Should foundations be trying to spend their way out of business?
TL;DR
Washington’s 1,645 philanthropic foundations hold approximately $65 billion in their collective endowment assets
Of this $65 billion, 161 organizations foundations account for 97% of this total, with the world’s largest foundation, the Bill & Melinda Gates Foundation, controlling $52 billion
There is debate whether foundations should be spending more of their endowment – some say foundations should maintain current spending to preserve future granting abilities, others say the need is too great now to not spend more.
Americans gave $428 billion to U.S charities in 2018 according to the Giving USA annual report and research compiled by the Indiana University School of Philanthropy. While individuals may comprise the greatest share of 2018 giving (68% of total donations), foundations have an arguably greater impact on the non-profit sector at-large (e.g. larger donations granted, competitive RFP processes, greater outcome and reporting requirements, etc.).
Because of this outsize impact, we decided to focus our latest analysis on the foundation sector, taking a deep dive into the market in Washington state. Later in the article, we take on the thorny question: how much should foundations be spending?
Washington is a foundation hub
First off, it’s worth celebrating the robust philanthropic foundation sector we have in Washington. Coinciding with the success of our technology, retail, and aerospace industries, Washington has cultivated a significant philanthropic base that has proven vital to many sectors. Seattle is fortunate to have the largest foundation in the world, the Bill and Melinda Gates Foundation (BMGF), which alone represents ~$52 billion (2017) in charitable assets and employs 1,500 people worldwide.
And even excluding the $52 billion BMGF gorilla, Washington has a thriving foundation sector, with over 1,600 registered philanthropic organizations, representing nearly $13 billion in assets. All in, that’s nearly $65 billion in assets registered in our state.
If we break down the foundation sector further, we can see the distribution of foundations by size and aggregate endowment holdings. From the data, we can see that most of Washington’s foundations have less than $1M in assets. The Gates Foundation holds 80% of Washington’s foundation endowments, with the next largest 160 foundations controlling an additional 17% in assets. In sum, 161 organizations are responsible for 97% of Washington’s endowment assets (about $63 billion).
(For details on our methodology, please see the end of this article. All data, unless otherwise stated, is based on publicly-available tax filings from the IRS, retrieved November 2019.)
What is the purpose of a foundation endowment?
No matter how you slice the data, there is a significant amount of wealth housed within philanthropic foundations in our state. And it’s important to remember, this $65 billion is more than just dollar signs and zeros -- these endowments represent significant potential to reshape the lives of millions via breakthrough health care treatments, re-imagined education models, and secure shelters.
Given the significant wealth of held in these endowments, there has been an emerging debate about the role of foundations within the non-profit sector. (A few examples here: Non-profit AF, Pensions & Investments.) At the risk of oversimplifying, the argument centers on one big question: how much should foundations spend annually out of their endowments?
Majority of Washington’s largest foundations grant between 3% and 6% of their endowments annually
Before we dig deeper, a wonky sidebar on endowments. Currently, the IRS mandates a minimum 5% in annual endowment spending for all foundations. Foundations often reach this target through a combination of grant making and operating expenses (e.g. staff salaries, organizational costs, etc.) . For many foundations, grant making alone is less than the 5% IRS minimum.
If foundations are required to spend 5% of their endowments each year, what happens to the rest of their funds? They invest it in the stock market. By investing, foundations expect to earn a market return greater than the amount of funds spent, to preserve their endowment fund for future years. For well-managed endowments, returns could be as high as 10% (or higher good years). Therefore, if a foundation spends 5% of it’s endowment, and earns 8% after inflation, the endowment would increase.
Looking at the largest Washington foundations by assets (based on 2016 IRS data), we find that the majority of foundations spend between 3% and 6% on grant making alone.
So where does this leave us? Two takeaways thus far: (1) foundations have a lot of money and (2) endowment granting is between 3% and 6% for Washington’s biggest foundations.
Now we can dig into the big question: are philanthropies spending enough? Should they be taking the long-term view and planning their money for perpetual granting? Or, should philanthropies operate with the goal to put themselves out of business and therefore spend more each year?
Point / counterpoint
Similar to our non-profit board debate from our June post, we decided to analyze both sides in a point / counterpoint style.
Foundations should continue to spend at current levels
Foundations provide critical support to non-profits by funding their operations. And non-profits are critical to our communities, they provide essential services in places where the private and public sectors are not. Until the private and public sectors are able and willing to replace the work of non-profits, we will continue to need foundations to fund non-profit work.
Foundation grants can be spent in ways that other money cannot. Foundation funds can help non-profits grow quicker than they could on individual donations alone. They also shoulder the risk of funding unproven ideas, incubating new services and programs for the government to later take on. Even if we solve all the problems of today, we know there will always be more problems tomorrow — we will need flexible philanthropic funding to help us fund the solutions.
Furthermore, foundations have learned a lot from their many years of grant making — studying interventions that worked and those that did not. From these many experiments, they have honed a data-driven strategy for giving to improve the chances grant funds will produce the designed outcomes. We rely on this expertise now, and will continue to in the future.
To sum up, preserving endowments now leaves foundations the necessary financial reserves to fund innovative solutions and non-profits to address future challenges.
Foundations should spend themselves out of business
There is a lot of need in the world. With such vast assets at their disposal, foundations have an obligation to spend a greater amount of their wealth to solve the problems of today. There are plenty of deserving organizations with proven theories of change that need funding to expand their impact. Foundations should increase funding to those organizations and proven models.
As a thought exercise, imagine if all of Washington’s foundations matched the Gates Foundation to grant 10% of their endowment annually? We would have hundreds of millions more each year that could go towards reducing poverty and improving the livelihoods of people worldwide. If we take a long-term view, what sort of future generational impact would that have? For the finance geeks out there, think of it like a net present value calculation with a low discount rate (or in this case “net present impact”). If we assume it will be increasingly expensive to provide services to future generations in poverty, we should spend now to prevent higher costs later.
As a compromise, foundations could seek to match spending to total market returns. For example, if a foundation’s endowment earns an inflation-adjusted 7%, then annual spending would also increase to 7%. This increase in spending could allow foundations to take even more risks in their portfolios. Or better yet, foundations could earmark these extra funds for community-driven investments – a funding pool to be driven by the very people foundations seek to assist. (See Edgar Villanueva’s interview with the New York Times for a deeper take on this).
What’s your take? Send us a note at contact@kineticwest.com with your thoughts.
Methodology Notes
For the purposes of this article, we define a philanthropic foundation as all private operating and non-operating foundations. Operating foundations can fund their own charitable activities (think libraries, zoos, etc.). Non-operating foundations are those that primarily give grants outside of their own organization. For more exciting details on non-profit taxonomy, check out this article from the IRS.
To analyze Washington’s foundation market, we excluded philanthropic organizations that do not file a specialized foundation tax return called a 990-PF. This left us with 1,957 philanthropic foundations in Washington state, after excluding the endowment management arm of BMGF (The Bill and Melinda Gates Foundation Trust), which provides the funds for BMGF’s endowment. If we further exclude all foundations with $0 in reported assets, we find 1,645 foundations.