Balancing the Mission Checkbook

There was a breakthrough last week for nonprofits. In a joint announcement, Guidestar and other major charity “watchdogs” made a very strong case that overhead ratios are meaningless. The phrase used in the opening paragraph says the ratio is “useless for evaluating a charity’s impact.” Read the full release The Worst (and Best) Way to Pick a Charity This Year and then copy it to share far and wide. Some of the reasons for de-emphasizing this ratio cited in the announcement will be familiar to nonprofit leaders:

• It tells you nothing about the impact the charity has on the people it’s trying to help.
• It discourages charities from investing in tools and expertise that would make them more effective.
• The rules for determining overhead costs are vague and every charity interprets them differently.

Hooray! I’ve been one of many voices speaking out on this problem for a long time, most recently in the post Donors and Overhead: Maybe They Don’t Care. This step by some of the most prominent national watchdogs, especially Charity Navigator, is huge. Ken Berger, CEO of Charity Navigator, elaborated on his own blog:

We do concur with the fundamental truth that the most critical dimension in evaluating a nonprofit has to do with achieving meaningful results.

Charity Navigator has been criticized for relying too heavily on the overhead ratio and other simplistic measures for their rating system. Berger has been blogging about their plans to shift to a more comprehensive approach, and this announcement is a breakthrough.

This feels like a gamechanger because now we can stop arguing about whether overhead is an accurate measure of charity performance. It’s not. Clearing that hurdle doesn’t get us to the finish line, though. Everyone in the nonprofit sector should cheer that the watchdogs are encouraging donors to review the impact and effectiveness of nonprofits - but how? There is not a single, simple alternative method to evaluate the effectiveness of all nonprofits. It’s essential for nonprofits to invest some time and brainpower to figure this out.

The organizations behind the press release have their own approaches:

• Consumer reviews: The personal experience approach of Great Nonprofits relies on a broad network of people who are involved with nonprofits to submit comments and ratings. Users of the website can search and browse for stories that interest or inspire them. Think of this as the Amazon reader reviews or TripAdvisor comments equivalent for nonprofits.

• Experts: Philanthropedia, on the other hand, relies on panels of experts in four different fields to pool their knowledge and assessment of which nonprofits are the “top” in effectiveness. Their “mutual funds” of nonprofits can become your vehicle for giving. In some ways this is a global, scaled up version of how we’ve used the local United Way.

• Data: GiveWell has a laser focus on reliable research and evaluation at nonprofits to support anecdotal stories or claims about impact. Read about their low opinion of the way nonprofits currently evaluate effectiveness. If better quality outcomes supported by good evidence is needed, then GiveWell will be there pushing us all.

Whatever approach you trust or endorse, get to it now. It will take us a long time reverse course for all the donors, advisers, and institutions that have used the program cost ratio as a stand-in for value. You’re going to have to offer some other data to replace it. Make it mean something. Ken Berger of Charity Navigator issued this call to action:

The nonprofit sector must get its act together and make sure it is really helping provide meaningful change in communities and peoples lives. It is life or death for many of those we serve whether we are effective or not. So let’s work together to measure, manage and deliver what is really important to make our world a better place.

I am so glad that I’m not the director of a Minnesota charter school. Imagine working in a small segment of the nonprofit sector, comprised of 150 organizations, and opening the paper to regularly find a headline announcing that your field is “out of control” or in “rough waters.” Meanwhile, you go to work every day to lead the teachers at your school and together work to educate the students whose families have chosen to enroll at your school. I wouldn’t appreciate, much less enjoy, the attention. Every report brings with it questions about whether our hypothetical school director is among those with the problems described in the news. Whatever the current condition of this individual school, they end up tainted a bit by the sheer volume of news.

In just the past week, our hypothetical charter school director has seen these reports:

• State charter schools program is ‘out of control’, reports the Star Tribune in an investigative article about the use of bonds for financing of 18 buildings for charter schools.
• The Pioneer Press reported Strapped St. Paul charter school to close midyear on the decision by the board of directors of Skills for Tomorrow school to close at the semester break because of declining enrollment.
• Last week, in Payment shift makes rough waters for charter schools Minnesota Public Radio provided background and examples of the impact on charter schools of the state’s new deferred payment schedule for all public school payments.

While each news story is accurate, it does not paint an accurate overall picture. The individual schools don’t have the chance to explain all of their plans, budgets, and curriculum philosophy to the community. I have a deep enough understanding of charter schools to respond to each with the comment that “it’s more complicated than that.” I don’t want to gloss over some very real issues with finance, leadership and governance at some charter schools, but I am trying to figure out why this small group of nonprofits is such a magnet for news, investigation, and opinion.

