Soundbites: The Constraints on the Nonprofit Sector

In this podcast, Heron’s Rodney Christopher discusses the importance of unrestricted revenue and offers thoughts on the overhead question.

Rodney Christopher, Heron’s director of capital markets and a veteran of the Nonprofit Finance Fund, joins Heron's Toni Johnson in a robust conversation to discuss how restricted dollars limits nonprofits from doing the most amount of good. Rodney further elaborates the erroneous use of the overhead ratio as a tool of measurement of the effectiveness of an organization in the nonprofit sector.

This is Toni Johnson with Heron.org. I’m here today with Rodney Christopher one of Heron’s Directors of Capital Markets and we’re here today to discuss the importance of unrestricted revenue for nonprofits. Hi Rodney.

Hi Toni. Thanks for having me.

You have been working for a long time in this field. First at the Nonprofit Finance Fund and then more recently with the Heron Foundation looking at enterprise capital. Can you talk a little bit about why unrestricted revenue is so important for nonprofits?

Gosh. The importance of unrestricted revenue, I mean we have a sector filled with organizations trying to do great things and right now they’re being given money away that doesn’t allow them to do great things so we’re giving them money in a way that requires them to be very very specific. To get money, it’s very exhausting that process. And you know think about it as you go to Macy’s and you go to buy a pair of shoes. You don’t get to tell the person at the register that this money can only go to serve the woman who cleans the third floor restroom. That is the way we are asking nonprofits to raise and deliver on their services. And I know a gentleman that came to work with us at Nonprofit Finance Fund that spend most of his career in the for-profit sector; big companies helping to grow small companies into big companies. He really wanted to bring that skill set into  the nonprofit sector and as he got more involved and he looked at what it means to run a non-profit organization and how you have cobble together money for all different kinds of resources he found himself saying “Wow this is like black diamond management”. And of course my first reaction is “What’s black diamond” and then he explained it’s a ski term for the hardest slopes and I thought “You know what that’s a really good way to describe it”.

You know people who run for-profit companies they get to work primarily on the criterion of are they generating a reasonable profit that concerns dividends to shareholders, that is their primary criterion. Nonprofits are juggling so many different responsibilities and asking them to do that without having money they can spend the way that it makes sense, is kind of hilarious but yet that’s the world in which we live. And really the reason why they exist, restricted dollars, is that the people who give money away have a few really important sort of challenges. One is that they’ve never run a non-profit organization. Another is, that they really want to know that their dollar is achieving a certain impact. And their assumption, which is in fact erroneous in my experience anyway, is that restricting that dollar towards a specific expense is going to achieve the outcome better than if they simply gave money to the organization, who then agreed explicitly what they are planning to do as organization with all the money that they get and then report out to their funders collectively this is what we’ve done. That individual funders really want to seek their own specific impact and they see the organization as a tool to do that.

And also quite frankly they don’t really trust the leadership of organizations to deliver on what they say they’re going to do. And it makes me sad frankly and it also presses my button on this question; Why are you giving money to an organization you don’t trust? That’s a very fundamental question and I think part of it is they don’t know who else to give it to. I mean they want to do well. I mean I’m grateful for philanthropy in all its many shapes and forms but I feel like it’s often really really misinformed; and it’s a hard thing to fix particularly if you’re running a non-profit organization, but one of the privileges about where we sit today is that we actually can engage funders, many of whom when you engage them on the subject they get it. It’s just they’ve not been given the opportunity to think about it very much because they’re so focused on the impact and their knowledge about the specific kind of impact. You know everybody has a program area. And you know here at Heron we’re really focused on the enterprise which is inclusive of all the program areas that are relevant. And we’ve really pushed their buttons and the organizations get uncomfortable talking about this suff too because they’re used to system that we have.

I had a dozen questions running through my mind while you were talking. One of the questions that I have is, when we’re talking about revenue and unrestricted revenue is this issue of ratio of overhead that keeps popping up and what’s the appropriate ratio? Can you talk a little about how the overhead question is damaging and where it might actually be helpful?

Sure. I mean this is a question in my twenty plus years working in this sector, it’s probably one of the question I’ve gotten asked most frequently by both people who run organizations and people who fund them and invest in them. Because everyone wants to have a number, they want a magic number. And what I love to tell people is in some respects it depends on the size of the organization. I think about the college that we went, everyone college needs to have certain functions. Every organization needs to have certain functions available to be successful. And when you’re in a much smaller shop the percent of the cost of the enterprise that needs to be spent on the financial aid officer, the business manager, the marketing team, the office of the president, all those things are expensive and even granted in smaller institutions they tend to pay less or the cost of the dollar amount is less, as a percent of the total for smaller enterprise that percentage could be 30 but it doesn’t have any baring on whether your organization is effective.

Similarly how often to we ask major corporations what percent do they spend on overhead? Now, one of the things I’ve learned since I’ve been here is there is this general admin is considered distinct from cost of goods sold when you’re analyzing the health of a for-profit enterprise. And there is some benchmarking. But it’s not done in the Draconian way that we are in this sector. I mean at the end of the day saying is it 10 percent or is it 20 percent, I’m thrilled to read that Darren Walker from the Ford Foundation has decided to double from 10 to 20. But at the end of day it’s not about the percentage, it’s about the enterprise, what’s it’s trying to achieve, what kind of resources it needs to do that. Because again, depending on what you’re trying to do, what we might agree could be considered overhead might simply be more expensive for some entities than others.

