Spending too much on overhead is bad. But how much is too much?
While scholars agree that the 15 percent line implicitly reflected in Part IX of Form 990 is too low, what’s the sweet spot? And, maybe more importantly, what do funders think?
Both scholars and funders are coming to recognize the importance of programming quality of spending adequately on overhead.
Over the past several years, the landscape has been changing. As more people realize that such costs have little to do with the effectiveness of a nonprofit, the focus is shifting toward a nonprofit’s impact.
General attitudes are changing despite the fact that charity watchdog groups are at odds about the extent to which the overhead ratios are helpful in assessing nonprofit organizational strengths. Charity Navigator has spearheaded The Overhead Myth campaign while Charity Watch maintains that overhead ratios are essential to assessing charitable effectiveness.
The Nonprofit Starvation Cycle is “leaving nonprofits so hungry for decent infrastructure that they can barely function as organizations — let alone serve their beneficiaries” according to Ann Goggins Gregory in the groundbreaking publication that first identified the Starvation Cycle. The Starvation Cycle involves nonprofits habitually spending inadequate funds on overhead such that a lack of infrastructure interferes with daily programming. Think about that day you and your coworkers fought with a $30 printer for several hours when a $100 printer would regularly and reliably print without issue. That wasted time is equal to wasted money. This is the cycle in a nutshell.
The cycle “starts with funders’ unrealistic expectations about how much running a nonprofit costs” and is fed by “nonprofits’ misrepresenting their costs while skimping on vital systems — acts that feed funders’ skewed beliefs,” according to Goggins Gregory. This is exacerbated by the fact that individual donors are more likely to give when they are told that 90 percent or 100 percent of their donation goes directly to programming.
Alleviating the starvation cycle
The first step to alleviate the starvation cycle is in the nonprofit’s hands. The organization’s leaders should and analyze the ways in which their nonprofit currently operates.
By delving deeper into understanding what the nonprofit organization needs to create a solid infrastructure, members of the board and those on staff can begin to develop a clear foundational need. Without a strong office support system, a nonprofit will be unable to function, just as a typical for-profit company would if they did not spend money on cultivating a well-balanced framework. One example in the Goggins Gregory study was a nonprofit’s, “furniture [was] so old and beaten down that the movers refused to move it.”
A nonprofit is well-advised to take the time with its staff and board to truly reflect on what is necessary for the nonprofit’s daily operational needs. If these basic necessities are not matching up with results, then it’s a sign an organization could be in serious trouble.
The second step in changing this cycle is to change the way donors view the concept of overhead. Funders must be comfortable knowing that part of their grant may go toward maintaining a successful office space. Of course, the amount spent on overhead should be reasonable. Some funders permit an agreed upon percentage of its dollars be used for the administrative needs of the nonprofit.
On the flipside, foundations and government funders must alleviate the tension nonprofits feel when they receive a grant. If these funders can begin to change the entrenched perception that all (or nearly all) overhead is bad, then nonprofits would feel more comfortable using part of the grant in order to continue running efficiently.
Together, funders and nonprofits can work together to alleviate the typical challenge of the starvation cycle. In fact since last year, the Ford Foundation permits grantees to use 20 percent of each grant award for overhead — effectively setting up the organization for success for having allocated enough funds to cover grant compliance and administrative costs.
If your nonprofit is struggling to make ends meet, take a look at what exactly makes up its overhead funding. Sometimes spending more there will increase success.
Attorney Zac Kester provides generalist and strategic nonprofit legal and consulting services. He holds a Master of Laws, a post-law school advanced degree, in which he studied the unique needs of tax-exempt nonprofit organizations. His legal and consulting career has focused on nonprofit organizations.
With highly experienced legal and training personnel, Charitable Allies provides all manner of legal and educational services for boards, officers, management and staff of myriad charities throughout the sector. From basic one-time questions about a single matter to training for boards and officers to complex reorganization or merger of activities, Charitable Allies is your go-to cost-effective provider of legal services for your nonprofit organization.