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Future Of Philanthropy

Demanding That Nonprofits Not Pay For Overhead Is Preventing Them From Doing Good

A new report highlights the damaging expectations we ask nonprofits to live by when we insist on telling them how to best spend their money.

Demanding That Nonprofits Not Pay For Overhead Is Preventing Them From Doing Good

Photo: M. Niebuhr via Shutterstock

Earlier this year, the popular veterans organization, Wounded Warrior Project, was rocked by a series of bad press. An investigation by The New York Times found that while the organization was raising an impressive $372 million in donations each year, a big chunk of that money wasn't going to veterans. Instead, the top executives were shelling out nearly 40% of their annual revenues to indulge business-class travel, expensive hotel stays, fanciful employee conferences, and their own exorbitant salaries.

While the Wounded Warrior Project's expenses were laughably tone-deaf, the affair highlights a major issue in the world of nonprofit funding: When foundations or individuals donate to an organization, they often expect their money is going to triage the issue—providing clean water, feeding children—and not to paying for office space or corporate retreats for nonprofit workers. To solve this, most foundations pay only up to 15% of any socially good group’s indirect costs, things like office space, salaries, or equipment.

cgdeaw via Shutterstock

But a new report from Bridgespan, a consulting firm for nonprofits and philanthropists, says this is incredibly damaging. The result is a "starvation cycle" in which foundations are crippling the outfits they’re trying to support. In the commercial world, investors have come to expect that companies in different spaces require different overhead. There is no boilerplate expense sheet. That’s a lesson nonprofit funders have failed to learn.

"What you need to invest in as a nonprofit depends on what you are doing," says Jeri Eckhart-Queenan, the lead author on the report. "A number of foundations have these flat-rate policies where they treat all nonprofits the same. That is the big ah-ha, here. We’ve had a very failed understanding of what it takes to get the job done."

The fix: Bridgespan is calling for a new era of "Pay-What-It-Takes" philanthropy—in essence, that grant makers need to figure out what amount of indirect costs per mission are normal, then pony up and pay them.

So far, the strategy has at least one major ally. In January, Ford Foundation president Darren Walker promised to increase grant money earmarked for indirect costs to 20%, doubling their previous standard. He’s called the previous funding threshold a "charade" and the "overhead fiction."

This is especially important at a time when some nonprofits appear to be struggling to understand even their own finances. According to a recent report by Oliver Wyman and Seachange Capital Partners only 30% of New York nonprofits can be considered "financially strong"—and "many trustees do not understand the financial condition of their organization or how it compares to its peers."

Dario Sabljak via Shutterstock

IDENTIFYING THE PROBLEM

Bridgespan has warned that nonprofits were being shortchanged this way before. That "starvation cycle" terminology dates back to 2009, when the firm pointed out that research by the Urban Institute's National Center for Charitable Statistics and Center on Philanthropy at Indiana University showed many NPOs with revenues over $100,000 still suffered from broken computers, untrained staff, and janky office furniture.

Part of the problem is that many funders have become obsessed with measuring their impact on a per-dollar basis, which means they’re more eager to give to specific projects than the institutional upkeep that supports them. But the 15% overhead limit doesn’t even parallel what commercial companies shell out. According to Bridgespan's research, the average S&P 500 firm spends about 34% of their budget on essential behind-the-scenes support. For IT companies it's more like 78%, the report notes. Some 21st-century nonprofits probably require the same kind of tech firepower.

In a survey of 20 high-profile nonprofits, Bridgespan found that indirect costs—those that don’t go to programs or services, including fundraising—ranged from 21% to 89% of each group's overall spending. To splice that data a more telling way, Bridgespan divided the nonprofit industry into four main sectors: U.S.-based direct service, policy and advocacy organizations, international networks, and research organizations.

How money gets spent by Save the Children would be drastically different than, say, the biohazard laboratory required at the Center for Infectious Disease Research. (One probably needs more counter space and test tubes.) So Bridgespan then divided each industry's expenses into a series of categories: administrative expenses, network and field costs, physical assets and knowledge management. Many agencies opted to share data anonymously, but, by sector, there were strong similarities.

Bridgespan's takeaways: "Flat-rate reimbursement for indirect costs is conceptually wrong because it doesn’t take into account the differences by segment," the report notes. And the given nonprofit reimbursement rate of 15% is definitely too low. "It doesn’t represent the actual indirect costs it takes to run any of the nonprofits we analyzed."

SO WHAT’S THE FIX?

Let’s start with the wrong way to solve this issue. In the Bridgespan report, one anonymous CEO noted that his or her group kept two budgets "one that has the real numbers, and another that shows the funders what they want to see." Another strategy might be to steal from one budget line item to cover for the shortfall in another. Such financial brinkmanship is fatally flawed, says study author Eckhart-Queenan, because it reinforces the idea that overhead is "a proxy for effectiveness or efficiency and it’s neither." As Save the Children has learned, sometimes the back-end budget doesn't have any wiggle room. Because their indirects costs aren't fully covered, the group ends up having to cover the deficit with between $12 to $18 million of their "unrestricted funding" funds annually, the report notes.

Change may not happen immediately. But Bridgespan's report at least provides some basis for re-thinking what's broken. "To our knowledge, this is the first time that anyone has suggested there might be a different rule of thumb [for funding] by types of nonprofit," Eckhart-Queenan says. No doubt, the next generation of Silicon Valley do-gooders entering this field will understand what it takes to run a company—any company. Perhaps it's time for more grantmakers like Ford to audit their own behavior.

For nonprofits needing a crash course in indirect cost calculation, Bridgespan offers a tool here.

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