Nonprofit Overhead Series: Pt. II – Misconceptions That Hurt Giving & Organizational Effectiveness

In 2007, U.S. giving totaled $306 billion, of which nearly 75 percent came from individuals/households and more than 12 percent from roughly 70,000 foundations… The top 5 percent of donors account for 59 percent of all giving, 56 percent of the assets invested in donor-advised funds are held by the top 10 providers, and the largest 7 percent of nonprofit organizations command 58 percent of revenues.

The Nonprofit Marketplace: Bridging the Information Gap in Philanthropy

A philanthropic capital advising service for high net worth clients purports to be in the business of helping its client “do good.” Yet, according to the article, “How to Help Charities Even During Hard Times,” published in the Associated Press on July 25, 2009 and picked up by other national media outlets, they advise clients to “pay especially close attention to the overhead. Anything above 9 percent to 14 percent is out of line, and signifies that too much money goes to staff or office space and not enough to the beneficiaries.” No mention is made of any other metric, and the message is reinforced to anyone reading the article.  

Wealth Advising Services With Misconceptions Hurts Giving

With capital advising services steering high net worth clients away from nonprofit organizations with overhead costs that are perceived to be too high, at more than 9 to 14 percent in this example,  it’s important that any misconceptions are cleared up. (This bare-bones percentage is lower than many grant-giving organizations allow at 15 percent. At 15 percent, the amount allowed for overhead by some grantors does not even cover the cost of grant administration.) From the statistics cited by the Nonprofit Marketplace: Bridging the Information Gap in Philanthropy, it is clear that donor-advised funds and high net worth clients control  an extremely high stake in giving. Disqualifying nonprofit organizations on the basis of incorrect advice could have profound implications.

Imagine trying to run an organization without spending more than 9 to 14 percent on overhead expenses. Compare that to the for-profit world. According to the article, “Why Overhead Isn’t Evil in the Nonprofit World,” by Nancy Lublin, in the fourth quarter of 2008, Apple, Inc. spent 78 percent on sales, general and administrative expenses.

It’s not just the wealthy and their advising services who share misconceptions about overhead costs in nonprofit organizations. A Bridgespan Group article that cited a 2001 survey by the  Better Business Bureau Wise Giving Alliance Donor Expectations Survey found that more than half of American adults believed that nonprofit organizations should have overhead rates of 20 percent or less. Four out of five felt that it should be less than 30 percent. They also ranked overhead ratio and transparency more important attributes in determining their willingness to give to a nonprofit organization than the success of their programs.

Dan Pallotta and Charitable

A very passionate and outspoken advocate of leveling the playing fields for non-profit and for-profit organizations is Dan Pallotta, the author of Uncharitable. He talks about his views in this interview with Reason TV.

Studies, Reports and Briefs on Nonprofit Overhead Costs

The Urban Institute’s National Center for Charitable Statistics (NCCS) and the Center on Philanthropy at Indiana University did a five-year study on nonprofit overhead costs. Researchers examined more than 220,000 IRS Forms 990 and conducted 1,500 in-depth surveys of organizations with revenues of more than $100,000.

From that study, several briefs,and guides were issued including :

1. What We Know About Overhead Costs in the Nonprofit Sector
2. Who Raises Contributions for America’s Nonprofit Organizations?
3. Getting What We Pay For: Low Overhead Limits Nonprofit Effectiveness
4. The Quality of Financial Reporting by Nonprofits: Findings and Implications

Other work such as, “Nonprofit Overhead Costs: Breaking the Vicious Cycle of Misleading Reporting, Unrealistic Expectations, and Pressure to Conform,” by William Bedsford, Ann Goggins Gregory, and Don Howard and “The Nonprofit Starvation Cycle,” by Gregory and Howard of the Bridgespan Group illustrate some of the other findings.

Misleading reporting: The majority of nonprofits under-report overhead on tax forms and in fundraising materials.
Unrealistic expectations: Donors tend to reward organizations with the “leanest” profiles. They also skew their funding towards programmatic activities.
Pressure to conform: Nonprofit leaders feel pressure to conform to funders’ expectations by spending as little as possible on overhead, and by reporting lower-than-actual overhead rates.

The Vicious Cycle as described by William Bedsford, Ann Goggins Gregory, and Don Howard

Addressing Misconceptions about Nonprofit Costs and Overhead

After reviewing these reports,  a few points stood out that addressed some preconceived notions about nonprofit costs and overhead:

• Nonprofits have an obligation to manage finances responsibly
• Some financial ratios can be useful tools
• Without contextual information, they can be misleading or useless
• The best measure of nonprofit effectiveness is accomplishment of mission
• Spending money on overhead, contrary to popularly held beliefs, frequently helps nonprofits achieve mission
• Organizations respond to perceived and explicit pressures to keep administrative and fund-raising expenses low
• Organizations that spend too little on infrastructure risk the ability to effectively deliver positive outcomes for clients
• Donors can be educated about evaluating nonprofits by mission and outcomes rather than costs or overhead ratios

Whose responsibility is it to educate donors about the better ways to measure nonprofit effectiveness? What role do charity rating services and watchdog groups play in donor perceptions of nonprofit organizations?

Bearing all of this in mind, effective communications from nonprofit organizations can be critical to their success and survival.

Part III of this three-part series addresses Communication and Donor Decision-Making.

Part I of this three-part series addresses Shifting the Focus to Outcomes.

Image Credit: http://www.bridgespan.org/nonprofit-overhead-costs-2008.aspx

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