GENEROUS FAMILIES - PART 3 - TRAPPED CAPITAL
This week’s The Provocateur brings our third and final blog post on the topic of Family Giving, authored by our colleague and guest author, Gena Rotstein, FEA, MA. Gena is one of Canada’s leading experts in Social Enterprise and Philanthropy. In September 2017, Gena, along with Richard Ouellette, launched Karma & Cents Inc. – a Social Impact Lab working with single and multi-family offices in designing impact driven legacy and philanthropy plans.
GENEROUS FAMILIES - PART 3 - TRAPPED CAPITAL
Why are there billions of assets ‘trapped’ in multi-generational private foundations?
Gena Rotstein, FEA, MA
March 10th 2020
We often hear people complain about the duplication of organizations and services in the charitable sector. With approximately 90,000 charitable organizations in Canada, it isn’t surprising that this is a perception. Rarely, do we talk about the duplication and resulting inefficiencies of private foundations in the charitable sector. Following this line of inquiry we dive into the impact that disconnected and siloed giving has on addressing critical issues in our communities. With an $8 trillion inter-generational wealth transfer occurring over the next three decades (This is an estimate from a variety of reports provided since 2014 from BMO, TD, and Bank of America. For the purposes of this blog we chose the low-end of the estimates.), it is important now, more than ever, that we understand and address some of the challenges that impact the business of philanthropy.
When it comes to the business of philanthropy, there are four key stakeholders - the funders, the inheritors, the wealth managers (paid advisors) and the charities. While we think that all four stakeholders have common interests, that of doing good, it is clear that the system is designed to not necessarily advance the social mandate… And here’s why…
THE BUSINESS OF PHILANTHROPY
The business of philanthropy in Canada is huge - there are approximately 5,976 private foundations in Canada (PFC, Canadian Foundation Facts, 2019), excluding accounts held in Donor Advised Funds and Community Foundations; 1,740 of which are multi-generational (Canada Revenue Agency, Jan. 2020 data). The total asset base of private foundations in Canada is approximately $50 billion (PFC, Canadian Foundation Facts, 2019). Of those, approximately 500 operate at, or below, the base minimum of 3.5% annual distribution (ibid). This represents approximately $6.8 billion of assets “trapped” in multi-generational private foundations.
You might ask, how can this be? If the original intention of the foundation was to deploy capital into the charitable sector in the most tax effective and efficient way, how can there be billions tied up in these corporate structures?
It’s all about the conflicting costs of doing the business of philanthropy.
Just like any business, a foundation has set-up costs, ongoing operational expenses and financial management fees. The expenses associated with setting up the foundation are lost costs, it is the ongoing maintenance and management of the foundation where the conflict arises. Instead of rewarding those who deploy capital effectively, we reward them by retaining and preserving capital. And herein lies the rub - we have set up our philanthropic management system with three outcomes, none of which has anything to do with “doing good.”
First and foremost, philanthropy and by extension, private foundations, are part of an overall wealth and tax planning strategy. This in and of itself is a good thing. You have been successful in business, you have built up wealth, you may have employed people, likely contributed back into the economy by buying stuff and paying your taxes; so a foundation allows you to reap some of those rewards by being able to give back to the community in the most tax effective and wealth prudent way. However, at no point in the technical solution planning with an accountant, tax advisor or wealth manager where philanthropy is part of the strategy, does the question about “What most needs doing in your community?” arise, nor are there questions around “What will it cost my community to NOT solve the social problem that I am most passionate about?” This means that a legal corporate structure is being created for the sole purpose of managing and housing assets. The assumption is, of course, that good will come out of it, but how effective that “good” will be is inconsequential to the tax and wealth planning discussion.
You might say, “Obviously a person who sets up a foundation has an understanding of the issues they want to support. That is why they know how much to put into their foundation to begin with.”
This leads me to my second point…
LACK OF INDUSTRY KNOWLEDGE
Unlike investing in private companies, where the investor tends to have a general understanding of the industry in which his or her investee operates, most donors don’t fully understand the charitable sector in which their beneficiary operates. Truth be told, most charities don’t fully know the competitive landscape in which they are operating (hence the duplication in the sector).
Philanthropy is a financial transaction based on an emotional experience. There is someone who is asking for support for a charitable project and there is someone who is emotionally moved to make the gift. Think of the language… a gift… not an investment. As such, the perception of the need to fully understand the charitable landscape is not required because at the end of the day, it is a gift, something that has little or no expectations around it, other than the recipient should use the funds as they promised.
To set up a foundation you don’t have to know, or even understand, the issue that you want to support. The majority of Canadian private foundations’ mandates are simply to give to other Qualified Donees (registered charities) (ibid). The CRA does not require a foundation, or for that matter, a front-line charity, to demonstrate that they have done their market research and determined that, in fact, a foundation is required. This is what leads to multi-generational trapped capital. Inheritors receive the foundation as part of their family’s estate and are now required to run the philanthropy business. If they weren’t brought into the fold when it was being established, or if they didn’t even know it existed until it was too late, the inheritors do not take on the leadership mantle of running the foundation. This lack of interest leads to the outsourcing of the ongoing management of the foundation.
Strategic philanthropy sometimes means that you have to cede your financial resources to other, already established foundations, which are operating in your space and who have proven that their funding approach and recipients are moving the dial on an issue.
This highlights the third issue, that of compensation of the external wealth advisors.
Financial reward is given to those who retain assets under management, not on disbursing funds effectively. This means that the compensation structure for the advisor dissuades conversation from moving assets out, either to other foundations who have demonstrated effective funding, or to the community at more than the base level of 3.5% per year.
THE PERFECT STORM
In 2010 research published from Boston College indicated that we are at the Golden Age of Philanthropy with a follow-up study in 2014. We have more money flowing between generations, more people thinking strategically about giving, but we also have financial and government systems that actually curtail or outright prevent significant, dial turning solutions using private philanthropy.
If we are going to solve some of our most complex social problems, and as governments push more of this problem solving down to the Civil Sector (i.e. philanthropy), it is imperative that we consider how we house the assets we want used for these purposes; how wealth advisors engage the Rising Generation (inheritors) in the planning of the family legacy; and what the compensation model looks like. Otherwise, the charitable sector is going to be put into a spin cycle of trapped capital and duplicate funding practices and missed opportunities.
Photo Credit: Harvard Business Review
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ABOUT THE AUTHOR
Gena Rotstein, FEA, MA, Principal
Karma & Cents Inc.
Gena Rotstein, FEA, MA, is one of Canada’s leading experts in Social Enterprise and Philanthropy. In September 2017, Gena launched along with Richard Ouellette, Karma & Cents Inc. A Social Impact Lab working with single and multi-family offices in designing impact driven legacy and philanthropy plans.
To date, Karma & Cents supports families across Canada advising on over $200 Million in charitable assets. With over 20 years of social business management and nonprofit work experience throughout Canada and the United States, Gena has worked with some of Canada’s most influential family foundations, family enterprises and financial institutions helping them generate greater social impact beyond traditional philanthropy for themselves and their clients.