Project Grants Need Not Be the Enemy: Part 3
This is the final of a series of three articles that share the work of a collaborative of 12 large private funders, called Funders for Real Cost, Real Change (FRC)1. The first piece synopsized the group’s work and lessons about the importance of equity considerations in project grantmaking. The second shared the results of groundbreaking research on the impact of the starvation cycle on NGOs worldwide, based on data among organizations in 10 countries across five regions of the globe. This article describes four grantmaking approaches explored by FRC for project grants that cover true costs and support healthy, resilient and innovative organizations.
Four Options for Project Grants that Support Grantee Health
“The funder community needs to be honest about recognizing the cost of a project and paying that ‘price.’”—a nonprofit leader
After two and a half years of exploration and discussion, including input from grantees themselves, the dozen foundations participating in Funders for Real Cost, Real Change identified four options for better project grantmaking:
- Funding the actual indirect cost rates of grantees as calculated according to an agreed-upon methodology
- Establishing a fixed or sliding scale indirect cost rate on project grants that is sufficient to cover most grantees’ indirect costs
- Issuing flexible project grants that allow for surpluses and do not require budgets delineating direct and indirect costs
- Supplementing project grants with general operating support
These options are not mutually exclusive. Funders may choose among these approaches based on grantee, grant type/amount, and other considerations. Nor are they listed in order of priority or preference; each option has advantages and disadvantages relevant to particular grantmaking situations.
Option 1: Funding actual indirect cost rates
A primary driver of the “starvation cycle” is the low cap on indirect cost rates that most funders impose on project grants. Grantees with a rate higher than allowed by a funder’s policy therefore see a gap in coverage of overhead costs—a gap which must be made up by other income, or by starving the important functions that indirect cost recovery supports. These functions include planning, leadership development, finance, human resources, IT, facilities, equipment, and even fundraising and marketing. One solution to underfunding indirect costs is simply to fund those costs at the rate that they are actually incurred by grantees.
Challenges with this approach include the lack of a clear and universal definition of what constitutes “indirect cost” for nonprofits. Individual funders often have different policies and standards on indirect cost calculation and coverage, while grantees have not had a single authoritative source of guidance for presenting an indirect rate on all project grants.
The collaborative has attempted to address this challenge by commissioning experts to develop guidelines and a tool for categorizing costs as direct or indirect within the context of a particular organization’s business model.2 These guidelines can serve as a basis for any grantee to present an indirect cost rate and for funders to understand the basis for that calculation. Funders could then apply the rate to any project grants issued, subject to limitations in a funder’s own policies.
Even with the guidelines, however, challenges inherent to this approach still exist. Some nonprofits—particularly smaller ones—may lack the finance expertise and systems necessary to use the guidance, leaving them unable to take advantage of potentially more generous rates. And grantmakers themselves must understand the methodology used to calculate indirect cost rates to ensure that grant budgets are aligned with grantees’ cost categorizations, which requires a level of budget analysis and scrutiny that private funders may wish to avoid.
Also, given the constraints of the “starvation cycle,” grantees’ actual indirect cost rates may represent an underinvestment, meaning that a grantee’s true indirect costs could still be inadequate for building and supporting an effective management infrastructure.
With those caveats in mind, circumstances in which funding actual indirect cost rates may work as a solution to the problem of underfunded costs include:
- Grantees with the capacity and/or support necessary to calculate an indirect cost rate based on guidelines
- A defensible assumption that grantees invest appropriately on indirect functions
- Grantmaking staff who understand and can have informed conversations with grantees on cost categorization
Option 2: Adequate fixed-rate indirect cost policy
Given the challenges associated with funding actual indirect costs, some funders may choose an approach of offering a fixed indirect rate on project grants. Many funders currently do this but typically use rates lower than necessary to cover the actual (much less ideal) indirect costs of grantees. Simply raising allowable indirect cost rates to a level sufficient to cover a fair share of indirect costs would improve project grantmaking.
Funders in the collaborative who have chosen a revised fixed rate approach have conducted research to determine adequate rates for their grantees.
The Robert Wood Johnson Foundation developed a policy providing a standard rate (20%) that covers the indirect cost rates calculated from IRS Form 990 data for the majority of its grantees. The MacArthur Foundation adopted a 29% indirect rate on project grants based on analysis (also using Form 990 data) indicating that this level is associated with financially stronger organizations.
As presented in the first article of this series, BDO FMA’s research indicates that—likely due to economies of scale—indirect cost rates tend to decrease as organizations grow. Based on this information, the Annie E. Casey Foundation has adopted a “sliding scale” policy in which grantees with smaller budgets are eligible for higher rates than larger grantees.
Circumstances in which a fixed-rate approach may work as a solution to the problem of underfunded costs include:
- Funders can set a rate appropriate to their grantees’ true indirect cost rates, ideally with a “cushion” for grantees who may be underinvesting in those functions
- Desire for an approach that reduces the complexity of organization-specific rates and calculations
Option 3: Issuing flexible project grants that allow for surpluses and do not require specifying direct and indirect costs
A more creative option is to do away with line-item budgets and distinctions between direct and indirect costs entirely, treating grant dollars as flexible in executing a project. While this would be a significant departure from the way most project grants are currently structured (although typical of contracts with consultants and vendors), this option has several potential benefits to both grantees and funders.
