Current nonprofit sector research and recommendations for effective day-to-day practice from ASU faculty, staff, students, and the nonprofit and philanthropic community.
“Capacity building is whatever is needed to bring a nonprofit to the next level of operational, programmatic, financial, or organizational maturity, so it may more effectively and efficiently advance its mission into the future. Capacity building is not a one-time effort to improve short-term effectiveness, but a continuous improvement strategy toward the creation of a sustainable and effective organization” (National Council of Nonprofits, 2017). For many organizations, capacity building would fall into the “overhead” category. Unfortunately for the nonprofit sector, higher overhead costs are correlated to an organization being irresponsible with its finances, ineffective, unable to carry out its mission, and even unethical.
Overhead is defined as a “percentage of a charity’s expenses that goes to administrative and fundraising costs” (Guidestar, 2014). The Overhead Myth is created when donors believe that nonprofits should keep these overhead expenses below a certain percentage of the nonprofit’s total expenditures – usually no more than 15 to 20 percent. In Dan Pallotta’s TED Talk, he discusses the Overhead Myth and how it can negatively affect nonprofits by hindering their ability to create long-term sustainable growth. Both internal and external stakeholders need to be better informed about why it is okay for overhead costs to be higher when the organization is trying to grow, become sustainable, and ultimately achieve its mission more effectively. Looking at overhead alone is a poor way to measure a nonprofit organization’s overall performance (Letter to the Donors of America, 2014). Therefore, other factors such as program performance, governance structure, staff professionalism, fundraising efficiency, and other practices should be considered as part of the bigger picture
Recommendations for Implementation
So how can nonprofits bust this Overhead Myth so that they can invest in capacity building and infrastructure to create a sustainable organization? Below are six practices, three internal and three external, that a nonprofit can implement to help alleviate the burden of the Overhead Myth.
- Functional Allocation Time Study (internal): Many organizations classify all of their employees’ salaries to overhead, and many donors view employee salaries as overhead. The truth is, it takes human resources, or employee salaries, to run most programs and make an impact. Therefore, conducting these time studies will help organizations better allocate their employees’ time based on the work they do in a typical work-week. This will not only educate funders, but it will also help lower “overhead” costs that were previously not allocated correctly.
- Budgeting for Change Capital (internal): Change capital is money that nonprofit organizations put aside each fiscal year so that they have a reserve of money when they want to invest in new initiatives. If a nonprofit organization budgets for a small surplus each fiscal year, they are creating enough cushion to be able to invest in new and innovative operations that could boost their social impact.
- Educating the Board of Directors and Reviewing Internal Policies (internal): By reviewing internal policies to make sure they are up-to-date with societal trends, the organization can be sure they accurately reflect their work in the current landscape of social issues. Also, since the members of the board usually do not come from the nonprofit sector, they sometimes lack a general understanding about how nonprofits operate or what they can and cannot do legally. Educating them about the trends and myths of the sector could go a long way to help them gain a better understanding of what would be best for the organization.
- Focus on Mission Impact (external): One of the most important thing that nonprofit organizations can do to alleviate the burden of the Overhead Myth is to focus on the impact of their organization. By becoming better storytellers, a nonprofit can send out a stronger message about the impact of their programs. Each organization is so unique in its own way that if it simply told a better story, the minute details of how it spends its money would be overshadowed.
- Use Better Metrics to Show Impact (external): It is time to retire the organizational expenses pie-chart that has been used obsessively in the nonprofit sector, and replace it with stories on mission impact (Guidestar, 2016). This is an outdated model that limits the impact and diversity of the work in the nonprofit sector.
- Educate Funders and Set Realistic Expectations (external): It is important to educate funders and other external constituents about the damaging consequences of the Overhead Myth and not investing in capacity building. Be upfront about the funds it will take to implement or run a program. Do not submit a grant proposal that only covers a portion of the program; submit a proposal asking to cover all the expenses, including supplies and salary of the program director. Asking and encouraging funders to give unrestricted gifts is also an effective strategy as the money can be used more freely.
The nonprofit sector has been given the responsibility of dealing with some of society’s largest issues. In return, they have been given very limited resources and an expectation for them to be efficient with what they are given and held to restricting rules. Because of these current expectations, a lot of the work conducted in the nonprofit sector are short-term, “Band-Aid” solutions, rather than addressing the root of systemic issues. It is a fact that nonprofits that spend too little on infrastructure have more limited effectiveness than those that spend a reasonable amount on it (Pallotta, 2008). It is time for the nonprofit sector as a whole to come together and educate the public and its funders about the importance of investing in capacity building.
- Gregory, A. G., & Howard, D. (2009). The Nonprofit Starvation Cycle. Stanford Social Innovation Review, (Fall 2009), 49-53. Retrieved February 22, 2017, from www.ssireview.com.
- Guidestar's Six Tips for Busting the Overhead Myth. (2016). Guidestar. Retrieved February 22, 2017, from www.guidestar.org.
- National Council of Nonprofits - What is Capacity Building? (2017). Retrieved February 22, 2017, from https://www.councilofnonprofits.org/tools-resources/what-capacity-building
- Pallotta, D. (2013, March). The way we think about charity is dead wrong [Video file]. Retrieved from https://www.ted.com/talks/dan_pallotta_the_way_we_think_about_charity_is_dead_wrong.
- Pallotta, D. (2010). Uncharitable: how restrains on nonprofits undermine their potential. Medford (Mass.): Tufts University Press.
- Taylor, A., Harold, J., & Berger, K. (2014). Guidestar. Letter to the Donors of America [Letter written 2014 to Donors of America]. Retrieved February 12, 2017, from http://overheadmyth.com/letter-to-the-donors-of-america/.