Philanthropy
GUEST ARTICLE: Ten Advantages Of Private Foundations Versus Donor-Advised Funds
This article by the chief executive at Foundation Source, Robert Chartener, outlines his thoughts on the key advantages that private foundations have over donor-advised funds.
(A donor-advised fund is administered by a third-party to manage the charitable donations on behalf of an organization, family or individual.)
Many advisors recommend a charitable vehicle for their philanthropic clients as part of an overall wealth management strategy. And for many advisors, the default recommendation for high net worth individuals and families is often a donor-advised fund (DAF). After all, they’re quick to set up, simple for the client to use, and require minimal ongoing effort to manage.
Although DAFs are a great option for many, a private foundation could be a better choice for some. Unfortunately, a private foundation is often dismissed out of hand because advisors may believe that they are inherently expensive, complicated, and time-consuming, both to set up and to manage.
Unless the client is going to fund it with at least $5 million, many contend it just doesn’t make sense. That was true 20 years ago, but not today. Times and private foundations have changed. Private foundations can be established quickly, with as little as $250,000, and, thanks to the advent of out- sourced management firms, are as easy to administer as a DAF but with some potentially important advantages.
Here are ten:
1. A private foundation is a legal entity controlled by the founder, not a giving account that’s housed and controlled by a public charity.
Among high net worth individuals, maintaining control of their hard-earned assets is a common priority. Happily, private foundations provide them with complete control. Unlike a donor-advised fund, where donors cede control when they deposit funds into their giving account, a private foundation is a freestanding legal entity that’s 100 per cent controlled by the donor. This is an important concern for clients who want to choose how the money is invested and where it is custodied, and it is a significant differentiator between private foundations and most DAFs. You and your client decide how the money is invested—not the board of another charity.
2. Your client can fund the private foundation with a wide array of assets.
Private foundations can own nearly any type of asset, including partnerships, real estate, jewelry, closely held stock, stock options, art, insurance policies, and other valuables. A donor-advised fund may limit investment options to cash equivalents, publicly-traded securities, and shares of mutual funds. Donations of real property and other non-marketable securities typically are sold or liquidated by the sponsoring organization.
For certain clients, these differences might be extremely
important. Let’s say that your client owns a warehouse worth
several million dollars. She could establish a private foundation
and donate
the warehouse, which could then be earmarked as a charitable
asset to further her philanthropic goals. If she loves art, she
could turn the warehouse into a community meeting place for
artists and art lovers with revolving art installations on
display. And because the foundation is using the warehouse for a
charitable cause, it isn’t subject to the 5 per cent required
minimum distribution. That’s meaningful considering the
property’s value. Alternatively, because private foundations may
hold tangible assets, your art-loving client could donate a
painting from her collection that would then be displayed in or
rented out to a museum. This would constitute yet another
charitable use.
3. Setting up a private foundation is now as fast and easy as a donor-advised fund.
For a very affordable fee, Foundation Source can set up your client’s foundation in as little as three business days. And once the foundation has been established, we process grants, monitor activities for potential compliance issues, and handle all required state and federal filings. We even provide a customized, secure, online “command center” so your client can collaborate on foundation activities, see all of the foundation’s activities in one place, enter grants online, and track the foundation’s progress toward its 5 per cent minimum distribution requirement. In practical terms, this means that your client provides the funding; you manage the assets; and we handle everything else.
4. The entry point is much lower than it used to be.
Until fairly recently, the operating costs of a private foundation made them impractical for any client with less than $5 million in funding. However, the economies of scale afforded by technology and outsourcing have dramatically lowered the costs of running a private foundation. It now makes sense to start a foundation with as little as $250,000 in initial funding. In fact, 67 per cent of all private foundations have less than $1 million in assets.
There are many reasons why donors might choose to “start small” with a private foundation. Increasingly, we’ve seen foundations being set up by donors who want to take an active role in their philanthropy rather than leaving a large bequest. These individuals often add to their foundations over time as they learn more about philanthropy. Others decide to start small to test out their family’s interest before funding the foundation in full.
5. Your client can be reimbursed for expenses incurred while carrying out foundation activities.
Foundation members may pay for reasonable and necessary expenses associated with running the foundation. Expenses that can be reimbursed by the foundation include board meetings, administration, site visits, travel expenses, and even costs associated with starting the foundation. As long as expenses help achieve the foundation’s charitable purpose, they count toward the foundation’s 5 per cent minimum distribution requirement. With a donor-advised fund, there is no option and no means of reimbursing legitimate charitable expenses.
6. Foundations enjoy a world of giving options.
Gifts from a donor-advised fund are typically restricted to
straightforward donations to US-based
501(c)(3) public charities. Private foundations provide many more
avenues to achieve the donor’s philanthropic goals, including:
• Making grants directly to individuals and families facing
hardship, emergencies, or medical distress;
• Supporting organizations based outside the US;
• Making loans, loan guarantees, and equity investments;
• Providing funding to for-profit businesses that support
the foundation’s charitable mission;
• Setting up and running scholarship and award programs;
and
• Running their own charitable program.
7. Foundations are entitled to hire staff, including family members.
State and federal regulations allow foundations to pay a salary to those who provide services to the foundation—even family members—as long as these individuals are qualified for the position, the compensation is reasonable and necessary, and the foundation follows the rules governing compensation to insiders. (Foundation Source provides an optional compensation benchmarking service for its client foundations.) Hiring and compensating staff is not an option with a donor- advised fund.
8. Your client can negotiate and enforce grant agreements.
It’s commonplace for private foundations to enter into an agreement with their grantees setting forth the purpose, terms, and conditions of their grant, with subsequent grant payments often tied to benchmarks of progress. Donor-advised funds offer no such option, so your client ultimately has little control over how the grantees use their funds. If your client intends to make major gifts, this differentiating factor could be critically important.
9. Your client’s name is on the check and he or she can hand-deliver it.
Creating a family legacy of giving is one of the rewards of philanthropy. With a private foundation, it is the name of the donor’s foundation, often the family name, that’s at the top of the grant check, providing well-earned recognition for the financial support that keeps non-profits going. And if your client prefers to personally deliver a grant check to the organization, be it a fundraising event or a recognition dinner, that’s easy to do with a private foundation. However, it’s simply not an option when giving through a donor-advised fund because the donor is not an agent of the sponsoring organization and therefore cannot be given control over the execution of grants.
10. A private foundation unifies a family.
Although donor-advised funds often tout their ability to unify families through shared philanthropic activity, their structure, which permits any named advisor on the account to make recommendations on their own initiative, is somewhat at odds with that objective. However, because all private foundations have boards, they are inherently collaborative enterprises that promote togetherness and provide a reason to meet and converse, even if family members are geographically dispersed.
Private foundations also serve as excellent forums for transmitting values, establishing altruistic behavior, and imparting valuable business skills, making them ideal for training the next generation for the responsibilities of wealth. Younger family members may be directly engaged in the governance, decision-making, and day-to-day activities of running the foundation. Through this active participation, they acquire skills in financial management, leadership, communications, teamwork, and planning. They also develop character and drive, inoculating children from the “affluenza” that many parents of means fear as a consequence of their own success.