Community Foundations Consider New Approaches for Financial Stability

The Arizona Community Foundation has always known that maintaining its statewide network of 11 affiliates — run from four

regional offices — is costly. But its president, Stephen Mittenthal, says that until the foundation participated this year in an extensive cost-and-revenue study, it had no idea that those affiliates accounted for 20 percent of the foundation’s costs, while producing just 3 percent of its revenue.

The study showed that the affiliates cost the foundation about $350,000 a year more than the revenue they brought in, a sum that amounts to a subsidy underwritten by more cost-effective services offered by the foundation.

“Now we can turn to the board and say, Let’s have a heart-to-heart discussion of this issue that we’ve skirted for 10 years,” says Mr. Mittenthal, namely, how to balance the foundation’s goal of serving communities across the state with the other parts of its mission.

Many community foundations around the country are engaging in similar reviews, prompted by concerns that their current economic model — in which operating budgets rise and fall in step with their assets — may be impossible to sustain.

While most community foundations enjoyed robust growth in their budgets during the 1990s as stocks soared, budgets for many have decreased significantly in the last few years, forcing some to scale back programs or trim their staffs even as demand for the grants and programs they support has continued to grow. Meanwhile, gifts to community foundations have fallen for the past two years.

“The difficulty they are having today is a long-term issue, not a short-term issue,” says Mark R. Kramer, managing director of the Foundation Strategy Group, a consulting firm in Cambridge, Mass., that recently examined nine community foundations, including Arizona, as part of a major cost-analysis study. The findings of the study — paid for in part by $62,000 from the Council on Foundations — will be presented at a meeting of community-foundation leaders in Baltimore this month.

‘In the Middle’

Much of the recent growth at community foundations has come in the form of donor-advised funds, which can be expensive to oversee. Through such funds, people donate cash, stock, or other assets to special accounts, claim a charitable deduction on their federal income taxes, and then recommend how, when, and to which charities the money in the accounts should be distributed.

Mr. Kramer says community foundations have tried to distinguish themselves from both the high-end philanthropic advisers like the Tides Foundation and Rockefeller Philanthropic Advisers, which spend lots of time with donors but price their fees accordingly, as well as from the mass-market funds run by financial powerhouses like Fidelity Investments and the Vanguard Group, which offer no-frills service but take a low percentage of the assets as a fee.

“Community foundations are in the middle,” says Mr. Kramer, “offering more services than commercial funds do but still trying to match their fees.”

Commercial funds generally charge a management fee of 1 percent of the assets they manage in donor-advised funds, and may discount that fee further for large funds. While many community foundations have charged similar fees, the report by the Foundation Strategy Group found that overseeing such funds costs community foundations an average of 1.3 percent, or $13 for every $1,000 put into such funds. And scholarship funds, which community foundations also offer, cost even more, at 1.7 percent.

The study found, in fact, that overall operating costs among the nine community foundations ranged from 0.6 percent to 1.6 percent of their assets, while the average was 0.94 percent.

Rethinking Operations

As the financial breakdowns have become clearer, some community foundations have started to rethink their operations.

Lewis M. Feldstein, president of the New Hampshire Charitable Foundation, says he sees a major shakeup ahead. “My guess is that the management changes this leads us to will be far more profound, and will go to the soul of who we are, much more than is reflected just in the pricing.”

Within a decade, he predicts, “you could see maybe a single back office for all community foundations in the country.” He adds: “It’s nuts to have 600 different finance offices doing pretty much the same thing. It’s hard to argue that the accounting or payroll done in New Hampshire is different from that done in Tallahassee or Portland.”

Investment management is another area ripe for collaboration, Mr. Feldstein says. “This is a legacy from the past, that we all want to manage our own investments. I can see going through a whole process and saying, What’s the premium we bring by doing something locally, and in what areas are we paying a cost for it?”

