Part 2: The Nitty Gritty Financial Side of Major Gifts
Last month, we laid out ways to identify and cultivate major gift prospects, especially those living far from campus. But the work isn’t over once you cultivate a major gift, in fact, this is when the real fun starts! As summarized in last month’s blog, we will continue the conversation by exploring five factors that major donors consider when contemplating a six, seven, or even eight figure gift to your school:
- Tax impact and consequences
- Gift fees
- Endowment investment returns
- Compliance with donor intent
- Peer pressure
Therefore, we’re providing tips in this blog article on how to handle major gifts after the ask.
According to a recent press release from CAE (Council for Aid to Education), increases in charitable contributions to colleges and universities in the United States were driven by personal giving, specifically, “gifts from alumni increased 14.5 percent” in 2017.
Major gift officers pursue high prospect donors for reasons of simple math—the time it would take to add up small gifts is not sustainable. For example, if we look at the 2016 Voluntary Support of Education (VSE) data for Pennsylvania State University (randomly selected from the report), we see that individuals—alumni and others—gave a total of $108.3 million. If we add up the gifts of the three largest living individual donors, their contributions equal $16.8 million.
This means that just three major individual donors contributed over 15% of that $108.3 million. At many institutions, that percentage is even higher (and growing).
Major donors are very knowledgeable. Not only that, they’re backed by a legion of sophisticated lawyers, accountants, and financial advisors who think through the most advantageous way to make a major or transformative gift.
Let’s examine what they look at.
1 – Tax Impact and Consequences
When a donor can give a dollar and the government will subsidize it 40% or more, the donor will likely structure their gift to achieve this benefit. In one study, donors ranked “awareness of tax advantages” as their third most important motivation for giving (Prince and File, 1994, cited in Vesterlund, “Why Do People Give” 569).
The recent increase in the standard deduction for federal income tax purposes generally does not affect wealthy donors, and they now can deduct charitable contributions up to 60% of adjusted gross income each year (30% for appreciated securities). This assumes that those donors have enough taxable income to absorb the deduction, so timing considerations may affect the period over which a donor offers to actually pay and fulfill a large commitment. This is especially true if the gift follows an event that generates a large taxable gain, such as the sale of a property or business.
The increase in the estate and gift tax exemption beginning in 2018 likely will have a significant impact on major and transformative gifts.
Donors who are motivated by the tax advantages of giving may now have less of an incentive, at least when it comes to their federal taxes.
The exemption was doubled to $11.2 million per individual, so a married couple can effectively shelter over $22 million of their wealth from federal gift and estate taxes. This means there is up to $11 million more that individuals can pass on to their children or other heirs without bearing this 40% federal tax, thereby reducing the incentive to give to charities. On the other hand, remember that 17 states and the District of Columbia levy inheritance taxes that kick in at much lower levels and at rates typically in the 14-20% range. Exemptions from these taxes in most states also are quite low, running only $5 million or less, thereby subjecting many more estates to state inheritance taxes than are due under the federal statutes.
This is complicated stuff, so make sure your department has access to good tax and financial counsel, so your staff understands the financial motivations driving a donor’s gift and how to help that donor optimize their giving. Taxes are only one factor a major donor considers, of course. Now, let’s turn to some of the stickier issues.
2 – Gift Fees
Many colleges and universities, especially those with separate foundations, levy gift fees on new gifts ranging up to 5%, and assess annual fees of up to 2% on endowments. Donors hate these fees, preferring, of course, that the full value of their gifts be used for their intended purposes, not to pay for “overhead” and the cost of fundraising.
Things really can go awry when a gift fee is not clearly disclosed to the donor, or when the donor who originally agreed to the fee is no longer alive. Writing about a recent battle over gift fees, Emily Bamforth states, “the family of Michael Moritz, the namesake of Ohio State’s Moritz College of Law, claims the school didn’t tell them about the fee. And they say because they weren’t notified, most likely many other donors don’t know about the fee.” Michael Moritz’s son, Jeffrey Moritz, is now suing OSU to vitiate the gift fee provision and restore the funds taken out of the endowment to cover part of the operating costs of the OSU foundation.
So, what if gift fees were lowered or cut out altogether?
This would require colleges and universities to cover the cost of fundraising directly out of their operating budgets, but would it really spur a significant increase in major gifts?
That question is being actively discussed today at the senior leadership and board levels of many schools. This is an important topic to watch.
3 – Endowment Investment Returns
“Why should I give a pile of cash to the endowment when I can earn a much higher return than has been earned historically by the institution’s investment managers?”
This is an advancement officer’s worst nightmare, but a common response from well-heeled donors who understand investing. Fundraisers feel powerless to influence the college or university’s (or foundation’s) investment strategy, which is likely to be conservative (in regards to risk), and thus unimpressive to high net worth donors who employ top investment advisors.
