Balancing the Mission Checkbook

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.

I think that I’m losing my ability to be patient and finesse conversations about how nonprofits can deal with the recession. Instead, I’m becoming a blunt instrument with one recurring message - Act Now.

Unfortunately, quite a few nonprofits are in very fragile financial condition and don’t have much elbow room. In other circumstances, I like to work through the possibilities and understand the complexities and reasons behind a nonprofit’s structure and history. Now it’s all about speed.

For example, in the last two weeks I’ve made these very direct and difficult comments to leaders of three different nonprofits:

• Direct comment 1: “I think that your grant budget is unrealistic. I think that you need to create a scenario budget plan to reduce expenses by 30%.”

• Direct comment 2: “Based on your history of recurring operating deficits, you need more than a few expense reductions. You need to reconsider the entire structure of your programs.”

• Direct comment 3: “You don’t have time to research some new grants. You’ll be out of cash in one month.”

Not much finessing here. Because of this need for urgency, we developed a Recession Risk and Preparedness Assessment for nonprofits to quickly identify how urgently they need to act and where to start. These twenty questions cover financial condition, financial information, organizational change factors, and leadership. Use it to find your starting point.

In this week’s issue of The Chronicle of Philanthropy, consultant Pat Nichols described how frustrating it is to watch ineffective and slow reactions to urgent situations in the article A CEO Survival Guide for Touch Times. Because this requires a paid subscription to access, here’s an excerpt of some key points in this excellent piece:

Center all decision making on the mission. If, in facing tough choices, we are not explicit and rigorous about how the decisions we make serve the mission, we have fallen short of our responsibilities.

Be open and engage everyone. Everyone will find this period and the process unsettling. No one, at the outset, can guarantee an outcome. What we can do, though, is find creative means to discuss what is happening and encourage participation from all quarters.

Move quickly but systematically. When uncertainty reigns, people draw comfort from knowing that, though there is no resolution at present, there is rapid and systematic movement toward a resolution.

Be hopeful in style and rigorous in analysis. This balancing act is, perhaps, the toughest of these principles to observe. As leaders, our colleagues depend on us to set a tone, and to convey hope. However, it is also crucial that we ask the tough questions and discount our desire to believe the best.

Live with ambiguity, acknowledge uncertainty. We must act on incomplete and imperfect information; we must make assumptions and decisions that will prove to be wrong. This requires that we acknowledge what we don’t know and be prepared to adjust when we are mistaken.

The time to act is now - for all of us.

All of us are reading waves of economic information right now - the stimulus, the proposed state and federal budgets - and are trying to sort out which parts have a direct impact on our communities and organizations. Both the stimulus and federal budget are big and bold and pretty overwhelming. There is so much to understand and analyze - thank goodness for some great resources like Minnesota Budget Bites and National Council of Nonprofits. I’m trying to keep up with the general framework and get into specific details when I need to. I hope that all of us who are committed to stronger communities will spend the necessary time to understand what’s needed and work together with the big picture in sight.

Considering the importance, scale and scope of the economic proposals, I am really disappointed that that the number one, highest priority, most important issue for many in the nonprofit world is the proposal contained in the President’s budget that would limit the extent of deductions for charitable contributions for those in the highest tax bracket, reported here in the Chronicle of Philanthropy.

Typical of the outcries in response is a statement from Independent Sector:

Independent Sector believes that this change could be a disincentive to some donors who might further cap their gifts on account of the new limit.

Most of the comments made by our well-known leaders include the phrase “In these hard economic times” and forecast doom if this change comes to pass.

I’m disappointed in this knee jerk reaction that’s just a version of NIMBYism at a time when we really need to pull together and work for the greater common good, which may involve sacrifice. Beyond that disappointment, I’m skeptical that doomsday will come. First of all, the change wouldn’t be effective until 2011, so it won’t impact donors “in this tough economic environment.” And if you really believe that your donors are in it for the tax deduction I think that you need to re-write your case statement. Surveys, like one conducted in 2006 by Center on Philanthropy at Indiana University for Bank of America, report that over 50% of the high net worth people interviewed would not decrease their giving even if there was no tax deduction at all. From what I’ve read, the tax deduction is more likely to impact the timing and form of a gift rather than whether a gift is made. It’s easy to get this form confused with substance. Consider this from Charity Navigator’s blog:

The data that we have seen over the years has shown a big spike in donations through our site during the last several days of the year, especially on December 31st which of course is the last day to make a qualified tax deductible charitable contribution (see our Tax Benefits of Giving article). This data indicates to us that the tax benefits really do motivate people to donate.

