Why Funders Should Pay for the True Costs of Nonprofits’ Work — Not Just the Direct Project Expenses

09/04/2019 |

Summary

How foundations fund is just as important as what they fund. Coverage of actual costs is critical for grantees’ organizational health, and we need strong organizations to have impact.

If foundations want to change the world, what should they fund?

Our answer may surprise you. As foundation program officers, we are motivated by — and have grant-making portfolios that target — specific issues. Norma works with African governments in using data and evidence to improve policy decision making and, ultimately, citizens’ lives. Marissa supports social-justice organizations and networks working to disrupt social, economic, and political inequality. And both of us are convinced that how we fund is just as important as what we fund. That’s why we teamed up with other funders to determine if we are sufficiently covering our grantees’ overhead costs.

In spring 2018, a five-funder collaborative (comprising the Ford, Hewlett, MacArthur, Open Society, and Packard Foundations) conducted a pilot project to explore how well current project grants provided for nonprofits’ indirect costs — their nonprogrammatic expenses, such as executive leadership and administrator salaries, technology, rent, and office supplies. To this end, the pilot undertook a process of “third-party indirect-cost verification,” during which external financial experts worked one on one with 22 grantees to calculate each organization’s indirect-cost rate: their ratio of total indirect costs to total direct costs.

Here’s what we learned.

Grantees typically are unable to secure sufficient funding for the indirect costs associated with their project work, and this hampers their impact.

Mirroring trends in the broader sector, the pilot results demonstrated a pattern of underfunding for project grants. Among the pilot participants, indirect-cost rates ranged from 12 percent to 60 percent. Across the sample, grantees’ verified indirect-cost rates exceeded our foundations’ allocations by an average of 17 percentage points. In terms of total cost coverage, this means the participating funders paid an average of 88 cents for every dollar of grantees’ actual expenses, creating a shortfall of roughly $12,000 for every $100,000 worth of work executed by the organization.

For a host of reasons, it can be difficult for grantees to ask for the funding they truly require. For instance, they may not have an in-depth knowledge of their cost structure, they may feel pressure to conform to unrealistic expectations around low overhead, or they may be uncomfortable questioning a potential funder’s approach to grant making, or some combination of these.

Regardless of why, the result is the same. Insufficient cost coverage actively undermines grantees’ ability to reach their goals.

When it comes to achieving impact and driving systemic change, resources make a huge difference.

We have the privilege of serving as program officers at foundations that give us access to a range of resources — from strong administrative support to sophisticated IT systems — that enhance our ability to deliver results.

By the same token, underresourcing hampers execution. Understandably, it is difficult for any grantee organization to focus fully on advancing the progress of a particular project while scrambling to cobble together funding for overhead costs. As funders, when we pay nonprofits’ actual costs, we provide our grantees with the time, space, resources, and freedom to realize their vision for impact.

Indeed, in the absence of adequate funding, grantees sometimes forgo high-impact opportunities. For example, a project-grant recipient working in Liberia nearly turned down an invitation to present its work to government leaders because the program staff members on the ground were overextended. Although this particular grantee was able to mobilize the resources necessary to respond to an unanticipated impact-multiplying opportunity, other organizations in similar situations often cannot do so.

We, along with our colleagues at the Ford and Hewlett Foundations, have found that unrestricted funding can increase grantees’ responsiveness and ingenuity when presented with opportunities (and challenges). For instance, an organization that recently received a general-operating-support grant from the Ford Foundation has decided to put this flexible funding toward strengthening and diversifying its leadership pipeline, thus mitigating risk of key-personnel dependency for the first time in its multidecade history. As this example indicates, grantees can involuntarily neglect core organizational needs in the absence of funding for nonprogrammatic expenses.

Coverage of actual costs is critical for grantees’ organizational health, and we need strong organizations to have impact.

By definition, project-centric funding divorces the success of a project from the overall strength of the grantee organization. In the abstract, it is clear that a grantee’s ability to generate impact will correlate closely with its organizational capacity. In practice, project funding obscures this connection, thereby allowing funders to justify making grants that fail to provide sufficient coverage of indirect costs.

When we fund projects, we find that the work rarely ends when the project does. Of the projects we have funded over the years, many have succeeded, and others have failed. In all cases, whether there was impact years later depends on the organization behind it. As funders, how can we expect organizations to thrive if we pay them only 88 cents on the dollar (and often much less)?

You don’t need to be a financial whiz. What’s most important is candid discussions with grantees about their actual costs.

Many grant makers — including us — don’t have the data or the technical skills required to calculate a grantee’s indirect-cost rate on their own. The five-funder pilot demonstrated the viability of using third-party indirect-cost verification to establish a credible indirect-cost rate — a rate that any funder can integrate into its project grants. Third-party verification is not only a tool for funders; the pilot’s nonprofit participants unanimously valued this independent technical support: 100 percent said they would recommend the process to peers.

Indirect-cost verification may not be the right option for all grantees or funders, but many would find it helpful. One of the core benefits was that it created a safe space for transparent, cost-focused conversations. Many nonprofits, including small ones, already have, or can hire, the financial expertise needed to calculate more accurate indirect costs.

Long-term, flexible funding relationships cultivate trust and true partnership.

Whether funders provide support to grantees at the project level or the enterprise level, adopting a longer term perspective and building flexibility into grants transforms our relationships. They move out of a transactional, grant-by-grant mode and into more strategically oriented partnerships.

Our main advice is simply to try it. Talk to a handful of grantees about these issues. Encourage them to calculate their true indirect-cost rate, if they don’t already know it. Carve out a little budget space to pay that true cost or to provide some flexible support, or both. See if it helps improve your working relationships and advance your goals for impact in the same way it has benefited ours.

Norma Altshuler is a program officer in Global Development and Population at the William and Flora Hewlett Foundation. Marissa Tirona is a program officer at the Ford Foundation, where she works on the BUILD initiative (Building Institutions and Networks).

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