I’ve worked for the Center for Watershed Protection, a non-profit, for the past 20 years. For about half that time I have helped the Center to fundraise by submitting proposals for a variety of grant and contract opportunities from government agencies, private foundations and other sources. With this experience, I have seen that many funding entities have misconceptions about non-profits that result in unnecessarily restrictive funding policies. Non-profit organizations, particularly small ones, struggle to stay afloat and it does not help when funding entities adopt misguided policies based on a lack of understanding. So here are my top 3 things you should know about non-profit funding—please share this with any grant-makers you know.
- Non-Profits Can (and Should) Make a Profit
I was recently told by a funder that my organization could not make a profit because we are a non-profit organization. This is a common misconception, as the term “non-profit” is not entirely accurate. In reality, a 501(c)(3) non-profit (named for the relevant section of the IRS code) may generate net earnings but is restricted from using this profit to benefit any private shareholder or individual. (Read the official definition here.) Just like any other business, it is a good idea for non-profits to build up a reserve fund to help ensure they are around in the long-term to continue doing good work. Non-profits can also use these funds to expand and improve their programs. (side note: non-profits may not earn a profit as the prime recipient of a federal grant (or as a subawardee of such a grant).
- Many Non-Profits do not Have a Major Source of Unrestricted Funding
It always surprises me how many people think that non-profits work “for free” in the sense that they provide services to the public at no cost. The underlying assumption is that “someone else” is paying the bill. While it’s true that some non-profits have a source of unrestricted funding (such as a line item in the congressional budget, funds collected from settlement fees, an endowment, or even a very large membership and donation base), many do not. Unrestricted funding is revenue that does not need to be earmarked for a particular use, and is very helpful in paying for the costs to run an organization that funders often do not want to pay for (see #3 below). So how do non-profits without a major source of unrestricted funds stay afloat? By cobbling together various grants and contracts, all of which require competing for these funds and delivering very specific scopes of work. In other words, the money is earmarked for specific tasks and cannot be used for operating costs.
- Indirect Does Not Equal Overhead (and neither are good measures of organizational effectiveness!)
You’ve probably heard the term “overhead” but may not be as familiar with “indirect” costs. People often think these terms are synonymous but they are not. In the non-profit world (specifically the IRS Form 990), the three categories of expenses include: 1) Management & General, 2) Fundraising, and 3) Program costs. Of these, the first two are considered Administrative Overhead, i.e., the cost to run the organization. Program expenses are those related to delivering the services vital to the non-profit’s mission.
In the federal grants world, the terminology is a little different and costs are generally divided into Direct (directly attributable to delivering programs), Indirect (fixed costs that are indirectly attributed to programs), and Administrative (costs that are for the sole purpose of administering the grant; these are limited to 10% of the award amount). Non-profits that apply for federal grants can calculate their organization’s indirect rate which is applied as a fixed percentage of the direct program costs. This rate is negotiated and approved by the federal granting agency and indirect costs can be included in budgets for federal grants (go here for more on Negotiated Indirect Cost Rate Agreements). Non-profits without an approved indirect rate can charge the (conservative) de minimus rate of 10%. Indirect costs include rent, utilities, office supplies, technology, staff training and professional development, as well as many other items that are necessary to run an effective program. These are not administrative or overhead costs.
I’ve seen a disturbing trend recently where funding organizations limit the amount of indirect that applicants can include in their budgets. This comes in two different formats, the first being private foundations who identify administrative expenses, overhead expenses, indirect costs, and salaries as unallowable costs. I am not sure what organizations can accomplish any meaningful work without paying their staff to do it, but I expect there are few who can actually make this work. These foundations operate under the mistaken assumption that by limiting “overhead” costs, more of their funding will go toward fulfillment of grantees’ missions and that when it comes to overhead lower is better.
The second situation is less common and consists of government agencies and private foundations who receive federal funding arbitrarily limiting indirect (typically to 10% or 15%) when making these funds available to non-profits and others through a competitive sub-award or contracting process. This is most likely due to confusion about the difference between indirect and administrative costs, or a mis-interpretation of the de minimus 10% rate as some sort of standard for organizational overhead. The 10% de minimus rate is a conservative number and indiscriminately using it as a limit for all organizations essentially penalizes non-profits for going through the process of calculating their indirect costs. Other funders don’t explicitly limit indirect but they instruct proposal reviewers to award higher scores to applicants with low (i.e., < 10%) indirect rates. (Incidentally, federal agencies—as well as recipients of federal funds who pass money through to sub-awardees—may not require the use of a lower indirect rate, unless authorized by federal statute, regulation or policy.)
In both cases, the result is that non-profits seeking funding from these entities either have to accept that they will not recoup the full costs to provide the proposed services, or look elsewhere for funding.
Fortunately, there are some funders who do understand and value the importance of strong leadership and infrastructure to support quality programs. Ford Foundation is a great example. Check out their videos below which do a great job of explaining these issues:
How Much Does It Cost to Do Good? Conversations on Nonprofit Overhead, Part 1
How Much Does It Cost to Do Good? Conversations on Nonprofit Overhead, Part 2
Uni Song, President of the Lloyd A. Fry Foundation, has presented on this topic and says that it is important that funders talk to non-profits about making sure to build in indirect and overhead cost into their proposal budgets.
“When we as grantmakers do not have these conversations, we inadvertently enforce an implicit cap on overhead. We are not encouraging nonprofits to make the investments necessary for strong budgeting, improving programs, and maintaining quality. Our strongest grantees — the ones with the most effective programs and the strongest outcomes — are the ones who:
- Provide the most and the strongest training to their staff
- Do the most research into evidence-based practice
- Have the strongest and most rigorous monitoring and assessment programs.
Such activities are not “overhead” activities to be kept as low as possible.” (read her full article here)
The National Council of NonProfits has started a campaign called #OwnYourOwnCosts with some great tools and resources for non-profits on understanding their indirect costs, the federal rules regarding indirect and how to advocate on their behalf so that grant-making agencies will honor these rules. And this link has more information on why “overhead” is not a good measure of non-profit effectiveness.
If all else fails, we can start being brutally honest with funders on grant proposals to help them understand. This blog by Vu Le, Executive Director of a Seattle-based non-profit lays it out in perfect form. (Really, you need to read this, it is awesome)
Karen Cappiella
Karen is a former GIS guru whose areas of expertise include applied watershed research, watershed planning, producing guidance documents and articles on watershed and stormwater management, and proposal writing. In addition to managing the Research Program, she coordinates proposal submissions for the Center. Karen has been with the Center since 2000, and has a B.A. in Geography from Millersville University and an M.A. in Geography from East Carolina University. She lives in New Market, Maryland with her husband and daughters.
