business or nonprofitFinally, it seems that the insanity around the “nonprofit starvation cycle” is coming to an end. For those of you who may be new to the world of philanthropy, the nonprofit starvation cycle happens when donors have unrealistic—and absurd—expectations regarding the costs of running an organization. For a long time, donors have been restricting their money to direct program costs. Apparently, it’s been acceptable for a business to have operating expenses, but not for a nonprofit. However, donors have missed the point. Nonprofits are a business. They’re simply a tax-exempt business.

This downward expense pressure from donors has caused the following situations:

  • There’s been a rigid doctrine by funders to place most, or all, nonprofits—no matter what’s happening in the organization—in a 15 percent straight jacket on expenses. In reality, this is an arbitrary number. When charities are in the midst of a capital campaign or are expanding their organization so they can grow to scale, they’re expenses rise as they’re making capital investments.
  • Some nonprofits claim to have as little as 5 percent or even zero costs. These rates of expenditure are simply not credible or realistic. And, it’s perpetuated the delusion that nonprofits should be operating with little to no overhead.
  • Nonprofit executives have had to, essentially, fudge the numbers. Since it’s not realistic to run an organization with little or zero expenses—unless it’s wholly volunteer-driven (and even then it’s a tough case)—charity directors have sought clever ways to bury operating expenses in program costs. The creative reporting, in turn, distorts program ratios.

I’ve written about the nonprofit starvation cycle in the past, and you can see some of those related posts by clicking here and here. I’m happy to report that the push-back that’s happening in the industry against this impossible and arbitrary reality is starting to change the conversation.

In the Stanford Social Innovation Review, philanthropy’s biggest funders are saying this has to change, and there’s been a grave injustice. By the way, the nonprofit starvation cycle is one of the reasons why the majority of charities remain small and can’t grow. They’re unable to get the operational investment capital to develop.

According to an SSIR Summer 2016 article, leading philanthropists are looking to move from the nonprofit starvation cycle to “pay-what-it-takes” philanthropy. This model is, “a flexible approach grounded in real costs that would replace the rigid 15 percent cap on overhead reimbursements followed by most major foundations.”

Pay-what-it-takes is dependent on transparent and clear reporting regarding actual program costs. And, more importantly, it shifts the dialogue from the actual program to the impact any given program and nonprofit are making.

In the SSIR article, the president of the Ford Foundation, Darren Walker, said, “All of us in the nonprofit ecosystem are party to a charade with terrible consequences—what we might call the ‘overhead fiction.'” To help alleviate and begin to adequately address the issue, last year the Ford Foundation doubled the rate it allowed nonprofits to report for overhead and administration.

The Bridgespan Group published a report that found the following at 20 leading nonprofit organizations they studied, “We discovered that indirect costs make up a much larger percentage of a nonprofit’s total costs than is widely understood. Of the nonprofits we surveyed, indirect costs made up between 21 percent and 89 percent of direct costs. The median indirect cost rate for all 20 nonprofits was 40 percent, nearly three times the 15 percent overhead rate that most foundations provide. To be clear: Higher or lower is neither better nor worse. These figures are not measures of either effectiveness or efficiency. Rather, they reflect the mix of direct and indirect costs required to deliver impact.”

I’ve been a social entrepreneur for a long time, and one of the biggest problems I believe the nonprofit sector has faced is the lunacy of having to report 15 percent or less operating costs, no matter what was happening in the organization. We’ve done damage to the sector because most charities haven’t been able to grow or develop. Donors have left many in an unsustainable position. We’ve also created a situation where there’s “creative” reporting, which damages the credibility of nonprofits. You have to wonder why so many people in the general public believe nonprofits are not to be trusted. It’s one of the reasons that charities aren’t viewed in a positive light.

I’m glad that the loud voices agitating for change are being heard. We have all the tools we need to eradicate poverty, hunger, and some diseases. The only way to make that happen is to be committed to operating in reality and move away from obscure and creative reporting.

 

Author of “Not Your Father’s Charity: Grip & Rip Leadership for Social Impact” (Free Digital Download)

© 2017 Wayne Elsey and Not Your Father’s Charity. All Rights Reserved.