Flexible project grants would eliminate the time-consuming process of developing and reviewing line-item budgets, which frankly are often “backed into” to reach a pre-determined amount anyway. Instead, grant discussions could focus primarily on scope and impact rather than on details of spending plans, simplifying grant review and directing focus to more mission-oriented elements of the funder/grantee relationship. And budget conversations could center on the overall resources required to execute a project and provide the grantee the autonomy and flexibility to manage that budget.
This approach could also address a critical flaw of project grants for the financial health of grantees. If the amount of a grant equals the cost of a project, then the best possible (financial) result for the recipient on that grant is break-even. An organization funded purely by break-even grants can never generate more income than expense, and thus can never accumulate assets to draw on in case of financial challenges or to invest in its mission.
A grant not tied to the “spend down” of specific line items permits the possibility of a financial surplus that could be used by grantees to address underfunded infrastructure needs and build reserves. Of course, such surpluses are only possible if grantees are able to understand their business model and cost structure to appropriately “price” their work, and to manage projects effectively while not exhausting all of the funds. But creating incentives to do those things is itself a potential benefit of flexible project grantmaking.
Circumstances in which a flexible project grant approach may work as a solution to the problem of underfunded costs include:
- Grantees who understand (or get support to understand) their business model and cost structure
- Trusting funder/grantee relationships that allow for honest negotiation about the scale, scope and costs of projects
- Grantmakers open to funding projects on the “cost-plus” basis typical of contracts with for-profit vendors
Option 4: Supplementing project grants with general operating support
Inadequate indirect cost funding generally forces grantees to rely on unrestricted donations to cover essential infrastructure costs. Given that, providing project grantees with additional funding—in the form of general operating support—is a simple solution, and can be used instead of or in combination with the options described above.3
A potential advantage of this approach lies in its ability to be applied on an as-needed basis in ways that may be more difficult with a one-size-fits-all policy. There’s also potential to address equity considerations that overlap with inadequate cost coverage, such as the fact that under-resourced organizations often have limited access to donors likely to provide unrestricted funds. Grantmakers who are so inclined can use general operating support to augment project funding while also addressing issues of resource equity.
On the other hand, the flexibility of this approach could also raise concerns about a lack of transparency (and comprehensiveness) in the way it is deployed. Ideally, it should not be the sole means for funders to address issues of inadequate funding of project grants. Instead, this approach could be an important supplement to other grantmaking options by ensuring that the needs and circumstances of individual grantees are taken into account.
Grantmakers who are persuaded that insufficient indirect cost recovery is a burden to grantees should consider changes that—one way or another—increase indirect cost rates on project grants. But “increasing indirect cost rates” is an empty message without actions that make such increases a meaningful change in project grant funding. Specifically, increasing indirect cost rates requires grantmakers to make one (or more) of the following changes in their grantmaking practices:
- Increase grant amounts to accommodate increased indirect cost reimbursements. The most straightforward way to increase indirect cost rates is to increase the overall size of grants. This would allow for project grants to fund the direct costs of project delivery while covering more of the grantee’s indirect costs. This change also means increasing overall grantmaking budgets, which may be an obstacle for some funders.
- Reduce the number of grants to accommodate increased indirect cost reimbursements on remaining grants. If overall grantmaking budgets do not increase, then increased indirect cost rates have to fit into an existing budget. One way to make this math work is to decrease the number of grants, redistributing the dollars from eliminated grants into increased indirect cost recovery for remaining grantees.
- Reduce the direct cost portion of grant amounts to accommodate increased indirect cost reimbursements. Another way to make the math work is to re-balance the proportion of direct and indirect costs on a grant, in effect decreasing the “project” portion of the grant to make room for additional indirect cost funding. But the scope, scale or timing of the project must align with project funding—otherwise the grantee is being asked to do more project work on a reduced budget and the “increase” in indirect cost funding is in name only. (Note that this option may be dissatisfying to grantees—or grantmakers—who do not wish to reduce a project’s scope and impact.)
Funders have an opportunity to reshape philanthropy with innovative approaches to supporting grantee health and ability to achieve long-term impact. But “raising” indirect cost rates without also taking steps to ensure that those rates translate into grantees’ ability to fund indirect costs is no improvement at all.
Members of FRC are exploring these options and invite their peers in philanthropy to do the same.
John Summers, Rodney Christopher and Katrina Bandong are on the philanthropic services team at BDO FMA. They served as facilitators and content developers for FRC.
The members of FRC 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.
1. Funders for Real Cost, Real Change (FRC) was a collaborative of 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. In addition to guidance from experienced members of FRC, the guidelines and tool received several rounds of compensated input from nonprofit leaders and were tested by three organizations before publication.
3. Beyond FRC, this idea was also identified in a March 2021 blog post by Nick Addington, Chief Executive of the William Grant Foundation in the U.K. Two Practical Ideas to Increase Unrestricted Funding, IVAR blog, March 2021