If your company or corporate foundation currently sets the typical 15 percent limit on the amount of a grant that can be used to cover overhead and indirect expenses at a nonprofit grantee organization, you may want to rethink that position. After examining the financial records of 20 well-known, high-performing nonprofits, the Bridgespan Group found that overhead varied between 21 percent and 89 percent of direct costs, just due to the nature of the organization’s work. In other words, the restrictions funders are placing on their grantees may be far too low—and leading to a “widespread, vexing starvation cycle” that prevents them from maximizing their impact, according to Bridgespan, a consulting firm specializing in the charitable sector.
The researchers found that flat-rate reimbursement models, common throughout the nonprofit sector, aren’t appropriate because the type of work a nonprofit engages in might require dramatically different levels of overhead and administrative costs than another group doing something else.
Because there is no generally accepted definition of what falls under the umbrella of “overhead,” the researchers started by identifying the indirect costs that should be tracked—those that are not directly attributable to a specific project but are nonetheless necessary and inextricably tied to a nonprofit’s ability to accomplish its goals:
- Administrative costs. Costs of shared functions housed in headquarters, including leadership, finance, human resources, technology, legal, and bids and proposals.
- Network and field expenses. Costs for maintaining field and network operations outside of headquarters.
- Physical assets. Costs for maintaining and acquiring project-related equipment, such as lab equipment and facilities.
- Knowledge management. Costs for building and maintaining subject and program expertise and internal knowledge, including staff costs.
The researchers then broke down nonprofits into four broad segments based on what they do and how they do it—U.S.-based direct service providers; U.S. policy and advocacy groups; international networks; and research organizations—and calculated the range and median indirect costs for each segment.
Indirect costs for the different segments varied considerably. For example, nonprofit research labs have a median indirect cost rate of 63 percent, nearly two-and-a-half times the 25 percent median rate of direct-service organizations covered in the Bridgespan survey.
But even within each segment, indirect costs ranged a bit, from 21 percent up to about 38 percent for U.S. direct service organizations; from about 23 percent up to 60 percent for U.S. policy and advocacy groups; from about 37 percent up to almost 70 percent for international networks; and from about 39 percent up to 89 percent for research organizations.
In all cases, indirect costs exceeded the typical 15 percent cap that is common among funders.
That difference, the researchers said, is due to the nature of the nonprofits’ work, not because of any inherent inefficiencies. In that sense, the variance in overhead costs mirrors the for-profit sector, where some industries have intrinsically higher indirect costs than others. For example, the study said, consumer staple companies have a median indirect cost rate of 34 percent, while information technology firms go as high as 78 percent. That’s not because IT companies are inefficient—their work just has different overhead requirements, the argument goes.
With so many funders holding to a 15 percent limit for overhead—or in some cases, 10 or 20 percent—nonprofits have to get creative with their finances to make up the funding shortfalls, the researchers said. Foundation program officers might team up with grantees to recategorize some indirect costs as direct costs so that they can be covered by the grant. Other times, funders award capacity-building or general operating grants to close the indirect cost gap, or come up with some other work-around to cover those expenses.
“As a result, we do not know as a sector what it really costs to achieve impact,” the researchers said.
Corporate grantmakers can help remedy this by adopting what Bridgespan calls “pay-what-it-takes” philanthropy—that is, allocating sufficient resources for grantees’ indirect costs, without holding to some arbitrary, precalculated idea of what that figure is. It means having an honest discussion with grantees about their finances, in an environment where they feel comfortable relating such information without fear of repercussions, the researchers said.
“It shifts from an emphasis on what it takes to fund a program to what it takes to achieve impact,” Bridgespan’s researchers said.
For more information on the study, including a discussion on different approaches to addressing the indirect costs of grantees, go to www.bridgespan.org.