News and analysis
August 16, 2012

Nonprofit Inquiry Thrusts Fundraising Costs Into the Spotlight

Shawn Spence, for The Chronicle

The economist Richard Steinberg says his projections show that a charity that spends a lot on fundraising in its early days could have more left over for its mission than one that skimps.

Despite their different missions, the Disabled Veterans National Foundation, a veterans charity, and SPCA International, an animal charity, have a lot in common.

They have both received F’s from CharityWatch, the charity-ratings group, because most of the money they raise from the public pays for direct-mail operations.

They have both been the subjects in recent months of CNN exposés that highlighted the small percentage of their revenues that they spend each year on direct services to veterans or animals (less than 10 percent, according to their most recent tax forms).

They are both in debt and owe millions of dollars to Quadriga Art, a direct-marketing company, and its subsidiary Brickmill Marketing Services.

And—in a somewhat more surprising link—they both cite the work of a prominent philanthropy professor, Richard Steinberg, to justify their fundraising approaches.

Payoffs in the Long Run

Mr. Steinberg, a professor of economics, philanthropic studies, and public affairs at Indiana University-Purdue University, was paid to write expert opinions for both charities in 2010—and in both cases, he concluded they were on the right track.

As start-ups, it made sense for them to spend heavily to recruit donors, he argued, forecasting that their investments would pay off in the long run.

Writing for the animal charity, he concluded that the group has “experienced relatively high costs and low donations during the first three years of existence. But this is a sign of enormous growth, not inefficiency or mismanagement.”

The charities now invoke Mr. Steinberg’s reports to deflect criticism

For example, after the Senate Finance Committee opened an investigation into the veterans group in May, the organization retorted in a statement that its “fundraising model has been validated by an independent audit conducted by one of the leading international fundraising experts and economists, Purdue University Economics Professor Richard Steinberg.”

Mr. Steinberg, an expert in the economics of fundraising, has been thrust into a real-world public debate in which his academic theories are not always appreciated.

When he tried to explain them on CNN’s online comments section, as “philstudier,” other commenters quickly attacked him. “If you are an expert, you are rubbish at it,” one person said. “Sounds like you are employed by DVNF,” said another.

But Mr. Steinberg is undaunted by the negative publicity. He readily discussed his opinions with The Chronicle and even e-mailed the invoices he sent for his work. (He received a total of $6,000 for two reports for DVNF and one for SPCA International, paid by Errol Copilevitz, a lawyer who represents both charities.)

Business Principles

Mr. Steinberg’s reports draw on research that he has conducted for decades into the optimal amount that charities should spend on fundraising if they want to have the maximum amount of money available for their programs. He says donors and nonprofits need to become more comfortable with business principles like the value of long-term investments.

“If you want to do good, you have to have a hard head to go with your soft heart,” he says. “How to evaluate charitable investments is not something anyone’s taught, not until we slowly change the system as people like me and others are introducing it into courses and are still developing some of the basics.”

Mr. Steinberg believes the public should be weaned from the idea that high “cost ratios”—the percentage of donations that are spent on fundraising as opposed to programs—are inherently bad.

He gives this example in his opinions: Charity A spends $10 to raise $100 in donations. Its cost ratio is only 10 percent, but it has only $90 to spend on its mission. Charity B spends $1-million to raise $1.5-million dollars. Its cost ratio, 67 percent, is high, but it has $500,000 to spend on its mission.

“One cannot spend a ratio on the mission,” he writes. “One can only spend the money left over after the costs of the campaign have been met.”

How High Is Too High?

The Senate investigation and news-media coverage have revived the perennial debate over how much a charity should spend to make money—and at what point the number is so high that it invites public skepticism.

Mr. Steinberg wins kudos from Dan Pallotta, a controversial former fundraiser and author of Uncharitable: How Restraints on Nonprofits Undermine Their Potential, who argues that nonprofits should operate more like businesses. The public is “illiterate” about the need to invest in fundraising to help an organization grow, he said in an interview, calling Mr. Steinberg “the hero of an unsexy cause.”

But the professor’s views make him an outlier in most of the nonprofit world.

Many other nonprofit experts agree that charities should not be evaluated solely, or even predominantly, by how much they spend to raise a dollar, but few would urge that it be completely disregarded.

After all, donors have a multitude of charities to pick from, including many others that help veterans and animals, which are easy causes to sell. Every dollar donated to a charity that is spending most of its money on direct-mail campaigns could be given instead to one that spends a healthy percentage on effective programs.

What’s more, Mr. Steinberg’s opinions on the Disabled Veterans National Foundation and SPCA International explored only a narrow aspect of their operations: whether their direct-mail campaigns were on a profitable course. He did not, nor was he asked to, examine how the charities were spending the money and whether they had sound management, were good fiscal stewards, or were meeting an important need.

