The draconian budget cuts that the White House unveiled will go through many changes before Congress adopts a long-term budget. However, President Trump’s desire to slash government funding could severely damage many nonprofits that depend on direct — and even indirect — federal support, potentially forcing some organizations to shut down.
With this impending crisis, foundations will become an even more important force in supporting important community services, in some cases even preventing their loss. Sadly, at this moment of significant need, foundations are falling far short of their potential. With a handful of exceptions, foundations are prisoners of structural failings that, if left unchecked, will preclude the potential for philanthropy to mitigate a looming catastrophe for the nonprofit world.
To be sure, America’s 87,000 foundations have delivered huge benefits by combating hunger, curing diseases, aiding veterans, assisting the elderly, and performing critical work to advance American and humanitarian values around the world. Their donors receive extraordinary tax benefits in recognition of their role as catalysts for civic innovation and social progress. And as a result of those tax benefits, foundations should be obligated to ensure they provide the greatest possible benefit to the organizations and communities they support.
The scale of the effort is remarkable: U.S. foundations awarded more than $52 billion in grants in 2014. By comparison, private venture-capital investments in the same period totaled only $48 billion. Yet the 4,000 investments by venture-capital funds averaged over $11 million each.
Grants from the thousand largest foundations went to 10 times as many organizations but averaged only $400,000. Put another way, the average venture-capital investment was 28 times larger than the average foundation grant.
There’s something wrong when organizations solving society’s most pressing problems have a harder time mobilizing serious capital than the latest start-up building an app for sharing cat pictures. In the past, this problem was unfortunate. Going forward, it may be an existential issue for civil society.
The Wrong Approach
It doesn’t have to be this way. At their best, foundations provide risk capital for society. Philanthropic resources can unlock transformational solutions that would be out of reach for government, businesses, or other players.
Judith Rodin, until recently the president of the Rockefeller Foundation, observed that “unlike governments, we don’t live or die by the polls or the next election. Unlike businesses, we don’t measure success in quarterly earnings.” These dynamics should empower foundations to take risks and invest in innovation.
But more often than not, they don’t.
In principle, providing small grants that benefit many groups may seem like a fine way of giving. In practice, it’s precisely the wrong approach to fund cash-strapped organizations trying to expand the reach of their solutions. Fundraising is incredibly expensive. Securing each grant requires an immense commitment of energy and resources on the part of both recipients and foundations. Instead of making large investments that translate into big, transformational wins, too many small grants are making little or no progress toward solving big problems.
It gets worse. Foundations usually bind their grantees to rigid, pre-set constraints. Imagine how much innovation we would see out of Silicon Valley if investors told tech startups that they had to get preapproval of their expenses, research, and activities years in advance and that shifts in strategy could be considered only on a biannual basis. This approach simplifies grant cycles and smooths board deliberations, but it’s a poor proxy for a serious strategy to maximize social impact.
Not only are foundation grants subject to rigid conditions, but in most cases grant makers allow only a small part of each award to cover an organization’s basic operating expenses. It shouldn’t surprise us that nonprofits struggle to attract and retain talented workers when they are barred from investing the bulk of their funding in the things we know help organizations grow and succeed.
On the rare occasions when foundations do award large grants, the money almost always goes to big, established entities. That approach is unlikely to deliver transformational solutions. A venture-capital fund claiming it wants to invest in the next Uber shouldn’t put big money into Ford. It’s a fine company, but not one that’s going to grow at spectacular rates or take risks like a smaller firm.
Agility Is Key
Nonprofits may be more important to the nation’s welfare now than at any other point in modern American history. In addition to impending cuts in government funding, new technologies such as artificial intelligence, autonomous vehicles, and blockchain (the digital underpinning of Bitcoin) are likely to cause massive upheaval in labor markets in the years ahead as automation and robotics replace human workers.
America will need nonprofits that are agile, efficient, and relentless in responding to these new dynamics. Foundations should be investing now to help nonprofits and communities manage this coming reality. That will be possible only if foundations rethink their approach.
Specifically, foundations should:
Provide the funding grantees need to be effective. That means making fewer, larger grants and reducing — if not entirely removing — restrictions on how funds can be spent.
Invest in expansion. When a program or approach has proven to be effective, foundations should provide the resources — financial and otherwise — to spread the effort widely, rather than moving on, as many do now, to the next shiny object. In some cases, especially with nonprofits working to advance democracy and advocacy, a relatively small investment may be enough to change how an entire system works and produce results with broad impact.
Embrace failure as a necessity and opportunity. The risk of failure is a requisite component of innovation. Finding the most effective ways to solve social problems requires a willingness to invest in some things that don’t work. Foundations’ aversion to risk is partly driven by understandable concerns about opportunity costs, since every dollar spent on a program that fails could have been spent on something that worked, but it has become an impediment to innovation. Foundations should dedicate a portion of their grant portfolios to awarding money to projects that are risky but that potentially bring high rewards. If grant portfolios achieve 100 percent success rates, are they really pushing the margins of innovation and developing new solutions to deliver social impact?
Pay for charities to consider and pursue strategic consolidation of their work. Of the 1.4 million nonprofits in the United States, fewer than 15 percent have operating budgets over $250,000. Many small organizations deliver needed services, but the cost of fragmentation is significant. Foundations can help spread much-needed programs by helping nonprofits merge or forge strategic alliances.
Use their investment portfolios to stomp out social problems. Most foundations distribute the federally required 5 percent of assets in grants every year, but that means they have a significant opportunity to invest the other 95 percent of their endowments in companies that are in line with their missions to deliver social or environmental benefits. For-profit investments that incorporate rigorous environmental, social, and governance standards can help shape a landscape in which grants are far more effective.
The need for many of these changes is common knowledge among nonprofits. However, the market forces that would normally force adaptation in other industries don’t exist in philanthropy, and nonprofit “customers” lack the leverage to force change. It’s up to foundations to heal themselves.
Grant makers must overhaul the way they work and broadcast the impact of those changes to encourage other foundation leaders to follow suit. They must also call out other grant makers when they don’t embrace more efficient ways to deploy philanthropic capital.
Perpetuating a status quo that’s failing to spread solutions at home and abroad isn’t a viable option. Given the stakes, dysfunctional foundation giving is a luxury the country can no longer afford.
Dahna Goldstein is a Bretton Woods II New America Fellow. She was previously the founder and CEO of PhilanTec and teaches technology entrepreneurship at Georgetown University. Tomicah Tillemann is director of Bretton Woods II at New America Foundation.