Expanding Your Comfort Zone: 5 Windows Into Risk in Family Philanthropy (Passages excerpt)

Philanthropy is often described as society’s “risk capital.” Our generosity can support causes and ideas that business and government agencies cannot or will not. We can use our resources to inspire new ideas, challenge existing thinking, or continue supporting an organization when others won’t.

However, the idea of risk in philanthropy quickly muddies as we direct our generosity through a family foundation, donor-advised fund, or other collective effort. Our ideas about and tolerance for risk diverge, shaped by individual, family branch, professional, and other experiences.

And, our own brains trip up our thinking about risk and even discourage us from discussing it. This post is a short introduction to NCFP’s new Passages Issues Brief, “Expanding your comfort zone: A window into risk in family philanthropy,” by NCFP consultant and author Tony Macklin. In the full board discussion paper you’ll learn how generous families can assess philanthropic risk, tame and mitigate risk, and even expand their comfort zone to embrace uncertainty. This paper also should be helpful to other types of grantmaking committees and their staff members.

“Philanthropy thrives on risk. It is risk that fuels our grantmaking engines, pushes us uphill, leads us in new directions. And yet risk also terrifies most foundation executives and boards.”

– Bill Somerville, Founder, Philanthropic Ventures Foundation,
in “Grassroots Philanthropy”, 2008

Five Windows into Philanthropic Risk

Too few families and foundations have a common framework for discussing risk. The framework below outlines five common, interrelated types of risk that affect philanthropic decisions. The framework is based on research into a variety of resources on risk in the business and philanthropic sectors and on human and organizational behavior.

NOTE: A more detailed version of the framework, along with a special new Featured Search on the topic of Taking Risks in Family Philanthropy, is available in the NCFP Knowledge Center.

No person will worry about all of the types of risk and few, if any, organizations will have the desire to delve into every type. However, it is easy to forget that each person’s comfort zone around risk may be based on personal and professional experiences very different from yours.

This framework can serve as a conversation tool to help your family or organization explore the risks most relevant to your philanthropy. The following are brief windows into the types of risk, along with suggested resources for exploring them further.

1. Personal Risk Profiles

Each of us acts and makes decisions in ways that are anything but rational. Our mental shortcuts and hidden biases lead us into making poor decisions and bad judgments. These cognitive biases, and the broader field of behavioral economics, have become more well-known through a growing number of books, magazine articles, TED Talks (including this talk by diversity advocate Verna Myers), podcasts, and more.

Cognitive biases unconsciously influence how we look at the world, including how we assess risk in our philanthropy. Common biases include:

• Expert or overconfidence: we are typically overconfident about the information we have, and the more we see ourselves as an expert, the more overly confident we become.
• Availability: we misdiagnose a problem because we give more meaning to recent, vivid examples and to personal examples.
• Confirmation: we seek information that confirms our existing beliefs and opinions, and we downplay or ignore data that refute them.
• Escalation of commitment or “sunk costs:” we tend to stay committed to existing investments and ideas, even when new data tell us that other options are better.
• Loss aversion: we dislike losses more than we like equivalent gains. Related is the “endowment effect” in which we place a higher value on an asset we own than we place on an identical asset we don’t own.
• Regret aversion: we tend to avoid making decisions because of our fear of unfavorable results. Our fears of taking an action that results in failure outweigh our fears of passive failure. These fears lead to a default emotional attachment to the status quo.

We are especially susceptible to these biases when we’re stressed, tired, under time pressure, and/or multi-tasking. How many of us are completely free from those problems at a family meeting or on a grantmaking committee phone call?

Our cognitive biases influence our default decision-making styles. Some people have a higher tolerance for ambiguity than others. Some rely on quiet, internal reflection while others reach decisions through conversation or even vigorous debate. And some rely on quick, intuitive gut checks while others seek a lot of facts and proof before reaching a decision. To reduce our aversion to loss and regret, we may seek more information as a delaying tactic to avoid making a decision.

2. Organizational Risks

A family’s culture is built on shared values, norms, traditions, and ideas around conformity. All of the elements of personal risk contribute to those values and norms.

The family’s culture informs the culture of its organized philanthropy, as do the norms, traditions, and values of any staff hired. The organizational culture, in turn, influences the behaviors and attitudes of everyone participating in it.

Philanthropic families often document their values and traditions and then translate those to their philanthropic organizations. But families don’t often explicitly discuss risk as part of the family or organizational culture.

McKinsey & Company defines an organization’s Risk Culture as:

“The norms of behavior for individuals and groups within an organization that determine the collective ability to identify and understand, openly discuss, and act on the organization’s current and future risks.”

Family culture and organization culture are topics larger than this short article can address. However, the sidebar at right provides an initial set of questions to discuss risk culture within the family and/or a family foundation.

Organization-level risk also involves risk to its:

• Reputation: the credibility, legitimacy, and respect it has among its constituencies and communities; and
• Brand: the unique promise it has made to its customers—its unique value-add—and the positive or negative emotional attachment the customers have to that promise.

Accountants call these ideas ‘intangible assets,’ but any risk to them can feel very tangible to family members. Multi-generation families may worry about protecting a vision of family legacy, which could also be intertwined with the legacy of a family business. A long-standing foundation may be cautious about damaging its reputation and brand when those assets helped it attract key partners and resources to a favored cause. And, a family may feel its reputation is enhanced by supporting a well-known museum or college, even if the institution isn’t as successful or relevant as it once was.

