How Much is Philanthropic Advice Worth?

(Note: The kind of advice I’m discussing in this post is grantmaking advice. In other words “which nonprofits should donors invest in”. My firm, Ensemble Capital Management, does not provide this sort of advice. We provide wealth management and philanthropic concierge services)

Recently I predicted that donors would move towards paying for grantmaking advice and that this would transform philanthropy. So how much and why will donors find it valuable to pay for this sort of service?

Let’s say there are five nonprofit organizations working on reducing homelessness in your city. Even without any quantitative impact statistics, it is completely commonsense to assume that some of those organizations are better than others. In fact, it is likely that one or two are significantly better than the others and that one or two are significantly worse. Just for the sake of argument let’s make some assumptions about the organizations.

Let’s assume that the five organizations have the following quantitative social return as measured by reduced cost to tax payers from reduced homelessness (ie. a return of 0% would mean that every dollar given to the organization reduced tax payer expenses by $1).

Org A: 35%, Org B: 25%, Org C: 10% Org D: 0% Org E: -20%

This example assumes that Org A and B are achieving great tax payer savings, Org C is producing a positive result. Org D is reducing tax payer costs on a dollar for dollar basis with donations (meaning the same results could be achieved by making donations to the government treasury). Org E is actually destroying value. If you gave an equal donation to each organization your average return would be 10%, so we can think of this as the “market return” or expected return.

Right now, I think that philanthropists are funding nonprofit organizations without focusing enough on which one is best. With this example we can see just how valuable advice that identifies the best nonprofits actually is.

If you gave $1 million to Org A, you would generate $1.35 million in tax savings. The same gift to Org C would save $1.1 million and a gift to Org E would save $800,000. If you assumed you couldn’t tell which one was best and gave $200,000 to each organization, you would save $1.1 million in taxes. This means that if you could pay an advisor to tell you which organization was the best, this advice would be worth $250,000 (the difference between the $1.35 million savings from funding Org A vs the $1.1 million savings from equally distributing your donation).

If you run the math, this means that an advisor who can correctly pick Org A out of the group can justify charging a fee equal to 18.5% of the donation. (Email me if you’d like to understand the math).

Most all donors would choke on the idea of paying an 18.5% fee on their donation. Donors don’t even like nonprofits have operating expenses, so most couldn’t stomach the idea of paying hefty “operating costs” just to decide which nonprofit to give to.

And yet by not paying and not identifying the best nonprofits, donors are destroying social value. They are starving great organizations of resources and subsidizing poorly performing nonprofits that should be going out of business.

The fact is, the spread of returns in my example is probably conservative. Those returns (from +35% to -20%) are more typical of the range you’d see in small to midsize businesses that are functioning in an imperfect market, but one that still rewards top performers and squeezes bad businesses until they go bankrupt. It seems to me that since in the nonprofit world, poorly performing nonprofits that have good fundraisers can stay in business, the spread between the best and worst performers is probable much larger than my example suggests (which means the advisor’s advice is worth more).

Now think about this: Americans gave $300 billion last year. 18.5% of that amount is $56 billion. It might seem ambitious, but that means that there is a potential $56 billion a year business opportunity for grantmaking consultants. That’s almost twice the size of the market of wine and beer. It is almost twice the size of the amount Americans gamble every year.

18.5% seems like a really high fee. $56 billion seems absurd. But think about it this way: If you endowed American giving, so that the $300 billion was a 5% annual payout (in line with most foundations) of our “community endowment”, then the fee would be equal to 0.93% of the endowment.

Guess what many for-profit investment advisors charge their clients? 1% of assets under management.

Being able to identify the best for-profit investments is a hugely valuable talent and a massive industry has grown up around it. I think that nonprofit analysis is just as valuable and we’re going to see quite a robust industry grow over time.

3 Comments

  1. Sean,

    I agree with you, but I don’t think you went far enough in your analysis; the complexity here is a scale of magnitude greater.

    You are comparing nonprofits as if they were businesses; meaning that a free market will starve the inefficient of resources while rewarding the efficient.

    This translates to perfect philanthropic knowledge, leading to rational giving, which rewards the efficient while starving the inefficient. I’m borrowing and translating economics concepts from the for-profit economy heavily here, but I think they apply.

    The problem is that nonprofits can collaborate as well as compete, and frequently do both. For example, what if organization E could produce a +40% return if they had a strategic marketing consultant donate their services for a month?

    Take web development as an example. What if an organization currently has a standard HTML website, with 1,000 pages of information? This creates an inefficiency, requiring tons of paid staff time to maintain and update. A $4k donation here that introduces a CMS could actually leverage a *far* greater return on investment, if the content has value. Nonprofit efficiency may not correlate to return on donation investment.

    Also, what we’re describing here are models of support for nonprofits; where is the space for helping / nurturing new nonprofit organizations within this model?

    Dave.

  2. You’re right Dave. For simplicity sake, my model assumes static returns and ignores the fact that more funding might change future returns.

    That’s another level of analysis, but it does not counteract my core argument.

    Your point about collaboration is important an interesting though. For-profit companies are barred from certain kinds of collaboration because doing so can hurt consumers. But nonprofit “monopoly practices” might actually result in more social good.

    Regarding “nurturing/supporting” nonprofits, there is every room for this in the model (just like there is room for venture capital behavior in for-profit markets). Again, this is another layer of analysis.

    All good point though. I’ll think about building them into future posts (but this post was about as long as I can expect my readers to sit with me!)

  3. Agreed. If anything, it bolsters your core argument; some specialized experience is likely required to be able to conduct further levels of analysis, going beyond a benchmark score (not that we have a uniform benchmarking system in place, of course).

    I need to spend more time around here ๐Ÿ™‚ I miss too much with my spotty attendance.