A Funder Collaborative Tackles the Nonprofit Starvation Cycle
This is the first of a series of three articles that share the work of a community of practice among 12 large private funders, calling themselves Funders for Real Cost, Real Change (FRC)[1]. This first piece synopsizes the group’s work and lessons about the importance of equity. The series borrows its name and some language from a February 2021 post by the first author on the Center for Effective Philanthropy blog.
“Programs do not occur in a vacuum and indirect cost recovery is critical to continue to deliver high quality programs and ensure core mission support is adequately funded.” — a nonprofit leader
The Nonprofit Starvation Cycle & Importance of “Overhead” Expenses
Strong arguments have been made for years about why funders should provide more multiyear general operating support (MYGOS) versus restricted project support. MYGOS provides maximum flexibility to nonprofits to achieve their mission from a position of organizational strength. If the arrival of COVID-19 and a renewed call for racial equity and justice have taught us anything, more MYGOS will make a big difference.
Yet, many funders do not, and may never, see their role as supporting entire organizations. They continue to believe that they will best achieve impact by funding specific projects, programs, or activities. And some funders who do provide general operating support continue to believe that project support remains a viable and appropriate tool in certain circumstances.
Still, it is simply not possible for any enterprise to create, deliver, and refine goods and services that meet needs without spending on crucial functions such as planning, leadership development, finance, human resources, IT, facilities, equipment, and even fundraising and marketing. These infrastructure necessities require dollars to support them. They are critical for nonprofits to deliver successfully on anything funded by project grants.
With this in mind, a funder collaborative aimed to tackle the question: Can project grants be structured in ways that do a better job of supporting the organizational health of their recipients?
Forming a Funder Community of Practice to Address the Cycle
The presidents of five large private foundations[3] commissioned research from The Bridgespan Group[4] which led them to conclude in 2018 that “the starvation cycle” is real and that their foundations were contributing actors. Aware that addressing this vexing problem requires multiple approaches, the presidents invited peers to join an effort to conduct further research and explore solutions that could work for their own foundations as well as the broader philanthropic community. In an April 2019 letter, the presidents acknowledged that “impact-seeking organizations must be healthy, resilient and innovative in order to be effective.” These words would establish a community of practice—later named Funders for Real Cost, Real Change (FRC)—to address the nonprofit starvation cycle.
The collaborative was facilitated by the writers of this article at BDO FMA, a 20-year-old national consulting firm building the fiscal and operational capacity of nonprofits and helping funders develop grant-making practices that support grantee health.
Upon expanding from five to a dozen institutional funders in June 2019, the community of practice comprised more than 40 staff among the member institutions who took on several key tasks:
- Developing a straightforward set of guidelines and a tool to help nonprofits calculate an organization-level indirect cost rate that can be discussed with funders.[5]
- Commissioning research to understand the effects of the starvation cycle on NGOs outside the U.S.
- Considering a range of options for structuring project grants to support organizational health, beyond the typical approach which requires nonprofits to create line-item project budgets and limits amounts allowed for “overhead”.
After two and a half COVID-interrupted years, the members of the collaborative—informed periodically by nonprofit leaders who were compensated for their time—seek to share the outcomes of their work and invite the philanthropic and nonprofit fields to engage with and build upon their efforts.Meaningful Progress Among Collaborative Members
Upon establishing the community of practice, it was made clear that members need not commit to making changes to their policies and practices—only that they would contribute their expertise and inquisitiveness to the work. As the community wrapped up its work in December of 2021, nine of the 12 members had made meaningful changes. Others are exploring changes in 2022, and most anticipate exploring future changes. Actions taken to date by funders in the collaborative include:
- Updating indirect cost policies on project grants either to increase the allowable rate or remove a cap (several funders increased their fixed indirect cost rates to at least 20%; it is common for such rates to max out at 15%)
- Increasing the proportion of general operating support grants made within their grantmaking portfolios
- Providing learning opportunities to staff to understand grantee financial health and better support the actual costs of project grants.
Acknowledging Equity – The Starvation Cycle Hurts Smaller Organizations More Than Larger Ones
In 2020, our society entered an unprecedented period with the onset of COVID-19 and the murder of George Floyd. The combination led the collaborative to repeatedly ask the question: How does insufficient coverage of indirect costs in project grants intersect with equity?
BDO FMA conducted research using available pre-COVID IRS Form 990 data from more than 240,000 organizations in the U.S. As presented in the graph below, we found that “reported” indirect cost (IDC) rates[6] are consistently higher for smaller nonprofits than for larger ones. The dark blue line, representing all nonprofits in the data set, was reinforced by data from the grantee portfolios of five foundations that are BDO FMA clients (each foundation is represented by a line of a different color).
