I attended a seminar hosted by Exponent Philanthropy where the presenters discussed a unique approach to grantmaking that they referred to as “Catalytic Grantmaking.” The presenters suggested that many of the steps in what they identified as the “traditional grantmaking” process could be ignored to produce a quicker and more dynamic grantmaking style, but as we’ll identify, this comes with associated risks that in many cases may outweigh its benefits.
The more typical traditional grantmaking approach is a structured process that may include many of the following items:
- drafting grant guidelines,
- publicizing the available grant,
- collecting proposals,
- selecting eligible candidates,
- reviewing proposals,
- conducting due diligence, including review of the grantee’s identity, status with the IRS and applicable state agencies, financials, prior history, experience, and past compliance or non-compliance with grant funds,
- making site visits or interviewing key leaders of promising applicants,
- making a board decision selecting an applicant,
- notifying the applicant and clarifying expectations,
- writing the check,
- collecting detailed grant reports from the grantee, including financials conveying how grants funds were used, details of compliance with the grant agreement, and the grantee’s progress toward achieving the grant purposes (expenditure responsibility requirement),
- detailed reporting to the IRS (expenditure responsibility requirement),
- evaluating the success and failures of the grant,
- changing programs, procedures and guidelines that didn’t work and…
If your eyes glazed over that list and you just skipped ahead to this sentence, I get it! It can be a lot of paperwork, procedures, budget-tracking, post-grant reporting and other time-consuming processes.
Some charities have criticized that the lengthy paperwork and process of traditional grantmaking can limit the free flow of communication between a grantor and charity as well as draw grantor focus away from the charity’s mission, community trust, and internal expertise. In addition, such processes may be so burdensome that they exhaust a charity’s limited internal funds, staff, and other resources trying to keep up with grant compliance, or even so burdensome that they stifle the charity’s ability to apply for the grant in the first place. It’s also a pretty time-consuming process for the grantor itself. In response, Catalytic Grantmaking encourages drastically reducing paperwork and reporting, and in some cases, throwing it out altogether.
Note that Catalytic Grantmaking also includes incorporating the idea of “Catalytic Philanthropy” which asks the grantor to use non-monetary resources when providing grants. Catalytic Philanthropy, is a separate but related concept, which you can learn more about on my earlier post here.
While many of the aforementioned procedures of traditional grantmaking are legally required when private foundations make grants to other private foundations (see our post on Expenditure Responsibility), they are not, however, mandated when a private foundation makes grants to public charities. (If you’re not sure what the difference between a private foundation and a public charity is, see our post on the distinction here). The expenditure responsibility requirements and other procedures are also not explicitly required if the grantor itself is a public charity (regardless of the recipient’s status as a public charity, private foundation, or otherwise).
With that in mind, a grantor could technically just give money to a charity it likes, consistent with its mission, without conducting any pre-grant inquiries or procedures. Or, alternatively, the grantor could still have some sort of grant application, but keep its inquiries drastically reduced to a simple one or two page questionnaire, and then have little to no follow up after.
But such approach could lead to some significant consequences.
Some Merits of Traditional Grantmaking Procedures
Grantees and grantors might think less burdensome and time-consuming requirements are the key to a more effective and efficient grantmaking process, but there are many reasons to justify the traditional grantmaking process—it’s a tried and true means of providing valuable procedures that set forth clear structure and guidelines to both the grantor and applicants alike. In addition, traditional grantmaking can provide tight legal protections that maintain a high degree of care consistent with the fiduciary duties of grantor’s leaders, compliance with the tax code, as well as ensuring that a grant is not diverted from its intended charitable purposes.
Most nonprofits are corporations, and, just like for-profit corporations, the directors and principal officers of nonprofits have fiduciary duties to the corporation. Fiduciary duties include the obligation of directors and officers to exercise reasonable prudence to help assure the nonprofit is acting in its best interests consistent with its purpose and applicable law. Such reasonable prudence includes ensuring the charitable assets of the nonprofit are sufficiently safeguarded which involves conducting grantmaking in a responsible manner.
Responsible grantmaking should often include many of the foregoing procedural requirements. Due diligence should be conducted, for example, to ensure that the grantee: has a compatible mission, has sufficient resources to effectively and lawfully use the granted funds for their intended purpose, and does not have a history of fund mismanagement.
Simply transferring a nonprofit’s money without such safeguards may be considered a breach of fiduciary duty of the grantor’s leadership. Consequences of such a breach can range from reputational damage to subjecting the nonprofit, as well as the directors or officers themselves, to financial liabilities such as civil penalties and attorney fees.
Risks and Consequences
In addition to risking a breach of fiduciary duty, failing to implement sufficient grantmaking procedures can also result in excise or penalty taxes, as well as, in the most egregious cases, the ultimate sanction—the revocation of 501(c)(3) status. The following are a few examples of how this could happen:
- Private Inurement – This may occur when a director of a public charity uses the organization’s assets for their own private purposes. Without proper due diligence to monitor how grant funds are used, monies could end up being used for a director’s private benefit instead of for furthering the organization’s charitable purposes. The penalty for private inurement is revocation of tax-exempt status.
- Diversion of Charitable Assets – This may occur when charitable assets (such as grant funds) are transferred to any person, not just an organization’s insider, for a purpose not related to furthering the charitable purposes of the organization. This may be a result of theft or embezzlement or even a well-intentioned transfer that is considered unrelated to furthering the charitable purposes of the organization and more than incidentally to advance some person’s private interests. In addition to the financial loss to the organization and reputational and state law concerns, there may be federal tax implications for the organization (violation of the private benefit doctrine) and the persons responsible for the diversion, as well as a loss of tax-exempt status in egregious cases. Responsible grantmaking procedures would help to avoid such outcome.
- Self-Dealing (private foundations only) – Self-dealing occurs when a disqualified person as to the private foundation (e.g., an insider like a director, officer, or certain related parties) transacts with a private foundation. These rules can result in a penalty to both such disqualified person, even if there is no economic benefit to that disqualified person, and to directors who knowingly approved such transaction. Again, without responsible grantmaking procedures, a self-dealing transaction could occur, which could lead to excise taxes and other penalties against the private foundation.
- Taxable Expenditures (private foundations only) – Expenditures made for specified purposes, including lobbying, electioneering and voting registration, grants to individuals, grants to any organization not classified as a public charity, and any other expenditure for noncharitable purposes, can result in the expenditure (here, the grant) being taxable to the private foundation grantor. There are exceptions to these rules, including where expenditure responsibility is exercised, but without sufficient responsible grantmaking procedures, grants can end up funding disallowable purposes resulting in taxes and penalties to the private foundation.
Ultimately, many of the procedures in traditional grantmaking serve an important purpose to safeguard proper use of a grantor’s assets and ensure its leaders’ compliance with their fiduciary obligations and applicable laws. Of course, there might be a balance to consider with the burdens and inefficiencies that may be created by these procedures—and that needs to be viewed from a micro- and macro-perspective. Catalytic Grantmaking may be an effective approach for some risk-tolerant grantors in situations where, for example, there is a strong basis for trust and perhaps other areas of grantee accountability; however, in general, we would not recommend using it as a default approach.