THE BLOG
02/11/2014 09:31 am ET Updated Apr 13, 2014

The New Four-Letter Word in The Nonprofit Sector

In the nonprofit sector, we've had the spotlight turned on to outrageous nonprofit executive salaries.

In December 2013, Massachusetts Attorney General Martha Coakley found that Massachusetts' charitable organizations were paying their leaders between $487,000 and $8.8 million a year in total compensation each year between 2009 and 2011.

Last year, The Huffington Post reported about 10 Insanely Overpaid Nonprofit Executives who were each compensated millions in annual salaries.

What about the nonprofit executive making an annual salary of $50,000? The public wouldn't outrage, but the irony is that donors hesitate to provide funding to underwrite the reasonable salary costs of a nonprofit executive because it is considered "overhead" -- the new four-letter word in the nonprofit sector.

In his now infamous TED Talk, Dan Pallotta, creator of the 3-day breast cancer walk, states, "Everything the donating public has been taught about giving is dysfunctional. Too many nonprofits are rewarded for how little they spend -- not for what they get done."

The "overhead myth" is centered on the idea that nonprofits are valued by how little they spend on overhead. Overhead includes salaries for non-program management, office space, office technology and office supplies -- the non-sexy budget line items of a nonprofit organization.

The leaders of the country's three leading sources of information on nonprofits -GuideStar, Charity Navigator and BBB Wise Giving Alliance -- penned an open letter to the donors of America denouncing the "overhead ratio" as a valid indicator of nonprofit performance.

"I totally agree that there is an overhead myth," Judy McDonald, Board Chair of The Parker Foundation, concurs, "However, I have never subscribed to that myth."

The Parker Foundation is based in San Diego, CA and funded 64 nonprofit organizations in the 2012-13 fiscal year for a total of $1.7 million -- with quite a bit of that funding going towards overhead. McDonald says that, "typically The Parker Foundation likes to fund things that no one wants to pay for." She admits that it is riskier to fund this way, but it is realistic. "Nonprofits can dress up their request for funds in a million different ways by the manner they write the grant, but when you talk to them, they just need money to cover the cost of overhead."

She says, "We encourage candor." The Parker Foundation is working to open up the dialogue between nonprofit and funder. "I think nonprofits lie sometimes to keep overhead numbers low and that is the opposite of what we want to know." Parker Foundation wants to know what kind of funding will benefit the organization most -- and often it is unrestricted general operating funds that support overhead costs. The Parker Foundation understands that overhead can be a significant part of an organization's budget.

This is not the common thought among funders. The Nonprofit Overhead Cost Study by the Urban Institute's National Center for Charitable Statistics and the Center on Philanthropy at Indiana University discovered the "Nonprofit Starvation Cycle," a vicious cycle that starts when funders have unrealistic expectations of how much nonprofits should spend on overhead and value nonprofits who spend little on overhead. To meet these unrealistic expectations, nonprofits begin to skimp on overhead and misrepresent their costs to make their overhead look smaller to receive funding -- thus perpetuating funders' unrealistic expectations.

With overhead being devalued, funders focus on supporting nonprofit programs. Retired Senator Dede Alpert, a member of the Board of Directors of the Girard Foundation and Price Charities, says, "Funders are more likely to fund programs within a nonprofit than overhead." There is a proclivity for funders to donate to programs that forces nonprofits to keep chasing funds to support the hard costs of their infrastructure.

McDonald hopes to shift this paradigm: "If the nonprofit is doing vital work to a make a community healthy -- then why should it matter to the funder which piece of the budget they underwrite? Labeling your investment is not important. Just buy a piece of it."

Peter Ellsworth of the Legler Benbough Foundation, another San Diego based foundation, provides a majority portion of their funding each year to nonprofit overhead that often pays for the salaries of the leadership of the organization. "If you don't have an appropriate leader, you are throwing your money down a rat hole. The only way you can attract a good leader is to pay for him or her." It troubles him that when a nonprofit experiences financial troubles, they start letting go of good leaders thinking that it will solve their financial problem, but he believes it is just crazy and won't work because it creates a larger problem: leadership deficit.

Ellsworth sees a large problem with overhead and it is not the funding. It is a question of what overhead. Hypothetically, there are five little nonprofit organizations all providing after school mentoring and each asking the foundation to fund a full-time bookkeeper. Ellsworth says, "If you put all the overhead together, it is ridiculous compared to what they are collectively achieving."

While Ellsworth is happy to fund overhead, he won't pay five times for the same service in five separate small nonprofits. Ellsworth suggests that collective overhead is the solution. "If small nonprofits can get together and utilize resources collectively, I will pay for that overhead."

McDonald of The Parker Foundation points to organizations like Mission Edge who provide the overhead expert services to nonprofits at a fraction of the cost because they contract out their employees to many nonprofits to provide the same service. "We ought to be using more ideas like Mission Edge because we can't expect a nonprofit staff member to do everything and be an expert in all areas. We need the right people doing the right jobs."

While most nonprofit executives can't fathom a million dollar salary (or more) each year, they do dream of finding funders to underwrite the true cost of their nonprofit's overhead and help them pay for great leadership in the nonprofit sector. What if we could shift the donor's mindset to value the leadership that is within "overhead" and pay for the piece of the organization that is incredibly valuable but doesn't have a sexy label?