As some background, Minnesota was the first state in the nation to create “charter schools.” Today Minnesota has about 150 operating charter schools, with roughly half in the Twin Cities Metro area, and the remainder in Greater Minnesota. Together, these schools serve about 33,000 students. Charter schools are true public schools. They are created by state law, are funded by government, and are subject to most state laws governing public education. They cannot charge tuition and they cannot discriminate in admissions. They are subject to state graduation requirements and the mandates of the federal No Child Left Behind legislation. Structurally, charter schools are both nonprofit corporations and independent school districts.

This structure presents complexities that affect both governance and financial management. As I detailed in a previous entry, Charter school myths and realities, the reality is that the management quality of most charter schools in Minnesota is on par with the management of nonprofit organizations overall. The vast majority of charter school directors and teachers are hardworking, mission-focused, committed educators, and I thank them for their work.

For such a small group of organizations, charter schools attract an awful lot of attention, scrutiny, and criticism. As a community, we feel strongly about education and about the use of taxes and public funds. Charter schools are right in the middle of both.  The field needs to find a way to communicate their value to the community - unless they like opening the paper every day to read another report about problems.

Three cheers, at least, are deserved for Grantmakers for Effective Organizations (GEO) new publication On the Money by Nancy Burd. You can download either the executive summary or full report from the website.

As summarized on the GEO website:

This publication highlights the financial challenges nonprofits face and the ways in which grantmakers are both improving the situation as well as perpetuating the problem.

The first section, Assessing the Problems, identifies five problem areas:

1. Restrictions on Funding
2. Misperceptions Around Sustainability and Growth
3. “Too Many Masters”
4. Onerous Grantmaking Practices
5. Knowledge Gaps

The other sections discuss Barriers to Smarter Grantmaking and Ideas for Grantmakers.

It’s impressive how in 28 pages the author distills a variety of ideas, research, and practices about the realities of financial instability faced by nonprofits. The report also provides helpful and realistic suggestions for grantmaking organizations based on practices that have already been developed and implemented by foundations.  The advice and guidance for funders is great, but this guidebook is a must read for everyone in our sector.

I’m pleased that GEO will be focusing on nonprofit finance and encouraging foundations to understand how “many prevailing approaches and practices in philanthropy can unwittingly create problems for the nonprofit sector.” Many nonprofits have experienced these unintended consequences and will welcome a dialogue on this topic.

However, nonprofit organizations also have a lot to learn from the report’s comprehensive overview of grantmaking. Misconceptions about the true cost of programs and capital needs apply equally (or more) at many nonprofits. We can’t expect a seismic shift in foundation practices and investment unless we nonprofit leaders understand and can effectively communicate what it takes to sustain ourselves.

Download this report, read it, and copy it for your board and senior staff.

Last week I had the pleasure to participate in the final round of judging for the Minnesota Cup business plan competition, “looking for the next great entrepreneurial success story in our state.” The judges finished the afternoon of presentations from the six impressive finalists with some discussion about the strengths and weaknesses of the business plans. Everyone agreed that all of the ideas were innovative and had great market potential. Most of the questions boiled down to execution – did they have the right people beyond the founder, would they be able to build the kinds of systems and structures they would need, would they have enough capital to spend to build the systems? The judges understood that breakthrough ideas are only as good as the follow through and structure to make them happen. The day ended with a well attended event and announcement of the winning business plan.  Each finalist won some seed funding and pro bono professional services for prevailing at the division level and the grand prize included more seed funding to implement the plan.

What a stark contrast, then, to read The Bridgespan Group’s recent article The Nonprofit Starvation Cycle about the causes and consequences of weak infrastructure at many nonprofits:

Organizations that build robust infrastructure—which includes sturdy information technology systems, financial systems, skills training, fundraising processes, and other essential overhead—are more likely to succeed than those that do not. This is not news, and nonprofits are no exception to the rule.

The judges for the Minnesota Cup business plan competition certainly know this about business. But what would be the questions raised by a corollary panel reviewing nonprofit plans? Unfortunately, I think they would focus on overhead ratios rather than the importance of having the right systems, structure, and technology to implement the plans, along with sufficient operations and finance staff. The infrastructure that’s encouraged for growing business is overlooked (or undermined) for nonprofits.

The Bridgespan Group believes that this starvation cycle begins with funders:

Our research reveals that a vicious cycle fuels the persistent underfunding of overhead. The first step in the cycle is funders’ unrealistic expectations about how much it costs to run a nonprofit. At the second step, nonprofits feel pressure to conform to funders’ unrealistic expectations. At the third step, nonprofits respond to this pressure in two ways: They spend too little on overhead, and they underreport their expenditures on tax forms and in fundraising materials. This underspending and underreporting in turn perpetuates funders’ unrealistic expectations. Over time, funders expect grantees to do more and more with less and less—a cycle that slowly starves nonprofits.

