21st Century philanthropy

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Peter Grant and Lindsay Driscoll produced a paper exploring the topic of what measures will lead to effective philanthropy in the 21st Century.

Effective philanthropy - The big questions

The researchers considered the following questions:

What are the barriers to more effective philanthropy?

How can the impact be increased?

Should there be a separate regulatory regime or rules for foundations as is the case in most other jurisdictions?

Do we need new tax incentives?

How far should a foundation use its investments to further its purposes and thus increase total impact?

How can tax effective cross border giving to a public benefit organisation in another country be facilitated?

How can close involvement by philanthropists in grantmaking, which seeks both impact and anonymity of funder be best facilitated?

Their findings are summarised below under the following areas:

• establishing 'umbrella' donor advised funds
• making philanthropy more effective
• encouraging good practice
• operational process design
• social investment
• establishing a ‘distribution quota’ for endowed foundations
• new tax incentives for donors
• cross-border giving.

Donor advised funds

The donor advised fund (DAF) is a very old concept. The Community Foundation is probably the best known example of the model.

Community Foundations are a collection of funds on a geographical basis where the donor can exercise as much, or as little, control as they wish. 

Benefits

The major advantages of this system are that they:

• provide economies of scale by bringing together many small funds under one umbrella body, ensuring that administrative costs can be minimised
• ensure that the DAF has strong funding systems and knowledge and that new funding ideas are not inhibited by having to set up administrative processes from scratch
• provide specialist, local knowledge that a national organisation could not possibly be expected to have
• bring together a mix of knowledge and expertise in both fund raising and fund distribution
• do not become ‘intoxicated with the power of the funder’ as they deal with many funding sources, have to remain aware of the wishes of different stakeholders and also plug gaps in local need by utilising the funds over which they have more direct control
• provide a strong degree of funding effectiveness, as demonstrated by a number of objective evaluations of their work
• ensure the donor is freed up from the administration and regulatory requirements, allowing them to focus on the 'doing' side of their philanthropy
• allow the donor to retain anonymity if desired
• establish a proactive and supportive relationship with the donor
• avoid the problems of dormancy and ineffectiveness that can hamper private charitable trusts when trustees get old, interests change or key people die.

The future

We believe that there is scope for the establishment of more umbrella DAFs. These could build on the excellent work already undertaken by the Community Foundations and CAF, but extend it to a far wider range of potential funds and recipients.

For example, ‘community of interest’ DAFs could cover specific fields such as older people’s health, activities for young people, the arts, environmental protection, international development or social justice.

Introducing an enhanced tax incentive for donations would be one possible incentive for the creation of DAFs.

Grant-making foundations throughout the world are seeking ways in which to work more effectively, with the aim of ensuring that what the work they fund has a measurable and positive impact on beneficiaries and communities.

Making philanthropy more effective

Recent trends

One major trend is the emergence of outcome funding, where applicants are asked to define the outcomes – or changes – that their work will achieve. This has led to a greater emphasis on evaluation and the measurement of change.

Another recent trend, especially in the UK, has been towards capacity building (increasing the capabilities and professional skills of organisations) and full cost recovery (providing funding that covers a proportion of core overheads as well as direct project costs).

Challenges

Although both of these trends have sound foundations, their introduction has not been without problems. The majority of voluntary organisations are not currently set up to support outcome funding. Full cost recovery is still more of an aspiration than a reality, especially as it quite obviously reduces the number of grants a foundation can make. 

These problems are being recognised and may be overcome if there is the will to do so. There are, however, some other impediments to funding effectiveness that are not sufficiently understood.

One size doesn't fit all

The move towards organisational capacity building indicates that voluntary bodies, like any other type of organisation, are at different stages of the ‘organisational life cycle’. Some are entirely new, some are in the growth stage, others are reaching maturity, while yet more are in various stages of decline.

However, this is not sufficiently recognised in many of the funding models used by foundations. Application and assessment processes tend towards ‘one size fits all’. Some foundations severely restrict their pool of applicants by adopting funding models that they perceive as being ‘superior’ to others.  

