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Building the Foundations of Excellence

Over the past couple of decades, the nonprofit sector has been plagued by a number of charity rating sites lulling potential donors into believing that the worth of an entire organization could be distilled down to a single metric: the percentage of funds spent on direct programmatic expenses versus so-called “overhead” expenses, which include critical resources such as personnel, physical and technology infrastructure, and fundraising capacity. The implicit (and sometimes explicit) message is that the greater the percentage of an organization’s total revenues spent on direct program expenses versus the percentage of overhead expenses, the more effective and worthy of support the organization would be.

Given the vast oversimplification, potential for misinterpretation and misrepresentation, and devaluing of an organization’s internal soundness that this perspective promotes, it’s encouraging to see that its logical flaws are being exposed and actively discussed within philanthropic circles. Foundations and other institutional donors are becoming increasingly sensitized to the unnecessary handicaps that such low tolerance for overhead imposes on nonprofits’ work and the crucial role that context plays in that work. Although the shift is far from complete, a growing segment of the philanthropic community is realizing that the picture of a nonprofit’s success is complex and that, in many cases, impact is in fact strengthened by the presence of resources that indirectly support programmatic work in conjunction with those wholly dedicated to it.

One of the major catalysts for promoting a more expansive view of nonprofits’ work was the 2013 TED Talk given by activist and fundraiser Dan Pallotta, which highlights the staggering disparities between the for-profit and nonprofit sectors in terms of what is considered acceptable spending for growth and idea capital. “The notion that ‘overhead’ is somehow an enemy of ‘the cause’ forces organizations to go without [what] they really need to grow,” Pallotta states. Citing fundraising capacity as an example of these unmet needs, he points out that “fundraising is the one thing that has the potential to multiply the amount of money available for the cause that we care about so deeply.” A conference brief issued by Grantmakers for Effective Organizations refers to leadership, operations, finances, technology, and facilities as the “back wheels” of the metaphorical tricycle of social impact, ensuring that an organization or program functions at peak performance. Recognizing the vital role played by these types of resources, in late 2013 the federal government began requiring federal grants and contracts to cover nonprofit overhead costs at up to 10% of the total funding package, with the option to negotiate higher from there if necessary.

An article that appeared in the Stanford Social Innovation Review – among the most respected publications in the philanthropic sector – framed the argument this way: “We can’t separate a program from the people who develop and deliver it. To ensure that a program can achieve maximum impact, we must actively invest in the staff who are supporting the program and make sure we have the best people on the job.” In that vein, the two-year-old Talent Philanthropy Project is dedicated to increasing foundations’ investments in nonprofit leadership and talent development.

All that said, it’s important to avoid taking overhead expenses to the extreme…so how much overhead is too much? Unfortunately, that question has no simple answers. According to the web site of the Nonprofit Overhead Project, an initiative of the California Association of Nonprofits, the actual amount that is appropriate varies widely, depending on a given organization’s current activities, goals, and desired scale for achieving positive change. It ultimately comes down to thoughtful, accurate accounting for the full costs of successfully delivering mission-related programs within the specific operating constraints an organization faces at any given time.

A recent Nonprofit Quarterly article provides some helpful advice about a few things nonprofits can do to move their constituents past the “overhead myth,” the subject of a 2013 open letter authored jointly by GuideStar, the BBB Wise Giving Alliance, and Charity Navigator:

  • Thoroughly analyze and then request support for your full costs: Explore questions such as: What are your current daily expenses, and how much cash do you need on hand at the leanest times of the year to continue paying your bills promptly? How much money should you set aside to maintain your facility, upgrade your technology, or invest in new systems? What potential risks are emerging, and what would it take to address them? Which opportunities should you seize, and how much funding would you need to do so? Once you have a clear sense of these answers, update your requests for support accordingly to reflect the full costs of delivering your services effectively and sustainably. The article cautions, “Don’t undercut your mission and put your community at risk by asking for less and promising more.”

  • Present your programmatic and operational activities as an integrated whole: Considering that operational activities carried out effectively amplify the strength, reach, and value of programmatic activities, emphasizing the ways in which your programs promote high quality, embody careful planning and innovation, demonstrate transparency and accountability, reflect organizational stability and sustainability, and attract talented staff and volunteers frames the conversation in a way that incorporates both kinds of expenses into a unified whole greater than the sum of its parts.

  • Don’t use your overhead ratio as a selling point, even if it’s low: The most critical information to convey to stakeholders about your organization is the specifics of how it successfully delivers on its mission, so provide relevant and compelling details to that effect. Highlight your organization’s achievements, impact, and plans, and help your supporters gain a clear understanding of how their involvement will position your organization for continued success in the future. Drawing attention to your overhead costs – however low they may be – has the potential to undermine more meaningful aspects of your work, inhibit your organization’s future growth, and perpetuate the idea that overhead costs should continue to serve as the leading organizational performance metric.

These are but a few of many possible approaches. How have you successfully made the case for your indirect costs to funders? How can this conversation continue to evolve in the field?