Think You Know Private Foundations? Think Again.

Private foundations are victims of misconceptions and stereotyping, even within the philanthropic community. It’s true. I find it ironic that philanthropists—many of whom dedicate vast resources in the service of abolishing stereotypes—should be so commonly misunderstood.

Before I elaborate, I will ask you two questions, and I don’t want you to spend time thinking about your answers. Just acknowledge and accept the first response that comes into your head:

1. Name a private foundation.
2. What is the total value of assets that a typical private foundation holds?

Given the expertise of this readership, I imagine that question number one elicited a variety of answers. Still, were you one of the people who said Gates, Rockefeller, or Ford? Because they are all such recognizable names, many of us, myself included, cite one of these three when pressed to name a foundation.

How about question number two? Was your answer somewhere in the $10 million to $20 million range? A little higher? That’s what many people would say. In fact, many wealth managers advise clients not even to consider creating a private foundation unless they have at least $1 million or even $5 million in investible assets. So would you be surprised to know that based on 2009 IRS reporting, of the more than 80,000 private foundations in the United States, two-thirds have endowments less than $1 million (the median is actually $500,000)?

The reality is that most people, including reporters, attorneys, wealth managers, and other professionals who engage with the philanthropic sector, know about private foundations only from studies, surveys, and press coverage focused on the largest two percent of private foundations—those with hundreds of millions of dollars. As a result, our understanding of what private foundations are and how they behave is dramatically skewed.

Ask yourself this: In what other field of study is the center of the bell curve defined by the relatively few outliers at the edges of the graph? Do we refer to the Rocky Mountains as “small” because they pale in comparison to Mt. Everest? Of course we don’t!

This past March, Foundation Source released a sneak preview of our 2013 annual report on private foundations (the full report came out in May), by sharing aggregated 2012 giving data for 732 of our private foundation clients. This is how we described the foundations, ranging in size from a few hundred thousand dollars in assets to as large as $50 million:

“… the foundations in this report provide a representative snapshot of the giving activity of the largest segment of private foundations in the U.S. today: private foundations with endowments less than $50 million that make up 98 percent of the approximately 80,000 private foundations in the US.”

When the media picked up our news, the headline in the Chronicle of Philanthropy read: “Small Grant Makers Lead Gains in Foundation Giving, Says Study.” Reuters invoked the “small” word on numerous occasions, including: “… these small private foundations paid out more than twice the Internal Revenue Service's minimum distribution requirement of 5 percent.” Advisor One declared: “Smaller Private Foundations Continue to Show Their Mettle.”

I was intrigued by this phenomenon because nowhere in our accompanying press materials did we use the word “small” or “smaller” to characterize the foundations in this report, nor did we imply that these foundations should be deemed small in comparison to the relatively few mega-foundations holding billions of dollars in assets.

Why should this matter? So what if most people view a $3 million foundation as small? It matters because society’s perceptions of private foundations are driven by surveys, reports, and news stories and these perceptions ultimately inform the economic and tax policies to which private foundations are subject. If people fundamentally believe that the investing and grantmaking behaviors of the mega-foundations are the norm, then it creates a ripple effect based on less-than-accurate assumptions.

Take, for example, the highly scrutinized 5 percent payout requirement, mandated by the IRS. Most people assume that the average private foundation donates five percent of its total assets each year, as they are legally required to do—no more, no less. After all, most foundations are set up in perpetuity, and if they’re to survive, their investments need to keep pace with their distributions and expenses. It stands to reason, therefore, that their distributions would hover around five percent.

This logic is actually quite sound, particularly when you’re talking about a billion-dollar foundation that hopes it will be here in the year 2113. But when we looked at the behavior of the majority of private foundations—the 98 percent with less than $50 million in assets—we discovered that we needed to reassess our long-held assumptions.

The private foundations in our 2012 report gave significantly more than they were required by law to give. In fact, during the challenging four-year economic period of 2008 through 2011, the foundations in our report consistently gave well in excess of the federally mandated 5 percent payout requirement, averaging a staggering 11.6 percent. Furthermore, the total value of grants increased 4.5 percent during that same period. In other words, the 5 percent payout requirement is not acting as a ceiling for these grantmakers; it’s the floor that serves as their starting point.

Foundation Center statistics tell us that 60 percent of all private foundations have formed in the last 15 years, and the majority of these entities have well below $10 million in assets. In other words, the face of private philanthropy is changing, so it’s high time that we reassess our distorted views about how they behave—views grounded in decades-old archetypes and skewed toward the very small upper end of the foundation spectrum.

Today’s average private foundation donor is younger than a generation ago. Philanthropists are no longer waiting until retirement to put their resources to work. Instead, they continue to fund their foundations with new capital on a recurring basis, and may regularly contribute more to their own foundations during any given year than they pay out. In 2012, the foundations in our report replenished their endowments by adding $1.06 for every dollar of spending (granting and charitable expenses). That was up from 93 cents contributed to their foundations for every dollar of spending in 2011 (which is still rather high).

More and more, philanthropists are still in their earning years, which means their foundations need not take as reactive or defensive a stance to the economy and are less risk-averse. They can be more aggressive, more entrepreneurial, they can embrace risk, they can fail, and they can try again.

Moving forward, I challenge readers to really think about what they mean when discussing the behaviors and characteristic of a “typical” foundation. By understanding the financial performance and giving behaviors exhibited by the 98 percent super-majority of private foundations in the United States, we gain a richer and more complete understanding of philanthropy in this country, as well as the market realities that motivate and influence high-net-worth donors. “Small” is the new “big” in this field.

Read more stories by King McGlaughon.