Report: Grant Makers' Demands Hinder Nonprofit Performance

September 7, 2019 — Indirect-cost policies and practices that prevail among major grant makers weaken their nonprofit grantees, which, as a result, "are too often unable to invest enough in their own capacity," according to a newly released report.

To assist, the Ford Foundation, the William and Flora Hewlett Foundation, the MacArthur Foundation, the Open Society Foundations, and the David and Lucile Packard Foundation this week announced they will seek to identify best practices and policies to combat the “starvation cycle” that undercuts the effectiveness of their grantees.

The foundations formed a collaborative with The Bridgespan Group, a Boston nonprofit that provides capacity advisory services to nonprofits, which produced the report.

"Funding sources—national, state and local governments; multilateral and bilateral institutions; private foundations and individuals—are part of a complex system with inconsistent practices, [and] many foundations do not have a written policy, which can contribute to greater uncertainty," notes the report, Momentum for Change: Ending the Nonprofit Starvation Cycle. It was based on several recent Bridgespan studies, discussions with 80 grantees, and input from financial experts and nonprofit intermediaries.

The vast majority of institutional funding, including about 70% to 90% of foundation grants, is issued as restricted grants and contracts tied to specific projects and programs. And, according to the report, Over half of the 15 largest U.S. foundations have a flat-rate indirect-cost reimbursement policy of 15% or less, while state and local governments granting federal money are supposed to provide a minimum reimbursement rate of 10%.

However, actual indirect costs for nonprofits range from 21% to 89%, averaging 29% for U.S.-based service organizations and 43% for U.S.-based advocacy organizations.

(Direct costs are expenses directly attributable to a specific project. Indirect costs are expenses not directly tied to a specific project but shared across multiple projects, but are essential to a nonprofit’s ability to accomplish its goals. Indirect costs are more expansive than overhead costs, which generally refer to administrative costs.)

Noting that recovering costs is an important component of basic financial health for organizations, the report states, "Chronic underfunding of indirect costs therefore contributes to financial weakness in the social sector."

In 2017, Bridgespan analyzed key financial health indicators for 274 nonprofits that were among the top grantees (by total grant dollars) receiving funds from two or more of the top 15 US foundations (by endowment). Between 40% and 50% of these grantees showed signs of financial stress, with scarce operating reserves and/or persistent budget deficits.

Twenty-six percent of grantees were close to insolvency (having run budget deficits in three of the last five years) and 23% had less than one month of operating reserves, and 30 grantees were technically insolvent and had borrowed against restricted grants to fund critical expenses.

Although they strive to deliver strong results, "nonprofits are too often unable to invest enough in their own capacity," according to the report.

In its 2018 State of the Sector Survey, the Nonprofit Finance Fund said the top two most frequently cited organizational challenges among responding nonprofits were financial sustainability (62%) and funding full costs (57%). Additionally, over 90% of respondents reported feeling underfunded by government funders as well as foundations.