Establishing a Foundation
/With the ease of setting up a donor-advised fund and the flexibility associated with philanthropic LLCs, both of which are increasingly common among the ultrawealthy, will today’s donors continue to set up new private foundations? Should they? While the terrain has changed and new options are available, there remain compelling reasons for donors to consider setting up a private foundation, and major new foundations are announced every year.
A foundation is classified as private when it receives less than one-third of its support from the general public (as is the case with community foundations, giving intermediaries and fundraising public charities like the Michael J. Fox Foundation for Parkinson’s Research). Sometimes, insiders consider foundations whose boards are composed of nonfamily, professionalized members as “private” foundations (like Ford Foundation), distinct from “family” foundations. But for the purposes of this guide, a private foundation is simply one endowed by a particular family’s or company’s wealth, whether the folks establishing it chose board members who are all family members or not.
A private foundation is a 501(c)(3) charity, and like any nonprofit, requires serious administrative attention that is not to be undertaken lightly. But establishing a private foundation also communicates a donor’s long-term dedication to philanthropy. For these and many other reasons, some donors find that setting up a private foundation is the right choice.
What Does it Take to Set Up a Private Foundation?
Foundations take work. They are subject to government regulations, and there is significant paperwork and administration required. If you establish a foundation, you’ll need to decide who is going to do this work. Larger foundations are often operated by professional staff. For a smaller foundation, you might consider doing the work yourself or within the family, or outsourcing to a foundation management company like Foundation Source. However you do it, running a foundation will cost time and money.
Foundation Source advises that it used to take $5 to $10 million to make it worth setting up a foundation, but with services like theirs, running a foundation is easier and less expensive, and it can be practical to start a foundation with as little as $250,000.
A wide range of financial or legal advisors can help prepare the necessary government paperwork to obtain 501(c)(3) status and register with state charity officials. As with DAFs, you get a tax deduction when you make contributions and can then give to charities over time.
A foundation has to pay out at least 5% of the fair market value of its assets every year. This 5% includes both grants and the foundation’s operating expenses. A foundation can be set up to exist in perpetuity or to spend down by a certain date. Private foundations are exempt from federal income tax, but do pay a 1.39% excise tax on assets annually. Foundations arerequired to disclose all grantees and grant amounts in a yearly 990-PF form. The IRS prohibits self-dealing, or personal gain, from foundations.
You can establish a foundation and also have a DAF and/or an LLC. You can also just write checks directly as an individual. But keep in mind that giving as an individual and giving from the foundation are not the same thing, and it’s important to keep the lines clear.
Pros and Cons
Even if a donor makes their foundation a time-limited operation instead of existing in perpetuity, creating a private foundation is inherently a long-term commitment, and that’s at the heart of its appeal for many donors who want to leave a legacy. Here are some of the tradeoffs associated with establishing a private foundation:
Commitment to distributing funds. Unlike DAF accounts, in which you can legally let the principal grow without ever distributing any charitable funds, private foundations are not a parking lot. Private foundations must give at least 5% of the organization’s average fair market value of assets held for investment annually toward the foundation’s declared charitable purpose. Funds used to further the exempt purpose of the private foundation — salaries, travel, etc. — qualify toward the annual giving requirement.
Full control over giving. Donors have more control with a private foundation than with a DAF. With a DAF, you recommend grants, but the host institution has the right to reject your recommendations. (It’s not that common, but it can happen.) With a foundation, youcan have more decision-making power, including the power to hand over grantmaking decisions to a board that you select, or to others. In addition to giving to other qualified charitable organizations, private foundations allow for the contribution of funds directly to individuals in need, using dollars previously deducted for tax purposes by the donors. A foundation can provide scholarships and make grants directly to individuals. Private foundations can give to 501(c)(4) organizations (social welfare organizations often associated with issue advocacy and political organizing), whereas most DAF managers prohibit giving to such organizations. Like all nonprofits, private foundations must have a board of directors of at least three people, which means an individual donor in theory gives over some control to two other people. But many donors designate their spouse and lawyer as the other board members, and living-donor foundations in practice follow the directions of their founders.
Full control over assets. A foundation also gives you more control over how to manage the investment of your endowment. With a DAF, the fund manager does this, though you can often choose between a few portfolios they offer. If you are keen to directly manage your investments or to hire investment managers yourself, a foundation might be the way to go. With a foundation, you’ll have more options for impact investing, including providing loans. In addition to impact investing with the foundation’s corpus, you can use program-related investments (PRIs) in the form of loans, loan guarantees and equity investments. These can get a return on investment, either through repayment or return on equity, and they can be recycled into the foundation’s philanthropic capital for your charitable causes.
