Part of your responsibility as a financial advisor is to assess and manage risk with respect to your clients’ financial investments. Shouldn’t the same responsibilities extend to the charitable “investments” your clients make?
As with any investment activity, when clients establish a philanthropic fund or family foundation, they’re investing with expectations of a return — the difference being instead of a financial return on investment (ROI), the philanthropic return is measured in social or environmental impact. Maximizing the potential of that return means managing or navigating risk associated with that philanthropic investment, and more specifically, impact risk — that is, events that could negatively affect the intended impact of a project. Working with your clients to maximize the ROI of charitable giving by managing impact risk is not only a role a financial advisor can play, but also one that the advisor should embrace and emphasize.
Need for Risk Management
Every year billions of charitable dollars are at stake because the philanthropic sector lacks an appropriate risk management practice. Despite data that shows about one in five philanthropic projects hit unexpected roadblocks and require contingency resources, neither funders nor grantees talk about what could go wrong, and only a small minority of funders budget for those needed contingency resources. Without planning for or managing risk, there’s a significant chance that the philanthropic investments you facilitate on behalf of your clients will yield no return — or worst case, a negative return — without additional intervention. Knowing those odds ahead of any investment you might make, regardless of sector, wouldn’t you want to plan for risk?
Four Tips
In 2016, I participated in a coalition of nonprofit leaders and advisors — The Commons — to develop a Risk Management Toolkit for philanthropic investing. Drawn from The Toolkit, the following tips can help you and your clients plan for and manage risk to maximize the desired return: impact.
1. Establish a Risk Profile
A critical first step in grantmaking is establishing risk appetite. Whether your client is new to philanthropy or has a well-established family foundation, it’s important to have a conversation to better understand the level of risk the funder is willing to take to achieve the desired impact. For example, a funder may be more comfortable investing in a tried-and-true model to alleviate food insecurity and expect average returns on that investment. On the other hand, another funder may want to invest in innovative food security programs that, because untested, are riskier investments, but if successful could have exponential impact. Understanding how your clients define and perceive risk from a cultural and operational perspective will not only help their foundation mitigate undesirable risks, but also will help clients better leverage their investments and achieve outsized impact in return.
Once you understand a foundation's risk appetite, you should help the foundation formally articulate it in a risk profile statement — just like we do on the financial investments side of our work (typically through an Investment Policy Statement). Describing the amount of risk an organization is willing to take is helpful for internal operations and, if shared with external stakeholders, a risk profile statement can signal to potential grantees whether or not their work aligns with a foundation’s mission. Risk profile statements can be specific to different kinds of risk — financial risk, reputational risk, governance risk and impact risk — but while the former describe risks to the foundation, it’s impact risk that can most directly affect ROI.
2. Grantmaking Budget Should Plan for Contingencies
Despite what we know about the likelihood of a project hitting an unexpected roadblock, few foundations actually set aside contingency resources. While the size and scale of contingency funding will depend on a donor’s risk profile and investment portfolio, it’s important that organizations have resources available when grantees hit an unexpected obstacle so that major programmatic goals aren’t missed and the initial resources invested in that project aren’t wasted. This is very similar to the way many venture capital funds keep some capital set aside for when their portfolio companies might need follow-on capital or they need to make a cash infusion to help try to prevent an investment from failing.
Once a contingency fund is established, it’s important to review on an annual basis if the resources you set aside were sufficient. Understanding how, when and why contingency funds were or weren’t used can help surface patterns from which internal best practices can be established and translated into policy.
3. Build Risk Into Bylaws and Processes
Research has found that 76 percent of funders don’t ask about what could go wrong in requests for proposals and grant applications. And if funders don’t ask, grantees won’t tell. Raising the topic of risk in the application process by including a risk profile statement and asking potential grantees about what could go wrong with a project can help foster a transparent exchange between a foundation and applicant from the outset.
Beyond the application process, integrating risk into the governance and operations of a foundation more broadly will ensure that the organization is equipped to deal with risk and contingencies in a timely manner when an obstacle or opportunity presents itself. Who makes the decisions around deployment of contingency resources? How much is budgeted for contingencies? How is the capital deployed in a timely manner while aligning with existing policies? Making sure that the bylaws of a foundation incorporate risk management protocols will help to put risk culture into practice.
4. Foster Transparency in Funder-Grantee Relationships
Essential to ensuring effective impact is the donor-grantee relationship. One of the greatest barriers to successful risk management in philanthropy is a lack of transparency and trust between funder and grantee. Funders are in a unique position, however, to foster an environment where nonprofit partners can be transparent about what might go wrong with a project so that, together, a funder and grantee can mitigate risk and work towards their shared goal.
Encourage your philanthropic clients to lead by example by talking openly about their risk profile with potential grantees. They should ask potential grantees the hard questions about what could go wrong, and ask what opportunities there are for outsized impact. Funders should be accessible if grantees encounter a roadblock and need contingency funding and, most importantly, be empathetic to and realistic about the challenges of nonprofit work.
Without bringing grantees in as equal partners by fostering trust and transparent exchange, we’ll fail to properly manage risk and, in turn, we’ll fail to attain the desired impact from a meaningful portion of the billions of philanthropic dollars “invested” every year.