I think that the authors describe the cycle perfectly, but you could replace the word “funders” with “boards of directors” or several other nonprofit stakeholders just as accurately. The burden of breaking the starvation cycle is shared and will require us to understand the real value of infrastructure in accomplishing mission. Start with this question: what could you achieve in the community if your organization had the structure – systems, facilities, processes, staff - that were needed for long term success? What would you need to make that happen, and how much would it cost?  For the entrepreneurs at the Minnesota Cup, their potential investors understand the importance of seed funding to build the staff and systems needed for success. We in the nonprofit world need to learn the language and incentives to advocate for infrastructure funding critical for community success.

I’m convinced that the reason that people care about the overhead ratio of charities is because we keep telling them that it’s important. I have an announcement to make: I am a donor to quite a few nonprofits, and I don’t care what percentage of their budget is spent for overhead. I think that a lot of donors would agree.

Yet, in another article advising us about charitable giving, 5 Tips on How to Stretch Your Charitable Dollars published in the New York Times online published by the AP and picked up by the New York Times and other newspapers, overhead is (once again) emphasized:

Tip #2: EXAMINE CHARITIES CLOSELY. Do the same due diligence on your donations that you would your investments or your business…
Pay especially close attention to the overhead. Anything above 9 to 14 percent is out of line and signifies that too much money goes to staff or office space and not enough to the beneficiaries, according to Stephanie Risa Stein, managing director of New York-based Philanthropic Capital Advisors LLC.

Here’s my soapbox

I agree that it’s wise to “Do the same due diligence on your donations that you would your investments or your business.” But when I review an investment opportunity, I review based on the expected criteria for a successful business - profitability, market share, and returns. I don’t review their overhead and management costs. So why would overhead be the criteria for a charity?

I’d like to re-write this “tip.”

EXAMINE CHARITIES CLOSELY. Do some due diligence on charities before you donate, just as you would for an investment or business opportunity. Pay especially close attention to how successful the nonprofit has been at achieving its mission. Do they provide information about how effective their programs are and what impact they have on the people and communities that they serve? Do they have a way to measure and communicate progress and/or success?

I put these two types of “due diligence” to the test with five Minnesota nonprofits that I have supported in the past. I looked at the 990s on Guidestar and found that their overhead ratios ranged from 5% to 17%. Then I looked up web sites and annual reports. Here’s what I (a donor) care about:

• St. Stephen’s Human Services provided food and shelter to 6,000 very poor adults and children
• CommonBond Communities houses 7,850 residents in quality affordable housing
• Admission Possible had a 99% success rate in students admitted to college
• Ten Thousand Things presents astounding theater to people in homeless shelters and prisons
• Minnesota Fringe Festival creates connections for audiences and artists that’s the envy of theater communities in many other cities (the 2009 festival starts this Thursday).

Which of these has the “best” overhead ratio?

I don’t care.

I care that they are effective nonprofits that can tell donors what they do and why it matters. Why would a donor rather examine overhead? Before someone jumps on this point, I agree that 90% on fundraising is completely unreasonable, but that kind of organization can’t demonstrate real results anyway. So can we stop using overhead as the primary criteria for donors - please?

One positive comment about this article - Rich Cowles, Executive Director of Charities Review Council is quoted with good advice for donors about budgeting and planning their giving. Nice national recognition of the Council’s good work and solid reputation.

For years I’ve wished that the programs of the Small Business Administration (SBA) were available to nonprofit organizations. The SBA is all about strengthening the country’s economy, and as a business banker the SBA was at the top of my list of resources for entrepreneurs as they started and grew their businesses. When I made the change to work exclusively with nonprofit organizations I was disappointed to lose access to those programs. Nonprofits are businesses, after all, with a significant role in employing people and generating economic activity. Minnesota Council of Nonprofit’s Minnesota Nonprofit Economy Report for 2008 reports that nonprofit employees represent about 10% of the states’ workforce, paying $12 billion in wages.

What I’ve missed most were the Small Business Development Centers that offer workshops and one on one help and the SBA loan programs that provide crucial growth funding. In a way, Nonprofits Assistance Fund and other capacity building organizations have filled this role for nonprofits.

Potential Nonprofit Resources

I’m very glad to know that the beginnings of some new resources for growing strong nonprofits are contained within the Serve America Act, passed in the last week in both a Senate version and House version. The President is expected to sign it next week. The amendment that creates a new program for nonprofit capacity building is summarized here by Independent Sector.

Housed within the Corporation for National and Community Service, the bill authorizes $25 million over five years to provide organizational development assistance to small and mid-size nonprofit organizations, in particular to “strengthen small charities around our country, especially where resources are scarce.”

I’m hopeful that we can get these resources out in the community soon, focused on building strong community organizations that know how to balance mission and management. I’ll keep waiting for an SBA loan program for nonprofit businesses. In the meantime, if you are in Minnesota and need working capital or a line of credit, Nonprofits Assistance Fund’s loan fund is here.