Delayed charitable donations – a new paradigm
Updated: Nov 10, 2020
I want to discuss a new way that charities could raise significant amounts of money beyond the means used today. You might call this a new paradigm, a new formula if you like, of how charities can raise money.
To start, let's review the two primary ways charities raise funds now:
The first way charities raise funds is by donors giving charitable donations each year. Donors scrape together what they can donate each year for the charities they support. Charities spend carefully to maximize the benefits delivered to society.
Each year charities solicit donations and assess what they have to spend. Some of the funds raised are used for fundraising as a necessary cost to sustain the charity.
The second way charities raise money is when donors give a substantial principal sum to a charitable foundation. When a donor provides significant amounts to a foundation, it is to spread philanthropic contributions over time. Donors hope their gift will generate income and thus continue as their legacy to support the charity perpetually.
The charitable foundation invests collected monies to earn annual income, dividends, and capital gains. The foundation then gives a portion of its yearly earnings to one or more supported charities each year.
The usual convention is to provide around four percent portion of the principal amount each year. The amount of four percent permits the principal amount to stay intact and grow enough to keep up with inflation. The foundation can thus fund charities without dipping into, or diminishing, the principal.
The charity receiving this money saves on fundraising costs and can budget more consistently. The foundation evens out the abundant and the lean years of fundraising. Foundations give charities a more or less permanent and hopefully growing source of funding. Significant growth comes from gathering in more donations.
Similar principles apply to private foundations, endowments, and other mechanisms, which are not discussed here for simplicity.
A New Paradigm:
Now let discuss a (sort of) new third model for raising money. It goes like this:
Money is set aside by a donor for giving to a charitable foundation. However, in this new model, the foundation does not immediately receive the funds. The money instead goes first to an independent party to invest the funds.
Over time the invested funds grow to reach a target value. At that target value level, the foundation receives the donation from the independent party. The foundation will then perform its usual function by funding charities sustainably with annual earnings of the principal amount.
I say 'sort of' a new model because this model is very similar to what donors to charitable foundations already do today. Today donors first save up money from some combination of earned wages, business profits, or investment returns. When the funds reach the target sized amount, the foundation receives a donation. The 'independent party,' in this case, is the donor's own savings account.
The limit to the size of a foundation is the amount the donors can give. Donors are limited by how much they have saved. Donor's savings, in turn, are primarily limited by the amounts invested and especially how many years the funds invested were able to grow.
Foundations are given large sums of money saved by the donors for many years, sometimes over their entire life. Foundations actively solicit consideration via Last Wills to receive funding when donors' estates are distributed.
This new model proposes to use an independent party to extend the growth period of the donor's investment beyond the donor's lifetime. Given enough time, a gift of any size can grow to enormous sums.
Let's examine a hypothetical example:
Donor A gives one hundred thousand dollars as part of his or her estate to a Charitable Foundation A. This foundation, in turn, invests the principle money and annually gives Charity A four percent of the principal, or four thousand dollars per year.
(See Table 1 below)
Donor B allocates ninety thousand dollars to Charitable Foundation B. Donor B also gives ten thousand dollars to an independent party, we'll call "Seed Funding Corporation B."
Charity B receives four percent from the ninety thousand dollars or three thousand six hundred dollars per year from Charitable Foundation B.
(See Table 1 below)
Seed Funding Corporation B grows their ten thousand dollars at just over five percent a year, and at the end of forty-six years amasses the equivalent in today's dollars of one hundred thousand dollars. This amount remains invested a further fourteen years doubling to two hundred thousand dollars.
After sixty years, Seed Funding Corporation B donates one hundred thousand dollars to Charitable Foundation B, which in turn raises the annual funding of Charity B by a further four thousand dollars per year. The remaining one hundred thousand dollars with Seed Funding Corporation B continues as an investment to double again and again.
Repeating in this manner, Seed Funding Corporation B supports a further donation of one hundred thousand dollars to Charitable Foundation B every fourteen years, which in turn can increase funding to Charity B by an additional four thousand dollars per year every fourteen years.
At one hundred years, Charity B is receiving nineteen thousand six hundred dollars per year – in today's dollars - with a further expectation of growth of an added four thousand dollars a year every fourteen years.
Charity A has in total received four hundred thousand dollars over the one hundred year period, while Charity B has received seven hundred and sixteen thousand dollars a difference of over three hundred thousand dollars.
By extension, at the end of two hundred years, Charity A has received eight hundred thousand dollars in today's dollars, and Charity B has received four million one hundred and twenty thousand dollars or greater than three million dollars more than Charity A.
Charity B, for the first sixty years, only has ninety percent of the donations that Charity A receives. However, since both donations are effectively net new money to each charity, they can budget accordingly without creating undue hardship. The largest deficit is highlighted in yellow on the far right at twenty-four thousand dollars in year sixty.
The potential is exciting for donors to be able to make a growing difference using an independent party for raising charitable funding. And though not used today, this approach has been used before over a two hundred year period by none other than Benjamin Franklin.
I have a lot of questions to guide my investigations:
How likely are the assumed rates of return on invested capital?
What is the nature of this proposed Seed Funding Corporation?
Is there a faster way to do this?
What are the tax implications?
What can we learn from Benjamin Franklin's enterprise?
What do you think? What questions do you have?