Organisational life cycles

This criticism is not too problematic if the funder understands that they will be concentrating their investments on a group of organisations that are at a specific stage in the organisational life cycle, rather than achieving the greatest impact in a particular field of activity. Unfortunately, some funders do not appear to understand this limitation. They advertise that they are a new kind of funder in a particular field and that their funding model will be the most effective to bring about changes in that field. It won’t be.

If the funding model works - and only evaluation of the outcomes will demonstrate this - it can only work with a specialised group of organisations working in that field.  Voluntary organisations, even within one particular field, come in all types and sizes and no one type or size is likely to be more effective than another – there will be a host of other factors that have an impact. Surely funders should have a range of funding models that they can apply and application and assessment processes that can take account of the different life cycle stage of their applicants?

Outcomes and ability

One way in which these processes can be developed is to recognise that if you are funding a project there are two main questions that a funder should ask:

• if this project works what will the outcomes be?
• is this organisation capable of achieving the planned project?

One of these questions is about outcomes, while the other is about organisational ability - and they are quite separate. Too often foundations confuse the two into one assessment system. This frequently leads to either a good idea that the funded organisation is incapable of delivering, or a project run by a sound organisation that achieves very little. The funder then wonders why this has happened. The answer often lies in the failings of their own processes.

Reporting on impact

In the last few years the Charity Commission has placed a greater emphasis on the impact of charities’ activities, including grant giving. The Standard Information Return requires all charities with an income of over £1 million to explain the impact of the activities carried out to further their purposes. SORP also requires an explanation of how performance measures up against the objectives set.

The new public benefit reporting requirement for all charities, including foundations, will also force trustees to consider how they are carrying out their charitable purposes for the public benefit.

Discussion around reporting on public benefit requirement has mostly been in the context of fee-charging charities, and to some extent religious charities, but we could see further discussion of how it could be applied to foundations.

One approach is, of course, for foundations to report on public benefit in terms of the benefit delivered by their grantee charities but in some sense this could be seen as ‘double counting’ of the public benefit, once by the foundation and once by the charity in their reporting.  A more meaningful approach would be for trustees of foundations to demonstrate the added value of their grant giving.  This could be in terms of such factors as capacity building, research, influencing policy, raising awareness and leverage of additional funding.

Knowledge of other players

A further barrier to effective philanthropy is a lack of knowledge about what others are doing, leading to duplication, overlap and funding gaps. This has been a criticism of charities since time immemorial and was particularly prevalent in the late nineteenth century. It is no less pertinent today.

Encouraging good practice

Grantmaking practice can be poor. Foundations often decide on the size and length of grants on the basis of their own needs or finances, independently of the needs they aim to tackle. This creates inefficiencies for the funding organisation and the charities they support: application guidelines can be vague, decision processes can be opaque and lengthy, and applicants are rarely told what their chances of success are.

All of this makes it difficult for charities to decide whether to invest resources in applying to particular foundations, or to know whether or when to expect funding when they do apply.

Trustee expertise

One way to improve grantmaking practice would be for foundations to have greater charitable sector or grantmaking expertise within their trustees and by delegating greater authority over grantmaking practice to skilled staff. This will not be possible in the case of small foundations without any paid staff which make up the majority of grant giving foundations, but it can be achieved by larger foundations. Better sharing of good practice may help foundations to make progress in this area.

A further problem is that trustees of foundations can sometimes be too risk averse; an increased emphasis on impact does not mean that trustees should avoid all risks and one of the strengths of independent charitable foundations is that they can take greater risks than some other funders, especially those that distribute public funds. In a time of recession and very tight funding for charities such an approach becomes even more needed.  Is it essential at such a time for the real value of the endowment to be maintained?

Operational process design

A greater understanding and promotion of sound operational design could have significant impact on effective funding.

All productive processes can be traced back to a generic design, the supply network design, which can then act as a ‘blueprint’ for all future process design in that field.

This is a critical concept for social funders. The processes they use can be described and this ‘process mapping’ can form the basis for all the operational planning of a grant programme or an entire grantmaking organisation.