Another one of my favorite examples: Years ago I was working at a New York City nonprofit that worked with other nonprofits, and I was horrified to learn that in low-income communities if you’re a non-profit and you need space, you need what is effectively commercial space to deliver programs.The sort of volume of commercial space available in low-income neighborhoods is actually quite low. As a result in Harlem you might, and this is years ago, you might spend significantly more per square foot as a renter of space for commercial purposes for a non-profit in Harlem than you would in Midtown Manhattan. And it was horrifying to me and frankly it makes, in large quotation marks, overhead much higher for for those organizations. And you have some who were fortunate enough to get free space, well that changes their overhead question. And for some owning space is really important, that increases their overhead, so it’s sort of it’s a sort of artificial measure and I’ve been doing this work a long time and I doesn’t have any baring on whether an organization is effective, I think there are many more things that are valuable to look at and I really wish overhead would go away.

And I think you know this, there’s been a project really focused on this and some really smart people like Jacob Herald at GuideStar, the folks at Nonprofit Association in DC have really done a lot of work and in fact, I believe it was effective 20- oh gosh 14 or 15- that the federal office of management and budget had changed the rules for how to determine what the indirect rate is, for non-profit organizations with money that flows from the federal government. It sort of changes the game because what often would happen is money would flow from federal to state to local each of those governments add their own criterion and takes some money away and they’re saying actually there’s a flat rate of at least 10%, which doesn’t sound like a lot on one hand, but if you knew that some nonprofits don’t even get that because they don’t have the systems in place to articulate what the real rate is. It just sort of creates a floor that more realistic. I feel like there’s progress but it’s one that people hold onto because it’s a number and people have to have the number.

So one of the things I’ve found interesting in my time in non-profit land is this idea that somehow people who work for nonprofits should be a paid a pittance, or nothing. I had a person just like a few weeks ago, when I said Heron was 100% for mission say “Ohh, there’s no overhead” and I was like actually I draw a salary. Can you talk a little about this disconnect around people in particular? I know there’s a lot of discomfort around this. I just feel like there’s some sense that we are Mother Teresa and that we should work for free as opposed to bringing in really talented people to solve really tough problems.

Yeah I mean, I think partly it stems from what you just described, for many people first and foremost charity is used to describe organizations a lot of the time. And in fact the internal revenue code right. And I think when people think of charity, they think of the people who are offering charity as doing it from the goodness of their hearts and not seeking any financial benefit as a result. And I think that is legitimate up to a point. I think the reality is that today the world in which we live in today requires, really, enterprises to deliver on sort of long term impact not just what you hand out today, it’s having the ability to be the food bank that’s there for the long term, to be the homeless services organization here for the long term.

As you described these aren’t problems that are going to go away quickly and so trying to starve the resources that make them successful. Its really addressing individual needs. I think it’s really problematic to ask nonprofit organizations to solve major societal problems by themselves. These are problems that require political will, they require economic resources being reallocated, it requires, you know, a social moray instead of systems where people actually value people. And the reality is not everyone feels the same way about it but everyone feels like, the economy should solve these problems. Well you know, they’re problems but you won’t necessarily solve them in one swell swoop right. You solve them by dealing with different individuals and their needs and what I find really exciting is when you see in various communities, groups of organizations and funders looking at a a systems issue and trying to figure out how to have multiple players address the various issues that people are facing. And I just feel like, I feel like we make this harder on organizations, I think we make it harder on society because we tend to make people feel like they are a problem, rather than that they have problems. I’d love to see us make that shift.

So last question; how do we change the conversation, particular about revenue? My mind was thinking “ah we need a like a revenue, an unrestricted revenue pledge” that we get people sign onto like to can make this something that’s fun and exciting where we’re actually changing the conversation as opposed to you know us shaking our finger and going, why are you hamstringing nonprofits?

Yeah I love that question, I mean you’re a much more creative person that I so an idea of doing a campaign of some sort of, the pledge idea, it’s sort an interesting twist on the pledge idea. I suspect that we can get people to do that, it’s a way of saying “let’s do this together” and celebrating that some us are doing it that which could infect incentivize others. My fantasy, which isn’t a direct answer but I think is relevant. Imagine that, just as we have in the for-profit sector among publicly traded companies, imagine if every non-profit had a business plan that they refreshed on a regular basis, that articulated their value proposition, articulated how they’re going to deliver, how they’re going to measure their performance, the capital they would need to invest in the enterprise, where the revenue is going to come from, ect.

And they simply shopped that plan around and various investors would invest for capital and various funders would provide revenue into a single plan and they would all get regular reports, investors might get more details than funders, but image if we had a system that was more like that, it would sort of force the question on unrestricted revenue. Because it really would become not a possibility, you either buy into the plan or you don’t. And if you’re a provider of revenue you get to witness the performance of the enterprise, and if you think they’re doing a good job you can buy more of their services, if you’re an investor and you believe they’re doing a great job, and they need more capital you can invest more capital. But you don’t get to decide as the investor or the funder how the organization spends their money. For me that would be a form of nirvana.

Wow thanks Rodney. For Heron.org this is Toni Johnson

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