This logic needs checking - do the tax benefits “motivate” people to donate, or have we in the nonprofit world trained our donors to give in December regardless of their motivation? The New York Times article Limiting Deductions on Charity Draws Ire quotes several other experts about the relationship between tax deduction and reasons for giving and their confidence that taxes are at the low on the list.

Even if this tax code change would have an impact on total giving, it’s important to focus on the forest, rather than the leaves on the trees. The proposed federal budget blueprint represents a seismic shift in priorities and structure. I agree with blogger John D. Columbo’s comment:

So let’s not turn this into a doomsday scenario, folks. The truth is, if Obama can fix our health care system, charities as a whole (and everyone else, from GM to the local barbershop) are going to be much better off in the long run.

Independent Sector’s statement (quoted above) includes only one other paragraph about the rest of the 140 page blueprint for the federal budget:

The budget outline also calls for winding down spending for the war in Iraq, boosting funding for domestic priorities, and creating a “reserve fund” of $634 billion to cover health care expansion. The President has stated that his outline will cut the deficit in half by 2013.

Well, maybe that doesn’t seem that important to them.

Who needs to be accountable now?

Last December I posted an entry in response to a Wall Street Journal column by Sally Beatty in which I chafed at her observation that charities were not accountable enough about how they used donated funds. She said:

“It’s time to make sure our gifts are being used as intelligently as possible. Instead of showering hard-earned dollars on charities and hoping for the best, we need to demand clear, detailed information on the results of their efforts. We ask the government and public corporations to be transparent and accountable. Charities should meet the same standard.”

It seemed that a lot of business leaders held this same view of nonprofits. It seems like a good time to revisit this notion and ask about whose standards of accountability to use now.

In the past few months we heard about the three page proposal from the Secretary of the Treasury asking for a $700 billion check to intervene in the financial meltdown (that ended up to actually be a blank check). The bailouts have continued, leading columnists like Floyd Norris of the New York Times to shout, Accountability needed with bailouts. Most recently, when executives of the Big Three automakers struck out with a request for their own bailout, House Speaker Nancy Pelosi said:

“It’s all about accountability and viability. Until we can see a plan where the auto industry is held accountable and a plan for viability on how they go into the future — until we see the plan, until they show us the plan, we cannot show them the money.”

Ask any nonprofit executive director or grant writer to guess how far they would get with a foundation or government agency if they submitted a three page request, or if they sat down at a site visit without a detailed project plan, budget, and evaluation outcomes. The answer is, not far.

Here’s a suggestion for how the nonprofit sector can contribute to the bailout – we can teach workshops and classes on accountability for government agencies and public corporations. Maybe it’s a new earned income opportunity.

How do you know what you don’t know? Someone asked this question last week in a workshop on the topic of board oversight and some high-profile problems. It’s such a great and critical question. There’s been a swirl of conversations in the last week or so about financial problems and governance issues at a number of nonprofits, both local and national. No matter what the details are, questions have been raised in every situation about the board’s role – what did they know, when did they know it, and what did they do? But what’s the first step for the board, since they are relying on reports from the staff and have little or no access to the raw information. Boards that ask for lots of details are accused of micro-managing and not trusting the staff. So how do you know what you don’t know? There has to be a balancing act between accepting reports at face value and asking questions that go beyond the information presented. I think that there’s an art to asking good questions – my favorites generally start with either “Why…?” or “What if…?” (I actually have those two words up on the wall in my office). Speaking last night to a group of people who had recently joined boards of nonprofits, I suggested that asking questions is their primary job. It’s great if they get an answer that makes sense. However, the role of governing requires further action and follow up when the answer doesn’t make sense, or when the answer is “Don’t worry about it,” or “I’ll find out later.” The distinction between hyper-questioning and prudent questioning depends on circumstances, but in every one of these recent governance and financial situations there were some “why” questions that needed to be asked and then carried through.

This complex balancing act between supporting and governing is discussed in the article Why Boards Don’t Govern available from CompassPoint. One point raised in this article is the importance of creating an atmosphere and culture at board meetings that encourages questions and disagreements. I know in financial matters, many board members feel like second-class citizens because they are not the “financial” board members. The fact is that if they have a question, or if something doesn’t make sense, they need to feel free and encouraged to ask the question. It just might be the question to unlocks the truth.

There was no telling what people might find out once they felt free to ask whatever questions they wanted to. (Joseph Heller, Catch 22).