Other less-sweeping options are also being explored, such as raising the fees charged to donor-advised funds or increasing the minimum balance required to open such an account. But a simple fix is likely to be elusive. A separate study of donor attitudes also conducted by the Foundation Strategy Group found that donors are very sensitive to price; most are reluctant to pay much more than the commercial funds charge, even in return for the considerably broader menu of services that community foundations typically provide. What’s more, many community foundations themselves focus on serving a wide swath of local donors and are loath to limit their services too much.

The Kalamazoo Foundation, in Michigan, for example, knows that the break-even point on its donor-advised funds is much higher than the $5,000 minimum it currently sets. But “we may end up not changing it,” says Susan Springgate, vice president for finance and administration, because the foundation’s board believes it is important to set the bar low as a way to bring in new philanthropists.

Even so, funds at or barely above the $10,000 minimum asset level required by many community foundations can be particularly costly to oversee. Mr. Kramer notes that one institution his firm examined was charging $100 (or 1 percent) to manage a $10,000 fund that actually was costing it $3,000 a year to operate. The foundation in effect was subsidizing that donor’s fund with other parts of its operations.

The Arizona Community Foundation has now raised its minimum annual fee for a donor-advised fund from $100 to $500 in an attempt to discourage the formation of such small funds. “We’ve got to be very careful, because we are the people’s philanthropy,” says Mr. Mittenthal. “But we just can’t administer a $5,000 fund economically.”

Weighing Changes

The Cleveland Foundation says it is also considering changes after learning the extent to which cost exceeds revenue for most of its products. At its December board meeting, the foundation will consider raising some of its fees, which might take effect as early as January.

The Greater Milwaukee Foundation believes part of the solution to covering costs will be to set a sliding scale for fees instead of the uniform-fee system the foundation currently uses. “We know we provide different levels of services, so now we have to stratify different levels of fees,” says Wendy Horton, chief financial officer. “We might say to a donor, You can have a small fund, but we’ll have to charge you 2 percent till you hit $50,000.”

But there are dangers in significantly raising the entry barriers to philanthropy, says Rick Cohen, executive director of the National Committee for Responsive Philanthropy. Donors who can’t afford the threshold amount miss out on the efforts community funds make to educate donors and engage them in their communities, he says. The donors may then opt for a commercial fund that doesn’t offer such services.

‘Narrow the Gap’

The Foundation Strategy Group study also highlights the importance of diversifying sources of revenue. The Columbus Foundation, for example, had been providing accounting and other back-office services free to nonprofit startups, as a way of nurturing their growth. “We’ve begun to charge a fee for that service,” says Ray Biddiscombe, vice president for finance and administration. “It’s not going to become a profit center, but it will narrow the gap caused by the use of our staff resources.”

At the Kalamazoo Community Foundation, officials have started imposing a 1-percent fee on program-related investments (investments in ventures with a charitable purpose, usually at below-market rates of return), for which it previously did not charge at all. And it is considering charging for the time donors spend consulting about investments.

But the study found significant differences among community foundations in the cost-effectiveness of the services they offer. Not all foundations, for example, lose money on donor-advised funds. The Arizona Community Foundation says it actually comes out ahead with the 1 percent it charges its donors who set up such funds. Mr. Mittenthal attributes the difference to new software that streamlines the process by allowing donors to interact with the community foundation mostly online, whether looking up information about potential grantees or submitting their grant recommendations.

“We’re running a paperless grant-making system,” says Mr. Mittenthal, who is hoping to market the software to other community funds, as well as use it to handle some of the grant-making logistics of small foundations.

The financial picture was not so good when the Arizona Foundation received a review of its scholarship funds. The community foundation learned that it was costing $65,000 a year to administer a $500,000 scholarship program for one donor (who has a family foundation), while it was charging just $40,000.

Faced with the gap between costs and revenue, Mr. Mittenthal says, “we went back to the donor and said, Here’s a list of all the costs associated with administering your scholarship fund, and we’re $25,000 short.” With the donor’s consent, the community foundation has since raised its management fee by nearly $20,000.

“The program is one of the best in the state,” Mr. Mittenthal says of the scholarship fund. “The donor loves it, the family is into it — they fly in from all over to talk with the students and have parties for them. It’s wonderful, because they really take an interest in these kids. But it all costs money.”