Choosing a model

The desired impact of a grantmaking programme derives from the mission and goals of the grantmaking organisation.  This enables the grantmaker to define the outcomes they want to achieve and, in turn, the outputs they might expect to see if they are making progress towards them.

The detailed grantmaking process or ‘model’ they then select should be the one most appropriate to achieving the intended results. This will determine the inputs required. This is the most difficult part and few grantmakers manage to select the detailed grantmaking ‘model’ that will be most appropriate to reach the intended outcomes – because the process of doing so is insufficiently understood.

Robust design processes

Grantmakers are always concerned to maximise the amount of resources they make available to grantees. However, if minimising expenditure on administration simply means minimising social impact, it is also pointless.

Grantmakers sometimes boast of how little they spend on administration, but they ought to be examining how effective they are. Robust grant programme design processes will help establish operational performance goals that can, if necessary, be balanced against each other.  

Getting it right

A criticism of this approach has been that an emphasis on process means that grantmaking, which is essentially about people, becomes straitjacketed and inflexible. However, if it does, it means you’ve got the design of the process wrong. 

A well-designed process will do just the opposite. It will free up thinking time for the crucial human decisions by making the more straightforward tasks quicker and more reliable.

The best businesses are extremely good at achieving this sort of balance. Their ‘agility of thinking’ is what marks them out from their competitors. They are able to take quick, informed decisions that sometimes significantly alter what they are doing or how they do it precisely because they are underpinned by clear, well-documented and robust processes that positively enable this kind of agility. A well designed process is the liberator of the mind, not its inhibitor.

Social investment

There has been much discussion over the last few years as to the extent to which foundations can, or should, further their charitable purposes not only through their grantmaking but also through their investments.

Social investment can take a number of forms and there is a range of often confusing associated vocabulary.

One distinction is between those types of investment where the financial return is the main objective and those which are chiefly concerned with carrying out the charitable purposes. Socially responsible investments come into the first category. This includes ethical investments where trustees use negative and positive screening in line with their charitable purposes but the main objective is to maximise the financial return. There are only a few circumstances where a lower financial return may be permissible.

There are strong reasons for trustees to consider adopting an ethical investment policy. Socially responsible investment does not result in underperformance and it can lead to increased public confidence. 

Social or performance related investments are terms used when the main objective of the investment is to carry out the charitable purposes rather than to achieve a financial return. Examples are where foundations use some of their capital to make loans or give quasi-capital to beneficiaries.

Charity Commission guidance

The Charity Commission published guidance on social investment in 2002. The guidance provides a detailed explanation and examples on the types of investments that are acceptable. It includes confirmation that there is scope for trustees to engage in social investment and, if handled well, this could increase the help a charity can offer in the short to medium term.

Despite this reassurance, foundations have been slow to engage in social investment and it appears that many foundations are unaware of the opportunity they have to make an added difference through their investment policies or how to exploit this opportunity. 

Mission-related investment

We're now seeing interest in the UK and the United States in mission -elated investment (also sometimes referred to as mission connected investment). In mission-related investment, trustees aim for a blended return - a lower return than they could get on the financial markets but which also delivers a charitable or social return consistent with their charitable objects.

This is sometimes referred to as a double or triple bottom line that is social, environmental and financial, and means that all the organisation’s resources can be used to deliver its charitable purposes.

Foundations using this approach usually only commit about five per cent of the total endowment in this way. As it is a departure from the usual rules on trustee investment there will need to be guidance from the Charity Commission, as there was for social investment, to give trustees the confidence to invest in this way.

Social enterprises

Linked to the issue of mission-related investment is the ability of foundations to invest in social enterprises. The United States has introduced a new legal vehicle for social enterprises - the low profit limited liability company (LC3) - which is a company with different tiers of ownership. The foundation’s share does not carry a share of the profit and takes away the risk, so that the company can borrow at a commercial rate.

In the UK the Community Interest Company provides a possible social enterprise vehicle for investment by foundations.

Distribution quota

Distribution quotas are designed to stop foundations from hoarding assets and benefiting from charitable tax credits at the expense of the Treasury.

