In just about any place you look today for advice on fundraising, overhead is being discussed. From Dan Pallotta’s widely viewed TED talk, “The Way We Think about Charity is Dead Wrong,” to conferences and publications, overhead is hotly debated. Some say it’s the wrong measure of a nonprofit organization’s success; others say it is the gold standard for measuring worthiness for support.
I recently undertook research into the subject of overhead for my doctoral project. My goal was to learn if nonprofit employees and board members understood donors’ views of overhead and were proactively learning about and responding to external factors that have the potential to increase overhead, or if they were essentially ignoring them—burying their heads in the sand when it comes to external pressures on nonprofit overhead.
There has been little consensus about the impact of focusing on overhead as a means of evaluating nonprofit organizations, either among nonprofit leadership or researchers. In the Fall 2009 issue of Stanford Social Innovation Review, Gregory and Howard identified the “nonprofit starvation cycle” which they defined as follows:
The first step in this cycle is the 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 (1).
On the other hand, Brian Mittendorf, a professor of accounting at Ohio State University’s Fisher School of Business, concluded from research that “there is limited evidence supporting the view that excessive scrutiny of accounting numbers is serving to undermine nonprofit growth” (2).
My research focused on three issues that potentially could increase overhead. Each one originated from a different source: reducing or eliminating the charitable tax deduction for some taxpayers (Congress); payments in lieu of taxes (PILOTs) being requested by state and local municipalities; and elimination of joint allocation of costs (an accepted accounting practice). These external factors push at nonprofits on the one side, while donors demanding lower overhead and more transparency apply pressure on the other side.
My research was done via a survey directed to employees and board members of nonprofit organizations. Of particular interest was measuring both the respondent’s perception of how much importance donors placed on the income tax deduction for charitable giving, and whether partial or total revocation of this deduction would impact donations from major donors to their organization. Survey respondents clearly believed the charitable deduction is important to donors, especially those giving $1,000 or more:
- Respondents were asked if they believed major donors would reduce their giving if the charitable tax deduction were reduced or eliminated. The consensus by more than half the respondents (56%) was that this would “definitely” have an impact on giving from major donors (a term I did not define since what is considered a major gift can vary by organization), while an additional 32% said “Possibly.
- Survey respondents also indicated what overhead rate their donors would consider the maximum acceptable amount. The most frequently chosen option was 10 – 15% (22% of responses), followed by 20 – 25% (17%), 15 – 20% (16%) and less than 10 percent (12%). However, 24% of the respondents indicated they did not know — concerning given the importance respondents gave to overhead as a factor for donors in making giving decisions.
- Survey respondents were also asked what they believed the impact on organizational income would be if overhead increased due to external factors. Three in ten respondents indicated it would be “significant,” while 34 percent felt if would have some impact.
The research also looked at the kinds of actions — internal and external — that nonprofit organizations might undertake if external issues that impact overhead exacerbate. In terms of external actions, five options were selected most frequently: protest/petition/testify; join others to protest; urge advocacy groups to apply pressure; encourage donors to sign a petition or call government representatives; and use media to call attention to issue.
Related to internal actions to take if overhead were to be negatively impacted by external legislation or regulation, responses typically focused on asking donors to give more; the most frequently chosen option was “ask all donors for an extra gift,” followed by “ask major donors for an extra gift to cover these costs.” “Ask board members for an extra gift” and “reduce our staff” were tied as the third more frequently chosen option.
Summary of Findings
A large majority of respondents from the nonprofit space have an opinion on the importance of the charitable deduction to their donors’ decision-making about contributions, but little awareness of the example external issues that have the potential to raise overhead.
There was low awareness of payments in lieu of taxes (PILOTs), despite that they are being assessed by more than 200 municipalities in more than half the states (3). Their increased use by governing entities to balance their budget suggests that this is a topic that deserved further attention to increase awareness in the nonprofit community, especially at the board level. Given the longer-term ramifications of paying or not paying PILOTs, having an existing board policy based on an understanding of the issue could facilitate a more thoughtful response. Discussion of this topic should involve not only board members but senior fundraising and nonfundraising managers, and potentially the corporation’s external accounting firm and/or auditors.
Joint allocation of costs (SOP 98-2) had low awareness as well, but because this is generally used only by larger organizations with heavy investments in areas that could potentially serve joint purposes, this was to be expected. For organizations that use this accounting method, proactive discussion about ways to countermand its impact if it is disallowed in the future is essential. Some of the watchdog groups are already presenting financial reports without this calculation, using formulas based on estimates rather than actual numbers to recalculate overhead rates. Any nonprofit currently using joint allocation of costs would be wise to prepare reports showing what their overhead would be without the application of SOP 98-2. That number would be the starting point for discussions about ways to reduce total overhead, increase program’s share of expenses, and/or communicate the need for overhead more effectively to donors. These proactive efforts could potentially help mitigate the impact of the higher figure that may result without the use of joint allocation of costs.
There is both good and bad news for the nonprofit sector about learning more about external issues that could negatively impact overhead.
