Venture Philanthropy

Posted by   admin on    April 1, 2004

Most of us learned as children that sharing is a good thing. We didn't know we were practicing philanthropy -- we just knew that giving to other people or important causes made us feel good. Decades ago, many people tended to give to the organizations that touched their lives, such as churches, hospitals and schools.

Today, there are more than 600,000 charities and foundations operating in the United States, representing, it seems, every conceivable cause on the planet. Charities are making their presence known through elaborate ad campaigns, web sites and high-profile fundraisers. These more organized, more visible efforts are necessary, charities say, because:

  • Their services are more in demand than ever.
  • Government funding is declining and, in many cases, disappearing.
  • The cost of everything continues to spiral upward.

As mentioned in our prior newsletters, we strive to provide articles on various aspects of wealth management to assist your understanding of why planning for the present and for your future has importance. Yes, we also promote our services; yet, you will find that we always seek to present thought provoking topics that are relevant to our wide audience. (By the way, with your help, our readership has grown and we have resolved to archive past newsletters on our web site. Keep those referrals coming! We appreciate it!)

A philanthropist is a lover of humanity, a person who looks towards the greater good of humanity. This is generally recognized by a donors deeds towards welfare (charity, public service etc.). The label is most often applied to someone who provides a large fraction of the money that supports the efforts in a particular category. Yet, donors have become savvier and now require greater accountability from the charities to which they give and are not always content to simply turn over her assets to a charitable organization and hope for the best. This month, Julie King, a trusts and estates attorney at Keeler Obenshain PC, provides us a look at a new trend referred to as venture philanthropy.

At the end, please review our performance update. We continue to perform well despite both the Dow Jones Industrial Average and S&P 500 index losing ground this month!

Sophisticated Giving

Today, there are more than 600,000 charities and foundations operating in the United States, representing, it seems, every conceivable cause on the planet. Charities are making their presence known through elaborate ad campaigns, web sites and high-profile fundraisers. These more organized, more visible efforts are necessary, charities say, because:

  • Their services are more in demand than ever.
  • Government funding is declining and, in many cases, disappearing.
  • The cost of everything continues to spiral upward.

Americans have responded generously -- charitable giving in 2002 totaled nearly $241 billion, according to the American Association of Fundraising Council. Yet, donors have become savvier and now require greater accountability from the charities to which they give and are not always content to simply turn over her assets to a charitable organization and hope for the best. For example, there are currently more than 50,000 private foundations in existence in the Unites States (up from 2,000 in 1950) and it is predicted that the next 40 years  as Americans experience the largest intergenerational transfer of wealth in history  will see the formation of more family private foundations than at any other time in history. This trend, sometimes referred to as venture philanthropy, is reflected not only in the growth of family private foundations, but also by the surge in popularity of two of the primary alternatives: the supporting organization and the donor-advised fund.

Private Foundations

By strict tax law definition, a private foundation is any charitable organization that is not a public charity. That definition does not give us much guidance, so it is more helpful to think about a private foundation as a charitable organization having three main features: (i) a single major source of funding, typically a family or corporation; (ii) a grant making program instead of direct operation of a charitable program; and (iii) payment of grants and expenses from endowment income instead of from the proceeds of a fund-raising program.

Private foundations are organized into five categories:

(i) The Endowed Private Foundation. The most familiar kind of private foundation, endowed foundations are typically funded by an individual or family and usually build up their endowments by expending only the minimum distributable amount in a variety of grant programs. Family members frequently participate as officers and directors, and grants tend to focus on an area of concern to the donor and his family, such as health or education.

(ii) Un-Endowed Private Foundation. This kind of foundation usually receives its funding annually from its founder (frequently a corporation) and has little or no endowment. This kind of foundation is frequently used to extend the donors giving over a period of a few months or for other timing reasons.

(iii) Pass-Through or Conduit Foundation. This kind of foundation is required to pass through contributions within two and a half months after the end of the year in which the contributions were made. In addition to more favorable income tax deduction treatment, timing issues are a motivating reason behind this type of foundation. For example, the owner of low-basis stock who wishes to make an immediate contribution before the company goes public might use it.

(iv) Pooled Common Fund. This is a fund in which the donor and the donor's spouse retain the right to annually designate which charitable organizations will receive the income earned on contributions by the donor. The income recipients must be public charities. At the end of the donors (or surviving spouses) life, the corpus of the fund goes to a charity designated by the donor.

(v) Operating Foundation. This kind of foundation operates its own charitable programs (such as a museum, clinic, or historical building) instead of making grants to other charitable organizations.

A private foundation is considered the vehicle of choice for the donor who wishes to maximize control exercised over both the investment and the distribution of the donated funds. However, the advantages of the private foundation must be weighed against the burdens and costs of administering it. In addition, a donor to the typical endowed private foundation is subject to more restrictive income tax deduction limitations.

Supporting Organization

A supporting organization is a separate entity formed by a donor and operated exclusively for the benefit of one or more designated public charities. It is attractive to many donors because contributions to it qualify for more generous income tax deduction treatment. However, supporting organizations do not afford the ability of the donor to control the organizations assets and may limit future philanthropic endeavors if, for example, the goals and purposes of the designated charitable beneficiaries later vary from those of the donor.