Lasting Legacy. Establishing a private foundation can create a legacy beyond your lifetime, even beyond your grandchildren’s lifetimes. Most foundations are set up (or assumed to operate) in perpetuity, and because their assets grow over time, the name of the foundation can burnish a family’s reputation for decades or centuries into the future. Today’s positive public perceptions of the names Rockefeller and Carnegie run counter to their contemporaneous reputations as robber barons. And, as Foundation Source notes in its promotional materials, “because gifts are made from an endowment that generates investment revenue, the total gifts made by the foundation over time can far surpass the initial funding.” That means your family wealth could continue making social change many generations into the future.
Increase family connections. Although a private foundation board can be composed of outside experts or really anyone the founder wants, many donors use foundations as a way to bring the family together around giving. As more wealthy families are separated by geography, family foundations can provide a purpose to bring board members together. One frequent criticism by philanthropy reformers is the practice of family foundations paying travel expenses of wealthy family members, but this is probably also a benefit that many are happy to use. It is also extremely common for family members to serve as paid staff of the foundation, which similarly is oft-critiqued, but clearly a plus for some families of wealth who believe their socially engaged and smart kids are best employed to carry out their charitable giving legacy. More generally, foundation meetings and grantee site visits can provide families more opportunities to get together and share how to make a difference in communities.
Decrease anonymity. A private foundation must file a 990-PF form annually, which includes reporting on the names and amounts given to nonprofits. That becomes public information and appears on sites like Candid. That has pluses and minuses. It means grantseekers may try to connect with your foundation, and it also means that the giving priorities of your foundation are open to public scrutiny. But this obligation also means that you are contributing to public knowledge of philanthropy and how those with wealth are doing good with their resources. If total anonymity is your goal, a DAF is a better option.
Increase connections in the donor community. Many people who start private foundations join — or encourage their foundation staff to join — funder groups like regional associations of grantmakers or issue-based affinity groups to coordinate with other funders, learn about their funding areas and form relationships with other donors. Organizations like the National Center for Family Philanthropy, Northern California Grantmakers and Grantmakers for Education are just a few of the dozens of organizations serving the needs of foundations.
Time and Expense. Even if you hire legal help or hire staff for grantmaking and administration, a private foundation will still require your attention to remain in compliance with laws related to private foundations. Like any nonprofit, foundations should keep regular meeting minutes, especially where grant and investment decisions are made. Tax filings required by the IRS and most states require four to eight hours for an accountant or attorney to complete each year (according to one law firm specializing in helping foundations).
Run charitable programs. Most foundations primarily operate to give grants, but private foundations can also create and manage their own charitable programs that permit foundations to directly fund and carry out their own projects. This could mean direct service operations like providing meals to vulnerable families or it could mean funding convenings of grantees to increase collaboration in a field where more partnerships could lead to greater impact.
Evolving mission. The founding documents describing the mission of a private foundation can be very specific (these often don’t age well) or broad (which can lead to perceived mission drift). Setting up a foundation in perpetuity means that 100 years later, the board of directors of the organization will be directing funds to activities you couldn’t possibly have envisioned, for better or for worse. Maybe you’d like your name associated with the social change of that era, or maybe you’re afraid the board chosen by future board members won’t hold your values. Setting up a foundation that will outlive you might require an evaluation of your own need for control into the future.
Taking Action
Establishing a private foundation is not a hugely complicated affair, but most donors will want to enlist the help of a CPA, lawyer or other advisors. But don’t hand over all the thinking to others.
Think about your philanthropic goals. How would establishing a foundation help you reach those goals? Could you reach those goals with a simpler structure, like a DAF, or simply writing checks, or a more flexible vehicle like an LLC? Or is a foundation the best vehicle for you? How do the pros and cons of setting up a foundation versus other types of philanthropic vehicles translate to your priorities?
Think about family and board composition. Think about your philanthropic goals in relation to your family and their priorities. How would establishing a family foundation help you reach those goals? How will you get your family engaged in the foundation? How will future generations be engaged to continue the foundation’s work? Do you and your family have shared values? How easy or difficult do you think it will be to agree on a philanthropic mission or vision? How will the foundation deal with conflict? Do you want to bring in experts on the issues you intend to fund to serve on the board? Do you want to set directions about how the board will be composed in the future?
Consult experts. If you do want to establish a foundation, you’ll want to have an attorney or foundation-management consultant set it up.
Stay engaged. Once it’s set up, will you run the foundation yourself? Hire staff? Outsource the work to a foundation manager or consultants? If you start a private foundation, you are creating a real nonprofit. Treat it like the serious social change endeavor it is.
