The Overhead Myth

At first glance, you’d think the worlds of my late brother Bernie Jr. and mine couldn’t be further apart. I work in the realm of philanthropy while Bernie Jr. was a venture capitalist.

Yet we both used to say that we basically have the same job, only in different sectors of the economy. My brother’s venture capital firm sought out talented people with promising ideas and invested in their work to generate a significant financial reward for himself and his partners. At the Community Foundation, we seek out talented people with promising ideas and invest in their work to generate a significant positive impact on the community.

When a venture capital firm, or a community foundation, makes a significant investment of money, you can be sure that our respective teams will be “all in” trying to turn the promise of a good idea into a reality. We offer advice and counsel, bring other resources to the table, make introductions to potential partners, and run interference to help clear the path to a successful outcome.

I’m pleased to say that I’ve been involved with some enormously successful initiatives during my career. And using the euphemistic language of foundations, those projects that did not meet our expectations turned out to be great learning opportunities for me. Either way, this has been a large part of my job at various foundations big and small over the years – identifying effective organizations in the charitable world and directing philanthropic resources to help them be successful.

With all that I have observed and learned in nearly 20 years of this work, I could not agree more with something I recently read.

“The percent of charity expenses that go to administrative and fundraising costs – commonly referred to as ‘overhead’ – is a poor measure of a charity’s performance.”

This idea comes from an open letter to the “Donors of America” signed by the chief executive officers of our nation’s three most prestigious sources of information about charities – the Better Business Bureau (BBB) Wise Giving Alliance, Guidestar, and Charity Navigator.

A BBB Wise Giving Alliance survey found that 62 percent of Americans believe that the typical charity spends more on overhead than it should. Yet the leaders of these charity watchdogs have come to the opposite conclusion.

“In fact, many charities should spend more on overhead,” they write. “Overhead costs include important investments charities make to improve their work: investments in training, planning, evaluation and internal systems – as well as their efforts to raise money so they can operate their programs. These expenses allow a charity to sustain itself (the way a family has to pay the electric bill) or improve itself (the way a family might invest in college tuition).”

These charity watchdog CEOs argue that when foundations and private donors focus too much attention on keeping overhead costs unreasonably low, we create what the Stanford Social Innovation Review calls the “Nonprofit Starvation Cycle.”

The Nonprofit Starvation Cycle begins with unrealistic expectations about how much it costs to run a charity. These organizations are nonprofit, but they still have all the costs associated with running any other kind of business.

Yet charities feel extreme pressure to conform to the unrealistic expectations of their funders and donors. So they respond to this pressure by working with old technology. They skimp on training for their staff. They leave critical positions unfilled or hire less-expensive unqualified employees and hope they can learn the job on the fly. And they eliminate the very supervisory positions that could help train and manage the unqualified staff because the supervisors provide no direct service to clients and thus are considered overhead.

Naturally, all this cost cutting makes funders and donors believe their unrealistic expectations were reasonable, further feeding the demand for overhead costs to be reduced even further. Left unchecked, this Nonprofit Starvation Cycle leaves us with poorly trained staffs, inadequate support and supervision, and an inadequate technological infrastructure to track client progress and monitor outcomes.

“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,” write Ann Gregory and Don Howard, the authors of the Nonprofit Starvation Cycle study published in the Stanford Social Innovation Review.

Of course, no one is arguing for unrestrained spending on overhead or bloated administrative line items in nonprofit budgets. In fact, the BBB Wise Giving Alliance, Guidestar, and Charity Navigator are hardly beloved by the nonprofit community because these watchdogs have been very aggressive and outspoken when they feel a charity is not doing its job well. But that’s exactly why they have such credibility when it comes to the issue of overhead spending.

“We ask you to pay attention to other factors of nonprofit performance: transparency, governance, leadership, and results,” write the CEOs of these three watchdog organizations. “So when you are making your charitable giving decisions, please consider the whole picture. The people and communities served by charities don’t need low overhead, they need high performance.”

To learn more, visit overheadmyth.com.