The situation in the United States and Canada

A distribution quota for private foundations exists in both the United States and Canada. In the United States this was one of a number of provisions introduced in 1969 to regulate the operations of private foundations. Other provisions include limits on business holdings, which has also been introduced recently in Canada, and a prohibition on self-dealing.

In the US the payout requirement for foundations is 5 per cent. In Canada the level was formerly 4.5 per cent, but this was reduced to 3.5 per cent in 2005. This reduction reflected the fact that a number of Canadian foundations primarily invest in bonds and the interest rate in bonds had fallen dramatically.

It is interesting that during an earlier period of low interest rates in Canada, the Revenue agreed that they would not take action against a foundation where the failure to meet the quota was directly attributable to low interest rates. In such a case the foundation was able to submit a request for alleviation on the grounds that their failure to comply was beyond their control.

How distribution quotas could work in the UK

Were the 5 per cent pay-out ‘rule’ adopted in the UK this could increase the charitable funding of endowed foundations by 31.5 per cent, or around £1 billion pounds each year.

There is some criticism of the operation of the disbursement quota requirements and some of the technical provisions. However, research with foundations in the United States and Canada suggests that they would not advocate the total abolition of the principle.

The impact of recession

At a time of recession and low interest rates, maintaining the payout from foundations becomes more important, as the needs of their recipients becomes greater and other resources are restricted. 

If the trustees of endowed foundations operate on a short-term horizon (say less than five years), the risk-averse route is to significantly reduce pay-out to maintain the value of the endowment.

The more appropriate route is for foundations to plan much further ahead and critically evaluate the needs of the sectors they fund against the long-term requirements for maintaining their endowments.

This may be difficult for some foundations and those with permanent endowment may need to consider whether they should seek authorisation from the Charity Commission to invest on a total return basis. During a recession, a minimum pay-out requirement should be even more carefully considered.

New tax incentives for donors

What role do tax incentives play?

There's a general consensus - in the UK and the United States - that although tax breaks aren't the reason why people make charitable donations, they do increase the amounts given and can also determine how the gift is made up (cash and/or property).

Charitable trusts

In the case of a charitable remainder trust the income is distributed to the trust’s beneficiary until the death of the donor, when the funds go to the nominated charity.

The opposite applies in the case of the charitable lead trust. Here, distributions are made to a nominated charity for a period of years and on the termination of the trust, the funds are distributed to designated beneficiaries.

These systems of split interest trusts have been considered by the UK government and rejected on more than one occasion. It would seem that the reasons for rejection have been the potential risk of abuse and complexity. There is also, potentially, an issue of public perception, particularly in the case of charitable lead trusts where the assets revert to the donor’s family.

There are, however, clearly merits in these tax breaks which have been tried and tested in the United States. The Lifetime Legacies Coalition is lobbying for the introduction of charitable remainder trust in the UK. 

The future

The the wider question of new tax breaks may be revisited by the government in the future and there is clearly scope for some fresh thinking, for example by giving enhanced incentives which increase year on year.

Cross-border giving

The current situation

Different countries have different definitions of charities and public-benefit organisations. The lack of equivalency has led to difficulties in cross-border giving.

Recent charity law reform in a number of countries has done nothing to improve the situation - if anything it has made it worse. There have however been a number of initiatives and mechanisms to facilitate cross-border giving, particularly between different European countries and the US. 

Currently there are only a few countries which allow tax incentives for cross-border charitable donations, including Slovenia, Finland and Denmark, but more countries may well follow suit in the near future. 

Opportunities and challenges

Freeing up cross-border giving in Europe will increase opportunities for philanthropy, but it will also present fundraising challenges for charities. UK charities will face competition from new markets in other countries, as well as other charities within the UK.

The issue of cross border giving is a complex area. At the current time there is only a small group of professional advisers and charities who can navigate the complexities and more needs to be done to raise awareness of the issues and the solutions.

Have your say

To what extent does your organisation use philanthropic sources of funding? Could you perhaps make more of your major donors?

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