A relative of mine owns two of the best restaurants in the San Francisco Bay Area. But when he wanted to open the first one 8 years ago, he had a hard time raising money from investors. It is tough to get people to invest in new restaurants. Like evaluating a charity, it is difficult for a potential investors to determine the probability of a new restaurant doing well. My relative found it almost impossible to raise funds until one very successful investor wrote him a check. The next day the phone started ringing as the big investor’s friends started calling up to demand that they too get to invest. My relative even received a $25,000 check made out to him personally with no note attached (the person who’s name was on the check was contacted and their desire to invest in the restaurant confirmed).
My relative’s restaurant got the funding it needed and a year later was named one of the top ten new restaurants in America.
In a way, my relative got lucky. But stop and think about what happened. In an industry where investors face a high likelihood of failure and a difficult environment to do due diligence, the key factor was the signal that went out once a big, successful investor went first. Humans are social animals. We like to see other people go first. But we also don’t want to be left behind. We like to stay with the herd.
In financial markets, “smart money” is the phrased used to talk about people who are “in the know”. Investors often try to follow “smart money” investors, assuming that if an investment is good enough for the smart money, it is good enough for them. The ultimate in “smart money” is Warren Buffett. By law, Buffett’s company must release information on the stocks they hold. Every time this list is updated, financial newscasters go wild figuring out what has changed. The stocks that Buffett has recently bought will go up as new investors start buying and stocks he has sold will go down.
Relying on other people in this way can be dangerous. No one is infallible. But investors know that Buffett and other smart money investors have greater resources to do due diligence. If Buffett calls a company asking questions, the CEO calls him back personally.
Unfortunately this “signaling” from “smart money” investors is pretty weak in philanthropy. This is why I wrote last week (follow up here) that I thought it was “validating” that the Hewlett Foundation funded GiveWell. Not only is Hewlett one of the biggest foundations, but they have a strong philanthropy program that funds projects that improve the state of philanthropy. You read some about their philanthropy work at GivingMarketplaces.org.
Hewlett has far more resources than most donors to do due diligence on a group like GiveWell. They have demonstrated expertise in the specific program area that GiveWell focuses on. While Hewlett may be wrong about GiveWell, the fact that they’ve invested means that one of the foremost grantmakers in this area thinks that GiveWell is worth investing in.
Should we all accept blindly that big foundations or any donor for that matter is infallible and assume that anything they fund is wonderful? Of course not. But it would also be foolish to ignore the potential for smart money to act as a signal of a program being valid or credible.
If a international aid group gets funding from the Gates Foundation, a charity evaluator gets funding from Hewlett, or a social enterprise focused on job creation gets funding from REDF, it would be silly for smaller donors to dismiss the viability of those grantees.
I think there is great potential for someone to capture the grantmaking activity of “smart money” in philanthropy and remix the data in a way that is useful for smaller donors who want to follow the smart money. The Nonprofit Knowledge Network might be the group that figures out how to do it.