by David Werdiger

Dan Pallotta’s TED talk on charity has raised waves all over the internet, and while some may consider his views controversial, his record stands as a pioneer of multi-day charitable events, which have proved to be hugely successful fundraisers. He throws down the challenge to charities to think and work more like businesses, particularly with respect to compensation, marketing, risk-taking, and time to return.

Charity, like any other enterprise, can and should be viewed through a prism of risk and reward. In the commercial world, individuals and companies invest resources (money, time, human capital) seeking a financial return on their investment. In the not-for-profit world, charities invest those same resources seeking to achieve some social change.

Compare the process of cancer research with the development of any drug by a large pharmaceutical company. Both make an investment (research and drug trials) seeking a return (cure/profit). Both will operate a series of initiatives each of which have a multi-stage lifecycle; some of these initiatives will be more speculative, others less so; some will be very successful, and others will stall or fail. Inside the org or company, the board or management will consider the aggregate risk of all the programs together and likely seek to have a “balanced portfolio” where they invest in a diversified mix. When we seek to measure the success of either the cancer research org or the pharmaceutical company, we look at them as a whole and the impact they have had in pursuing their goals.

The measurement of success certainly varies – for companies, it is profit and “shareholder value”; for cancer research orgs, it might be lifetime survival rates; and so on for other not-for-profits. While it is often more difficult for charities to measure the return on their investment, the principles of risk and return apply equally to all.

In the commercial world, investors have different appetites for risk. Retirees may have a more conservative approach to risk because they have a good idea of how much they need to live, and how long that might continue. On that basis, they might invest in government bonds that produce a small but fixed return at zero risk. A hedge-fund manager or venture capitalist may seek high risk investments where there is a chance they can lose the entire investment, but also a chance of very high returns.

The markets offer a vast array of investments available, each with a different risk profile, and investors allocate their money across a portfolio. The smart investor goes in with eyes open knowing the risk/reward profile. A low-risk fund does not have a mandate to indulge in high-risk activities (and vice versa) – that would be a breach of the implied (and sometimes explicit) agreement between investor and investment, and would break the entire system.

Now, consider the position of a philanthropist, who for these purposes we should consider an investor in the not-for-profit sector. The philanthropist seeks to achieve social change through a variety of ways, most commonly by donating money. The smart philanthropist, like the smart investor, should make themselves aware of the options available for achieving the desired social change. For someone interested in alleviating hunger and poverty, there are many options: they can give money directly to a homeless person sitting on the street, they can donate to a shelter or soup kitchen, they can fund a program that helps people find work so they can sustain themselves, they can pay for wrist bands that will in turn fund awareness or other programs, and so on. Each of these activities has a risk/reward profile. The smart philanthropist, like the smart investor, maintains a portfolio so they are exposed to the appropriate mix of risk and reward in the enterprises they choose to fund.

Equally, there is a compact between philanthropist and not-for-profit: in consideration for a donation, the not-for-profit will do what it represents it will do, in the manner it is expected to do it. If the homeless shelter starts renting rooms for hire so it can raise money to buy another shelter, it has broken the compact. If the wrist-band program directs the money it raised to make even more wrist bands so it can raise even more money, it has broken the compact.

Now, to the crunch: while it’s very reasonable for Pallotta to ask not-for-profits to spend big to attract top talent, indulge in high-risk/high-return fundraising, or embark on a project that may only see results in five years, this can only be done with integrity if it is within the granter-grantee compact. That way, the philanthropist can go in with eyes open, knowing what they can expect from their “investment”.

What this means to the not-for-profits is that they must start being more open and transparent about their own risk/reward profile, in much the same way that companies do. If they want to embark on an aggressive marketing campaign to raise awareness for their cause, then the marketing team must sell this to the management and board, and they in turn must sell it to the donors.

When both not-for-profits and philanthropists fully embrace this risk/reward dynamic, the landscape of the sector can shift completely to one where risk/reward becomes a more openly considered metric by which not-for-profits are judged (rather than overhead). In the marketplace where not-for-profits compete for the funding dollar, philanthropists invest in a portfolio that aligns both with the social change they seek, and also with their appetite for risk in the way the change is sought.

We do this already in the world of commercial investment. It’s time for the philanthropic world to follow that lead.

David Werdiger is a director of Australian Jewish Funders, a past director and current committee member of JewishCare, a technology entrepreneur, and a writer and public speaker. You can connect with David on LinkedIn, Facebook, Twitter, or Google+.