Risk is the likelihood of an undesirable outcome. Every action includes an element of risk.
Philanthropy is no exception to this rule. In fact, charitable donations — because they seek to solve seemingly intractable problems — are often referred to as society’s ultimate “risk capital.”
Risk and return analyses are important considerations when making any investment decision. In the context of philanthropy, this includes grants as well as impact-investing decisions that seek social as well as financial returns.
“Philanthropy should be taking much bigger risks than business,” said philanthropist Bill Gates. “If these are easy problems, business and government can come in and solve them.
An important new report has developed a framework for understanding and valuing the role of risk in contemporary philanthropy. The Open Road Alliance, The Rockefeller Foundation and Arabella Advisors collaborated on “Risk Management for Philanthropy – a Toolkit,” which is described as “the first practical, comprehensive framework providing guidance to funders on how to implement best practices in risk-management.”
Report findings are based in part on a survey of 200 donors and 200 nonprofits. The report looks at risk in philanthropy through two distinct lenses.
What is your appetite for risk in philanthropy?
The first lens asks donors to subjectively assess their own appetites for risk-taking in order to determine the risk culture in each donor’s family, foundation or business. Donors are encouraged to answer a series of suggested questions and engage in recommended exercises to ascertain their own risk-tolerance level. These include:
- How do we define risk in philanthropy?
- Are we more concerned about losing money, losing face or losing opportunities for great impact?
- Do we prefer to invest in innovative or tried-and-true methods?
- What is an acceptable failure rate?
- How often do we discuss risk management, failure, and the trade-offs between risk and reward?
The authors of the report are neutral as to whether a donor’s risk-tolerance profile should be high, medium or low.
In order to be an effective, strategic grant-maker, however, it is important to determine where on the spectrum a donor sits — and then to donate accordingly.
Management and mitigation
The second lens is focused on risk-management and mitigation. The referenced survey revealed that the success of one in five philanthropy projects is jeopardized by the occurrence of unexpected events. Only 17 percent of donors, however, set aside any funds for project contingencies. During the application process, 76 percent of donors fail to ask potential grantees about possible risks to the project.
The varied risks inherent in the grant-making process include:
- Financial risk. Could the donor lose money?
- Reputational risk. Could the donor lose face or suffer embarrassment?
- Governance risk. Could events affect compliance with legal, tax or good-governance practices?
- Impact risk. Could events (political, social, environmental or logistical) derail the hoped-for impact of the project?
Prudent risk-management practices for potential projects include risk-assessment, efforts to mitigate predictable risks, contingency planning for risks, and risk monitoring. Each practice requires critical internal and external communication.
At the outset of a potential funding relationship, discussing risk factors with grantees helps prepare for the future and signifies an important dynamic for the grantor/grantee relationship.
In my September 2016 column, “Rethinking and revising the Donor Bill of Rights,” I wrote that the most effective grantor/grantee relationships occur when both parties consider them to be partnerships to achieve common missions. The strength of any partnership depends on communication, including communication about risk. This report offers many suggestions about how and when donors and grantees should communicate about risk-related topics.
A certain amount of risk taking lies at the heart of all philanthropy. A clear understanding of risk tolerance and risk management when making grants is a key element of strategic philanthropy. This important new analysis will inform the conversation about risk and encourage wiser actions by grantors and grantees alike.