This article first published in the Financial Times in January 2017.

Donors encourage smaller organisations — but does that help beneficiaries?

There are 165,000 registered charities in England and Wales alone, which people often say is a lot. But is it? Moreover, it is too many? It’s not clear what “the right number” of charities actually means. By comparison, the UK has nearly 30 times as many companies.

The reason there are so many charities stems from the economics and dynamics of the charity sector, which are worth understanding as they’re completely different to those underpinning how businesses work. When entrepreneur and former mayor of New York, Michael Bloomberg, embarked upon philanthropy, Richard Riordan, then mayor of Los Angeles, advised him: “You are going into another world. It’s like going to Mars — [there is] a different logical and mathematical system.”

Defining your cause can help. When a member of my family was diagnosed with an unusual type of cancer, I was grateful for the Rarer Cancers Foundation, as it had heard of that particular cancer, unlike the larger charities I contacted first which hadn’t.

Many charities are set up precisely because there is a gap. For instance, if you fall off your boat in the Severn estuary, with luck the Severn Area Rescue Association will fish you out. It was founded because the Royal National Lifeboat Institution only operates at sea but doesn’t cover rivers (except the tidal part of the river Thames), and the Severn estuary counts as a river. Sara was called out 66 times last year alone.

But in the charity sector — on Mars, as Mr Riordan suggests — the incentives are often counterintuitive and can lead to fragmentation.

The incentives on trustees are quite unlike those on corporate directors. Normally, if two charities merge, about half the trustees become superfluous. Many people seem to like being trustees so are unlikely to vote themselves out of a role. The other half have the increased work and responsibility of overseeing a larger organisation. Trustees almost invariably work for free, so are maybe disinclined to vote for more hassle and risk.

The incentives for staff are a factor. In business, entrepreneurs who merge their businesses into bigger companies will often receive pay-offs to offset the loss of their job. This doesn’t happen in the charitable sector because it’s legally difficult to make a pay-off. After a merger, several of managers simply face redundancy. This is nobody’s fault — just a consequence of charity law — but does disincentivise staff from pursuing potential tie-ups.

People establish charities for very different reasons to why they found companies; in some instances, it can be as a permanent reminder of somebody who has died.

And lastly, donors often inadvertently encourage proliferation. For example, manyfoundations will only give an organisation one grant at a time. This sounds like a good idea — until you think about it. That rule seems to assume that an organisation can only have one ongoing good or important initiative, which is obviously not always the case.

That “one at a time” rule also deters mergers. I was once involved in a proposed merger of two charities, both of which fitted the criteria of the Esmée Fairbairn Foundation, a large grant-maker that follows the rule of one grant at a time (except in “exceptional circumstances”). Separately, the two charities were eligible for two grants; combined, they’d have been eligible for just one. That price was too high and it destroyed the merger.

Ironically, the Esmée Fairbairn Foundation later created a fund specifically to encourage charity mergers, but retained the one at a time rule.

One impact of this rule is that some funders will fund only small charities. For example, the Polden-Puckham Charitable Foundation will only* fund charities with revenues of less than £300,000. Separately, two charities each with revenues of, say, £200,000 might be eligible for two grants, but if they merge, they’re eligible for none at all.

Notice that both situations disqualify organisations irrespective of merit.

Why do donors do this? It’s not entirely clear, though they sometimes talk about being fair to their many applicants. That seems wrong to me. Surely, the issue is not fairness between organisations but rather doing what is best for beneficiaries? It seems unlikely that they are best served by organisations that are forced to remain small and, therefore, probably inefficient.

Perhaps donors like the fact that they gain more influence with a small organisation than they would if it were an equivalent gift to to a larger body. Or is it simply, as Marianne Bertrand of the University of Chicago Booth School of Business suggests, just that “everybody likes a baby, but nobody likes a teenager”?

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*Since this article was written, the Polden-Puckham Charitable Foundation have written to say that it does sometimes fund organisations with more than £300k revenue.