(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.