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The Tapp Blog

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

Office Overhead

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.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.

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.

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."

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 junky 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. 

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."

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