Overwhelmingly, respondents indicated that they preferred to learn about these kinds of issues through “articles, newsletters and blogs delivered electronically.” The positive news is that this is currently how this information is delivered; only for PILOTs would one need to go beyond industry publications to stay abreast of the issues. The negative news is that responses to the survey indicated that this information is failing to impact a majority of recipients and that proactive actions are not resulting from provision of the information. This suggests that the major need in the nonprofit community is not more information, but rather information that is followed by clear recommendations in terms of what one needs to do as a result. Those writing these blogs, articles and newsletters can better affect the nonprofit community’s future by including recommended action steps for responding to information that is shared.
The study showed that while nonprofit leadership is concerned about donors’ perceptions of overhead and efficiency in the way organizations use donated funds, the majority are not proactively developing strategies to implement should external forces enact laws or policies that negatively impact overhead. Current industry literature is reporting on the issues that the research considered, but that is not having the effect of changing behaviors regarding planning and strategic thinking by the average member of leadership, paid and unpaid, within the nonprofit community.
So what should we do next?
Although this study was not extensive enough to be considered definitive, the findings do point to a need for the nonprofit sector to bring the conversation about overhead out of the nonprofit community and begin significant dialog with individual, foundation and corporate donors. Understanding what impact overhead has on the giving decisions of potential and current donors would enable nonprofit organizations to know how much corporate attention to expend addressing issues that potentially could increase overhead rates.
Given the overall high value respondents placed on the charitable deduction, and the level of board members and senior fundraising managers who were unsure whether or not its reduction or elimination would impact major-donor giving, nonprofit organizations should undertake research of their own donor bases and potential supporters so they can participate with elected officials in conversations about potential changes from a position of knowledge. A nationwide research project could also look at whether donors feel a loss or reduction of the deduction will have more impact on their giving to different types (e.g., environment, education) and sizes (e.g., grassroots, national) of nonprofit organizations. For example, would a loss of the deduction harm educational institutions more than religious institutions? Would local grassroots organizations experience less impact than national charities? Research across a wide variety of nonprofits, both to look at attitudes as a whole and specific to organizations, could be undertaken on a cooperative basis, thus providing quantifiable evidence to potentially influence future debate in Congress.
An industry-wide effort to understand donors’ tolerance for overhead is essential.
This must be undertaken at the individual organization level, as well as within the broader marketplace. The majority of respondents felt rising overhead would have “some” to a “significant” impact on contributions to their organizations. Given that these respondents considered overhead a significant factor in their donors’ giving decisions and anticipated a negative impact on contributions because of rising overhead, this lack of understanding regarding what constitutes an acceptable overhead rate is concerning. Knowing the expectations of its donors (or at minimum, to organizations similar in size and focus) would enable an organization’s board members and senior leadership to make plans and set strategy based on facts, not simply in response to changes or fear of changes. Perhaps this research could be undertaken by a foundation willing to invest in strengthening the overall nonprofit community over time, or it could be funded by individual organizations, each paying a proportional share based on income or other measures that would ensure both large and small organizations can participate and, thus, benefit from the research.
Perhaps a dose of reality is also needed for many of us in the nonprofit community.
When asked about dealing with rising overhead due to external factors, respondents were open to joining with other nonprofits to protest and encouraging advocacy groups to lobby on their behalf. However, internal actions showed a dependency to address rising overhead by asking donors for more money, despite an earlier acknowledgement that overhead rates are an important consideration when making a decision to contribute, and even more so for those donors giving larger amounts. Failure to consider alternative responses that are not contingent on donors giving more could result in forced reductions in staff, compensation and/or program without the benefit of time to carefully consider alternate options.
Nonprofit organizations in the United States are increasingly called upon to respond to humanitarian needs and other challenges to our way of life. These organizations depend on donors (individual, corporate and foundation) to provide the funds that enable them to rise to the challenges placed before them. It is imperative that nonprofit organizations have a true understanding of what role overhead plays in Americans’ charitable-giving decisions—both for their individual organizations and the industry as a whole. Only then can they argue proactively, from a position based on factual evidence, against external legislation and regulation that could potentially increase overhead costs, thus seriously compromising their abilities to fulfill their missions.
© 2015, Pamela J Barden
- Gregory, A. G., & Howard, D. (2009, Fall). The nonprofit starvation cycle. Stanford Social Innovation Review. Retrieved from http://www.ssireview.org/articles/entry/the_nonprofit_starvation_cycle/
- Mittendorf, B. (2013a, April 23). Do nonprofits really limit advertising because of pressure to cut overhead? Nonprofit Quarterly. Retrieved from http://www.nonprofitquarterly.org/management/22174-do-nonprofits-really-limit-advertising-because-of-pressure-to-cut-overhead.html
- Langley, A., Kenyon, D., & Bailin, P. (2012). Payments in lieu of taxes by nonprofits: Which nonprofits make PILOTs and which localities receive them. Lincoln Institute of Land Policy [Working Paper]. Retrieved from http://community-wealth.org/sites/clone.community-wealth.org/files/downloads/article-langley-et-al.pdf