A supporting organization must demonstrate one of three types of relationships with designated public charities: (i) either it is operated, supervised or controlled by one or more public charities (described as a parent-subsidiary relationship); or, (ii) it is supervised or controlled in connection with the benefited public charities (a brother-sister relationship); or, (iii) it is operated in connection with the benefited public charities.

A donor comparing a supporting organization to a private foundation will most likely consider the latter type to be the best alternative, as it requires the least supervision by the designated public charities. However, even this kind of supporting organization must demonstrate its connection to an existing public charity by satisfying various tests. A detailed discussion of these tests is beyond the scope of this article but, generally, the tests require a supporting organization to demonstrate that its operations and activities are inextricably and substantially linked to one or more public charities.

From a practical perspective, the restrictive rules applicable to supporting organizations probably limit their attractiveness only to those donors who have (a) a particular public charity beneficiary in mind that is motivated to cooperate with the donor; (b) a group of friends or other non-disqualified persons suitable to be directors without violating the control rules; and (c) sufficient assets to make a stand-alone entity worthwhile.

Donor-Advised Fund

A significant event in philanthropy went unnoticed. There are now more donor advised funds than foundations in the United States. The May 15, 2003, edition of The Chronicle of Philanthropy reported that donors had set-up 62,245 donor advised fund accounts by 2001, while the Foundation Center estimated that 61,180 private, community and corporate foundations were in existence that same year. While the number of private foundations accelerated in the late-1990s, donor advised fund growth has been even faster. Despite the weak economy, the number of donor advised fund accounts grew more than 12%, to 70,066 accounts in 2002.

The term donor-advised fund is not defined by statute or Treasury regulation. In practice, a donor-advised fund is a fund established by a donor at a community foundation, a university, a public charity, or a mutual fund company. The donor, or someone designated by the donor, exercises the privilege of making nonbinding recommendations to the governing body administering the fund suggesting which charitable entities should receive grants from that particular fund. The administrator holds and invests the assets in the fund, handles checks for distributions, collects and retains receipts from charities and is responsible for all federal and state reporting. For these services, the administrator charges an annual fee, typically 1 to 2 percent of the funds assets. The administrator will also establish the minimum donation required to establish a fund. The minimum can be as little as $5,000 or $10,000 at a mutual fund company or as large as $250,000 or $1 million at a university.

An attractive feature is that contributions to donor-advised funds qualify for the more advantageous public charity income tax deduction limitations. And, while the donor retains some involvement in the grant making process, the administrator handles all administration of the fund at a cost that is usually significantly lower than for a private foundation or supporting organization.

The primary disadvantage to a donor-advised fund, especially when compared to a private foundation, is that the donor must give up control over the funds assets. Grant recommendations by the donor, or by a designee of the donor, can be advisory only and, typically, the right to advise is limited to the lifespan of the donor or other designated advisor. Other disadvantages to a donor-advised fund (especially those at community foundations) are that grants may be restricted to charitable organizations in a particular community, region or state. Others have policies against funding charitable organizations that are unfamiliar to staff members or that do not support certain core beliefs.

What does this mean for philanthropy? On the one hand, it means that philanthropy is becoming "democratized." Instead of the exclusive province of individuals of significant wealth where you need $3-$5 million to set up your foundation, the "price" of entry is a few simple forms, and $10,000.

It also means that philanthropy is maturing. For decades, financial experts have been advising their clients to diversify their portfolios, and allocate their investments among a number of asset classes so as to minimize their risk and maximize their return. Now the same is occurring in philanthropy. A generation ago, wealthy individuals equated philanthropy as two options -- the checkbook or the foundation. Over the last 30 years, with the emergence of community foundations, national donor advised funds, and planned giving specialists, coupled with an interest among financial service firms to serve high net worth clients, the same message is being delivered to philanthropists. Don't tie up all your charitable assets in a foundation -- establish a donor advised fund, set up a charitable remainder trust, or charitable gift annuity.

ELF Capital Management Investment Performance Update

For the month ended March 31, 2004, our one-month performance is up 1.29%, our three-month return is up 3.99% and our one-year return is up 21.94%

For disclosure purposes, past performance is not necessarily indicative of future results and ELF Capital Management LLC (ELF), formerly Hoffman White & Kaelber Financial Services LLC, cannot guarantee the success of its services. There is a chance that investments managed by ELF may lose a substantial amount of their initial value.

ELF is an independent discretionary investment management firm established in February 2003. ELF manages a strategic allocation of primarily exchange-traded index funds (ETFs), and may invest in other carefully selected securities. ELF may also employ hedging techniques, through the use of short positions and options. ELF manages individual portfolio accounts for both individual and business clients.

The ELF ETF Strategy returns presented herein represents a composite of actual results from all client portfolios managed by ELF. Currently, it is the only composite presented by ELF and separate client account portfolio positions are substantially similar, except as may be modified for retirement plan accounts and accounts with net equity of $60,000 or less. There is no minimum account size for inclusion into ELFs ETF Strategy composite and accounts with net equity of $60,000 or less have a tendency to downwardly skew the combined results.

The performance data presented herein includes the reinvestment of dividends and capital gains; as well, ELFs ETF Strategy composite returns are presented after deducting actual management fees, transaction costs or other expenses, if any. ELF charges an annual investment management fee as follows: 1.25% on the first $250,000; 1.00% on the next $750,000; 0.95% on the next $4,000,000; and, 0.75% thereafter.

Copyright 2004 ELF Capital Management, LLC. All rights reserved.