The latter troubles Doug White, a philanthropy ethics expert and former academic director of New York University’s George H. Heyman Jr. Center for Philanthropy and Fundraising.

He says Mr. Steinberg’s opinions are sound academically but fail to consider the big picture, especially the “financial bargain” that governments strike with charities by giving donors a charitable deduction. “How are they helping society?,” he says. “That’s what the IRS cares about, what attorneys general care about, what Congress cares about.”

Free-Speech Rights

This is not the first time Mr. Steinberg has waded into a dispute involving a charity with high fundraising costs and ties to a controversial for-profit firm.

In the 1990s, he served as an expert witness for the United Cancer Council, a nonprofit that engaged in a high-profile, nine-year battle with the Internal Revenue Service. The agency pulled the charity’s tax exemption in 1990, retroactive until 1984, arguing that a fundraising company, Watson and Hughey, was an “insider” that had improperly seized control of the group and that the nonprofit’s board of directors ran the organization for the company’s “private benefit.”

A U.S. federal appeals court ruled against the IRS on the “insider” argument but asked the U.S. Tax Court to rule on the “private benefit” allegation.The case ended with an out-of-court settlement in 2000 that required the cancer group, which had declared bankruptcy 10 years earlier, to donate its assets only to charities that had never had a relationship with the fundraising company, renamed Direct Response Consulting Services.

In a paper describing his expert-witness testimony, Mr. Steinberg challenged the notion that Watson and Hughey had set up a “sham charity to further its private benefit.”

Instead, he said, the charity “conferred private benefits as an incidental side effect” of pursuing its tax-exempt activities.

He also warned that the IRS was attempting “to regulate fundraising speech through the back door of tax incentives.” He cited a string of U.S. Supreme Court rulings that have overturnedrestricted state efforts to regulate high fundraising costs on grounds that they violated First Amendment free-speech protections .

He defended an agreement under which Watson and Hughey fronted money to the United Cancer Council for direct-mail activities in exchange for the exclusive right to market the mailing lists, saying it benefited a charity that was on the verge of bankruptcy.

Mr. Copilevitz, whose firm often represents charities that are in trouble with regulators, was head of the legal team representing the winning party in one of the Supreme Court cases. He says he asked Mr. Steinberg to write the opinions for DVNF and SPCA International.

The charities wanted to reassure their boards and the public about their “unusual” fundraising strategies, which called for a speedy but expensive effort to build up a large pool of donors, he says.

Deeper in Debt

Under the deals examined by Mr. Steinberg, Quadriga advanced money to the animal charity, and Brickmill did the same for the veterans charity, both agreeing to let the organizations pay their bills out of the donations they received. Once again, he defended the commercial companies, saying they provided the kind of financing that the charities would have had a hard time finding elsewhere.

However, since he wrote his opinions for DVNF and SPCA International, the two nonprofits have fallen deeper into debt each year, leaving them little to spend on programs that help veterans or animals.

His explanation: “The reason they’re so heavily in debt is because they were offered a deal to grow from nonexistence to millions of dollars in a couple of years.”

Mr. Steinberg says he plans to present a paper next fall to an academic conference about how to do the kind of economic studies he has done for the two charities.

He also produced an expert-witness report on behalf of Pierre Barnoti, the founder of SPCA International, who was dismissed as executive director of the Canadian Society for the Prevention of Cruelty to Animals in 2008.

Mr. Barnoti has sued the Canadian charity, which accumulated millions of dollars of debts to Quadriga Art while he was in charge, saying he was unfairly fired.

Mr. Steinberg, who was paid $8,000 for that report, used similar arguments to those in his opinions for DVNF and SPCA International, citing the potential long-term gain from heavy spending to find donors.

For now, the charity still owes about $1.2-million in long-term debt to Quadriga, which has a lien on the group’s building as a guarantee, said its executive director, Nicholas Gilman, and treasurer, Pierre Lessard.

They said the group, which has a contract with Quadriga until 2013, has worked with the firm to revise the direct-mail operation to help stem the losses.

The Senate Finance Committee opened its investigation of DVNF after two prominent senators—Max Baucus, the panel’s Democratic chairman, and Richard Burr, the senior Republican on the Veterans Committee—questioned whether the group was spending enough money on its stated charitable purpose to deserve its tax exemption.

For people who accept Mr. Steinberg’s emphasis on the importance of maximizing proceeds over time, that is a wrong-headed way to evaluate a charity.

But others say the public will never buy the hard-line “it takes money to make money” approach.

“The problem with it is that charities are different than business,” says Leslie Lenkowsky, a Chronicle columnist and professor of public affairs and philanthropic studies at Indiana University’s Center on Philanthropy. “The public expects charities to behave charitably even if they are not acting in an economically rational way.”

Send an e-mail to Suzanne Perry.