3. Strategy Risks

The third type of risk is connected to a foundation’s or family’s philanthropic strategies—its grantmaking programs, leadership initiatives, and other means of making a difference. In its 2011 common risks report, Risk and Philanthropy, the Resource Alliance defined strategic risk as “the risk of not having an accurate strategic perspective on the social problems at hand.” The philanthropists interviewed for the report identified three issues that created risk and uncertainty in planning their giving strategies:

• The difficulty in defining impact;
• The difficulty in choosing the most effective innovation or intervention methods, especially at the beginning of a strategy; and
• The difficulty in establishing meaningful metric

The philanthropists also identified common risks in implementing their giving strategies. These included: selecting the appropriate business model for their giving, diversifying risk in their own mechanisms for portfolios of grantees, finding mechanisms for sharing risk with other donors, and building sufficient trust in grantees.

In Give Smart, Tierney and Fleishman describe strategic risk as:

“[T]he risk that your efforts will come to naught; that the resources you have invested either fail to generate any results whatsoever, or that the results are, at best, unsatisfactory.”

They suggest that a donor assess his or her appetite for strategic risk on three scales (e.g. from 1-10):

• Scale: the level of resources you intend to commit and/or the magnitude of success you hope to achieve;
• Complexity: the inherent difficulty of your theory of change, including the impact of external risks; and
• Uncertainty: the level of confidence in the key assumptions underpinning your theory of change.

Tierney and Fleishman also caution donors and foundations to consider “secondary risks” of their grantmaking strategies. How would unsatisfactory results or failure affect the lives of the staff of grantees? How would those same results affect the lives of their beneficiaries?

4. Grant or Investment Risks

This type of risk is likely the most discussed in philanthropy. For both grants and investments, it revolves around issues of due diligence, performance monitoring, evaluation, and opportunity costs.

Accounting, insurance, and other professionals may raise questions about enterprise risk management (ERM) when reviewing nonprofits, social enterprises, or potential investments. This view of risk management deals with issues such as ethics and fraud, financial controls, compliance concerns, and business continuity.

Most foundations look at factors other than enterprise risk in their assessment of potential grantees and investments. The due diligence, monitoring, and evaluation practices of philanthropic families and foundations vary widely. Each family tailors those practices to its values and interests, individual and family views on risk, and the size and types of grants or social investments the family makes.

John Bare, Vice President of The Arthur M. Blank Family Foundation suggests a three-part picture of risk in due diligence and evaluation:

• Idea risk: What is the idea’s track record and the logic connecting the activities to a desired result?
• Implementation risk (also called execution risk): How likely will the organization reach its goals given its capacity and connections and given the complexity of the problem and solution?
• Evidence risk: How hard is it to detect the results and how hard is it to attribute them to the grant?

The Foundation Center sponsors two online resources, GrantCraft and IssueLab, which provide guidance on due diligence, site visits, grant monitoring, and evaluation criteria and processes. If you are interested in more deeply assessing risk in grantees and grants, these guides are a great start:

• The Due Diligence Tool for Use in Pre-Grant Assessment and Due Diligence Done Well: co-published by La Piana Consulting and Grantmakers for Effective Organizations. Both guides help in identifying risks and red flags in an organization’s track record, governance and leadership, vision and strategy, financial health, and more.
• The Little Blue Book: NPC’s Guide to Analysing Charities: published by New Philanthropy Capital. Though written for United Kingdombased funders, the guide provides good questions for assessing risk in any nonprofit’s activities, results, leadership, people and resources, ambition, and more.

Individuals and foundations who apply an investment approach to their philanthropy may also attempt to assess opportunity cost—the risk of making a grant today that has lower impact in the future than projected, and that ends up being a worse choice than the grant not made.

5. External Risks

External risks are factors beyond your foundation’s direct influence or control. Unlike many personal, strategy, or grantmaking risks, external risks are not preventable and often can’t be avoided. Common external risks affecting a philanthropic strategy or set of grants include:

• Dependencies: potential problems with partners, supply chains, and other logistics upon which grantees rely to deliver their services.
• Economic: local, national, and global shifts, either gradual or sudden (e.g. the U.S. financial crisis in 2008 or a revolution in a third-world country).
• Environmental: short-term weather patterns, mid-term natural disasters, and long-term climate change.
• Political: changes in public will, political will, administrative policies, laws, and elected officials.
• Sector: changes to the stability of a sector (e.g. performing arts or community development corporations) and the potential threat of competitors or disruptive technologies.

Experts on risk recommend that organizations use scenario planning techniques to assess the most likely external risks and then create contingency plans for those risks.

Special thanks from the author

This Issue Brief originated in the planning of a session with the same title for NCFP’s 2015 National Forum on Family Philanthropy. My sincere appreciation goes to John Bare (Arthur M. Blank Family Foundation), Laurie Michaels and Maya Winkelstein (Open Road Alliance), Lenore Hanisch and June Wilson (Quixote Foundation), and Anne Hudson (a friend and member of a family foundation), all of whom helped to shape the ideas on risk and 5-part framework. John also wrote a blog post with a similar title for NCFP, Laurie and June spoke at the session, and Lenore brought high-end donuts to attract people to the session. Donuts are never a risky bet.