The best your department can do is explain that your investment office is sensitive to the issue and invests not to generate excess returns, but to preserve the gift principal so the programs the donor desires to underwrite can be sustained over time. Every gift officer must understand this issue and have a ready answer when asked. Failing to do so will speak volumes to major donor prospects. Similarly, investment officers must be sensitive to this issue and held accountable to produce investment performance that will not impede a major donor’s willingness to hand over assets to the institution or foundation.
4 – Compliance with Donor Intent
Alleged non-compliance with the donor’s intended use of a major or transformational gift has led to many epic disputes between donors and colleges and universities over the years. Take the recent case of the Pearson Family Members Foundation and the University of Chicago. The foundation is suing the university to recoup $22.9 million already paid towards a $100 million pledge to establish a center to study ways to resolve global disputes. The family foundation claims the university’s leaders have failed to demonstrate they are using the gift for its intended purposes.
As Mike Scutari writes in his Inside Philanthropy article, “the saga is being portrayed as a cautionary tale for donors and universities alike. To the former, if a mega-gift comes with conditions attached, those conditions may not be met. To the latter, that transformative mega-gift may quickly dissolve into an acrimonious lawsuit.” While this case involves a mega-gift, all donors committing larger gifts expect compliance with the terms of their gift agreements, so it is important to make sure the donor’s intent is clearly articulated in the agreements.
Unfortunately, drafting gift agreements can be as much art as it is science in many cases. The last thing to remember is that donors will look at their year-end reports to see whether funds actually were spent as expected. Advancement officers responsible for those donors should also review these reports and be prepared to answer a donor’s questions about the reports. Sadly, colleges and universities occasionally do fail to deliver on endowed programs, or drag their feet investing at the rate expected by the donor. So be forewarned, landing a major gift agreement is not the end game!
5 – Peer Pressure
Why do institutions spend so much time naming buildings, scholarship funds, endowed chairs and virtually anything else associated with the school? Why does so much of the institution’s marketing feature major donors telling their stories?
It is widely accepted that recognizing major donors through naming rights motivates other potential donors to follow suit with their own meaningful gifts. Vesterlund shares interesting insights on this: the “initial donor, who knows that his contribution will be announced, will investigate the quality of the charity before donating, and…the donor subsequently reveals the quality through his contribution.”
Large contributions signal that the institution is WORTH a lot.
This is actually more persuasive to future donors than a fundraiser’s attempts to show that the institution is of high quality and worth donating to. Donors are prone to be suspicious of fundraisers’ claims because all fundraisers naturally have to show that their institution is high-quality. A single large donation by a respected donor can bypass this skepticism (Vesterlund 579).
Furthermore, research shows that individuals tend to contribute more when the announced contribution is large (578).
Donors frequently resist the need to publicize the gift, only to accede to the recognition. Feigned humility or genuine benevolence aside, naming opportunities are worth the effort. Recognition societies, awards dinners, coveted board appointments and the like are all part of the process.
That said, we know of a recent situation where a truly shy donor funded a large university honors scholarship program and, after much prodding, accepted that the program should bear his name. Despite his reticence, something else happened. The students who benefited from his scholarship program became emissaries promoting the need for scholarships and inspired significant gifts to this and other scholarship programs. Of course, on a much larger scale, this does seem to be an “arms race” to see who can make the largest gift ever received. The skillful use of peer pressure by using a major donor to promote a cause can pay big dividends.
Together, these and other factors form the quantitative motivations of a major gift donor. Although this doesn’t tell us anything about the passion that inspired the gift, it tells us much about how and why they’ve gone ahead with it. The next time stewardship reports are sent to donors, this glimpse inside the donor’s mind can help you think about how they will view them.
For example, let’s say Institution X’s endowment is $100 million and the spending rate is 5% of principal. So, $5 million went out for scholarships and other initiatives. Let’s say Institution X takes 1% out of the endowment each year as a gift fee to cover operating costs. Therefore, the total withdrawal rate is 6%. If the endowment’s investments gain less than 6% per year on average, Institution X has a real problem, especially after factoring in inflation. Donors are troubled by any declining value of their gift corpus.
According to a CAE press release, “endowment values increased 9.1 percent at institutions.” But the release goes on to caution: “when the value of endowments decline, other sources of revenue also tend to decline. This is why drawing down on assets in robust economic climates may be deleterious to universities’ long-term financial stability.”
However you look at this, the stakes of this work are high.
As you can hopefully see, we’ve done a lot of thinking and research on these issues. Since ALUMinate was founded by donors, for donors, we’re available to help your institution identify and cultivate major gifts in regions. Contact us today to learn how.
We hope you found this inside look at major gifts helpful. Check back on January 8, 2019 for our next post. Until then, happy holidays from the ALUMinate team!