Caspiedade more and more contracts, increasing its revenues from $2 million in 2008 to $7 million in 2011. Caspiedade was able to fully pay off its loan to SITAWI, and we granted a second loan for $175,000 in December 2010.

This rapid growth meant increased indirect financial commitments, such as HR and administrative expenses, which the low margins of government contracts (2.3 percent of income on average in this case) could not cover. In response, it did what a lot of nonprofits find themselves doing: creating additional income through a social business. Caspiedade rented out a sports pitch and started a project to produce handicrafts for sale. Despite generating $100,000 in income, the project had a net loss of $50,000 in the first year. In the for-profit world, this shortfall would be met by reserves until the project reached breakeven; but in the nonprofit world, with no sure opportunity to reach sustainability, it needed to scale back the project and book the losses.

Simultaneously, Caspiedade had between $500,000 and $750,000 in pending government contract payments at any one time. In many countries, organizations providing services to government must—and should—continue providing the service despite late payments. In Brazil, organizations must also stay up-to-date on their taxes every month. SITAWI’s social loan allowed Caspiedade to remain solvent, but as the amount of taxes it owed grew, it was increasingly unable to keep its operations going. During 2012, SITAWI provided management advice to Caspiedade, but by early 2013, the challenges were too great and Caspiedade ceased operations.

Although this illustrates what can—and does—go wrong in the social sector, we believe that there are useful lessons for practitioners from across the sector:

  1. Social organizations need support in improving financial and cash-flow management, diversifying income sources, and predicting the impact of strategic decisions. In Brazil, we have a number of organizations, such as SEBRAE, GIFE, and Diálogo Social providing this training, but we need a broader and deeper offering.
  2. Creditors, such as SITAWI, should analyze investees in more detail and in their wider context, and continue the evaluation throughout the life of the relationship. One simple solution would have been to stop funding organizations receiving government funding, but could harm otherwise strong organizations as well as going against our mission, so we decided to restrict our exposure to “government risk.” Additionally, we reached out to our global peers, such as Nonprofit Finance Fund in the United States, to benchmark ourselves against their best practices and improve our own procedures.
  3. Public authorities must contribute to developing their partner organizations by supporting further education, facilitating access to complementary funding sources, and using more flexible models. These do exist: Caspiedade’s contract to run its canteen involved the state government transferring funds weekly and Caspiedade receiving any pending amounts after a review of accounts annually.

It will be no easy feat to get Brazilian nonprofits, funders, and government around the same table to find common solutions, but we are hopeful that by identifying where we need efficiencies and what we can change, we can prevent similar cases in the future. We will need to discover or fine-tune some solutions, but many are out there already; it’s a matter of changing the mindset from contracting to partnering, for real.