On every line, the median IDC rate reported by organizations with annual expenses above $100 million was less than 15%, while in most cases the median IDC rate reported by organizations with less than $2 million in annual expenses was at least 20%. This suggests economies of scale whereby the core costs of running an organization decrease as a percentage of total costs as organizations grow.
As a result, low fixed-rate indirect cost policies on project grants will generally be more harmful to smaller organizations.
Most nonprofits and NGOs are at the smaller end of this spectrum—in the U.S., two-thirds of the organizations in this 990 data pool have annual expenses less than $1 million. Many would agree that smaller organizations are critical contributors to civil society.
Research by others in the field, as well as observation by the participants in the collaborative of their own grantee portfolios, indicates that Black, Indigenous, and People of Color (BIPOC)-led nonprofits are on average smaller than white-led organizations, and thus tend to be more burdened by low caps on indirect cost coverage than do white-led organizations. In addition, BIPOC-led nonprofits tend to have less access to the kind of flexible philanthropic support that can pay for indirect costs and infrastructure investments (e.g., high net worth donors, special events, direct mail). This “double whammy” severely burdens smaller organizations, including those led by and serving communities of color, in their efforts to achieve financial health.
Urgency to Address the Cycle
The work of this funder collaborative suggests strongly that institutional and individual philanthropists have an opportunity to ensure that grantees are able to invest in the infrastructure necessary to deliver on the programs they—and their funders—want to achieve. This is especially important for smaller and otherwise under-resourced organizations. With some creativity and willingness (see the third article of this series for some options), project grants do not have to be the enemy of the organizations whose work they aim to support.
Upcoming Articles and The Future of This Work
In the coming weeks, two more articles about the work of this funder collaborative will be posted in The Chronicle. One will share research results of the starvation cycle’s impact on NGOs worldwide, based on data among organizations in 10 countries across five regions of the globe. The final piece will lay out four options for improving indirect cost recovery being explored by the members of the collaborative and worthy of consideration among their philanthropic peers.
The funders have resourced a partnership of philanthropy-serving organizations (PSOs) to further engage the funding, nonprofit, and NGO communities globally on the work developed by FRC. Those PSOs are Ariadne, a European network of funders, and EDGE Funders Alliance, a global philanthropy network. To sign up for a mailing list to learn more about engagement efforts starting later this spring, click here.
Rodney Christopher, John Summers and Katrina Bandong are on the philanthropic services team at BDO FMA. They served as facilitators and content developers for FRC. They wish to acknowledge contributions to the work of FRC by Alicia De Toffoli.
[1] Funders for Real Cost, Real Change (FRC) was a collaborative of 40+ staff from 12 private philanthropic institutions that from 2019 – 2021 explored ways to improve indirect cost recovery in project grants. Members included Arnold Ventures, Conrad N. Hilton Foundation, David and Lucile Packard Foundation, Ford Foundation, James Irvine Foundation, John D. and Catherine T. MacArthur Foundation, Oak Foundation, Open Society Foundations, Robert Wood Johnson Foundation, Rockefeller Foundation, W.K. Kellogg Foundation, and William and Flora Hewlett Foundation. FRC was facilitated by BDO FMA.
[2] A term coined by Ann Goggins Gregory and Don Howard at The Bridgespan Group in a Fall 2009 Stanford Social Innovation Review article.
[3] Those five presidents were: Darren Walker, Ford Foundation; Larry Kramer, The William and Flora Hewlett Foundation; Julia Stasch, The John D. and Catherine T. MacArthur Foundation; Patrick Gaspard, Open Society Foundations; Carol Larson, David and Lucile Packard Foundation.
[4] Ending the Nonprofit Starvation Cycle, published in the Chronicle of Philanthropy, paid for and created by The Bridgespan Group, September 2019.
[5] Indirect cost rates are a calculation of an organization’s total indirect (administrative and fundraising) costs divided by direct (program) costs. When project grants add an indirect cost rate to the direct costs in a grant, it allows an organization to cover a proportionate share of the indirect costs associated with the funded project.
[6] While these ”reported” indirect cost rates are based on calculations from IRS Form 990 filings, it is important to understand that nonprofits often feel pressure to under-report indirect costs in such public-facing documents. Research described in the “Ending the Nonprofit Starvation Cycle” series noted above found that a sample of 22 nonprofits generally had higher “actual” indirect cost rates than those reported publicly.