Finance

Overhead Funding May Not Be Expanding, But The Conversation Is

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Something I had meant to mention in my post yesterday was that Priceonomics’ admiration of Yerba Buena’s Dream House Raffle sounded very similar to fund raising philosophy espoused by Dan Pallotta.

Said Priceonomics,

There is something admirable about Yerba Buena’s Dream House Raffle.

Every nonprofit spends a lot of time conducting and worrying about fundraising, and that is time that could be spent on the nonprofit’s mission. The Yerba Buena Center for the Arts identified a new revenue stream and has done well at it. It now raises more money from its raffle than it receives from individual donations or from the city of San Francisco.

Dan Pallotta says something similar in his 2013 TED Talk:

Now, if you were a philanthropist really interested in breast cancer, what would make more sense: go out and find the most innovative researcher in the world and give her 350,000 dollars for research, or give her fundraising department the 350,000 dollars to multiply it into 194 million dollars for breast cancer research?

If you have been following my blog for any period of time, you know that there has been a lot of discussion and examination about overhead ratio as a valid measure of institutional effectiveness.

Of late, the topic has been spilling out of publications focused on non-profit audiences and into the mainstream. This week, FastCompany’s FastCoExist took up the topic in a piece titled, “Demanding That Nonprofits Not Pay For Overhead Is Preventing Them From Doing Good.”

Upon reading the transcript of Dan Pallotta’s talk, I see the FastCoExist article basically says everything he did three years earlier. Except there continues to be more research conducted that is supporting the validity of the claim. FastCo cites a new Bridgespan Group study that shows how uniformly applying a flat rate limit on overhead is undermining non-profit effectiveness.

According to a recent report by Oliver Wyman and Seachange Capital Partners only 30% of New York nonprofits can be considered “financially strong”—and “many trustees do not understand the financial condition of their organization or how it compares to its peers.”

[…]

Part of the problem is that many funders have become obsessed with measuring their impact on a per-dollar basis, which means they’re more eager to give to specific projects than the institutional upkeep that supports them. But the 15% overhead limit doesn’t even parallel what commercial companies shell out. According to Bridgespan’s research, the average S&P 500 firm spends about 34% of their budget on essential behind-the-scenes support. For IT companies it’s more like 78%, the report notes. Some 21st-century nonprofits probably require the same kind of tech firepower.

Similarly Pallotta noted,

So we tell the for-profit sector, “Spend, spend, spend on advertising, until the last dollar no longer produces a penny of value.” But we don’t like to see our donations spent on advertising in charity. Our attitude is, “Well, look, if you can get the advertising donated, you know, to air at four o’clock in the morning, I’m okay with that. But I don’t want my donation spent on advertising, I want it go to the needy.” As if the money invested in advertising could not bring in dramatically greater sums of money to serve the needy.

What Bridgespan did in their research was segment non-profits into four general areas (U.S.-based direct service, policy and advocacy organizations, international networks, and research organizations) and then broke down expenses into five different categories. It probably isn’t any surprise that different segments of the non-profit sector vary widely in their needs.

There is a graphic in the FastCo article that illustrates this, but for example research organizations spent huge percentages on physical assets compared to policy and advocacy organizations. Policy and advocacy organizations didn’t spend any money on field and network operations, whereas the international and research segments did, but in greatly differing amounts.

They use this research to support their assertion that requiring flat-rate reimbursements for overhead costs across the entire non-profit sector is inappropriate. Not to mention that the percentages they set are restrictively low.

Regardless of whether this research brings about change in the immediate future, at least the scope of those involved in the conversation continues to expand.

Removing Overhead Ratio As A Measure Is Not Enough

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On Non-Profit Quarterly Claire Knowlton wrote a piece advocating for moving past a focus on overhead costs and direct program expenses in favor of full funding of non-profits by foundations. (Or at least recognition of full costs incurred by a non-profit.)

She seems to start from the premise that programs undertaken are essentially jobs non-profits do to further the interests of the funders. This sort of shifts the whole dynamic from a situation where non-profits cast about to find money in order to provide services to one where foundations seek skilled entities to solve problems for them.

Imagine if your personal paycheck were like a restricted grant. Instead of representing your value and level of responsibility in the company, your paycheck is based on a predetermined line-item budget that details exactly how you can spend your earnings. A portion of your paycheck can be used for rent, some for utilities, but most is earmarked for business attire, transportation to work, and coffee to keep you productive throughout the day. The thinking here is that by tying your paycheck to the expenses that contribute to your work, the company is making sure that you will show up on time, appropriately caffeinated, and properly dressed. It’s as if every penny of your paycheck is spent before you cash it.

To some extent, you had a say in your paycheck budget. In fact, you had to present a proposed paycheck budget when you applied for the job. Your friends on the inside said no one who spends more than 20 percent of his or her paycheck on rent has ever been hired. To get the job, you cut your rent line item. That means making do with an efficiency unit above an all-night bowling alley, but it’s better than not having a job at all. Some line items were nonnegotiable from the start: As a policy, your company won’t pay for haircuts; but that’s okay—you can let your hair grow long.

She goes on with this analogy noting that the “company” wants to make sure you are working effectively so they require you to generate reports–except that the cost of doing so will cause the ratio of time you devote on administrative tasks vs. the central tasks they are paying you to accomplish to skew higher. The employer won’t like that.

Because every penny of your paycheck is pre-spent, there is nothing left over for the future or to take care of retirement, emergencies and replacing your aging car (equipment).

In terms of a solution, she says:

“If we start to fully fund nonprofits for their day-to-day program and overhead expenses, and abandon overhead measurements as a proxy for mission fulfillment and efficiency, it’s the equivalent of giving nonprofits control over their paycheck.”

But she says the term “full costs” include:

Day-to-day operating expenses + working capital + reserves + fixed asset additions + debt principal repayment = full costs

In addition to laying out her argument, she makes suggestions to both non-profits and foundations about how they can change the conversation and practices.

Full funding of costs according to her definition would allow non-profits to be more focused on outcomes rather than compliance in order to survive.

This distinction is important. One of my initial thoughts when I read this was that what Knowlton was talking about would primarily be applicable to social service non-profits because fewer foundations would be interested in funding an arts non-profit primarily focused on creating performances.

The thing is, many performing arts organizations are just as focused on compliance and survival as any other non-profit. There are a lot of sincere ambitions that get abridged and curtailed because there isn’t possibility of revenue or funding.

I don’t know how many conversations I have had that started enthusiastically but were quickly ended by the phrase, “…unless we can get a grant to cover it.” Enthusiasm to do a week long residency with multiple interactions turns into a single lecture-demo for lack of funding. Opportunities for single lecture-demos get turned down for not being revenue generating. The outcome focused on is surviving another season.

After awhile, no one even entertains exciting ambitions and settle for minimal token gestures that will garner them a little bit of funding.

A situation where both the organizations and foundations embrace philosophies that make a complete assessment of what would be required to fully fund an arts non-profit could yield amazing outcomes from some.

In addition to funding capacity building for the organization so that everything from the board governance to hiring practices were strengthened, a rigorous study of what the local market would bear in terms of pricing, (including the optimal pricing spread for events), would provide a clear picture of what the capacity is for revenue.

This way there is a good basis for decision making by the organization as well as stronger justification of the funding that is needed to offset the difference between earned revenue, donations and program expense.

While I am skeptical full funding will happen, articles like this one and the conversation about eliminating overhead ratio as a measure of effectiveness are indications that there is potential for a shift toward more constructive policies.

Companies No Longer Want To Sponsor Simply For The Exposure

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The most recent issue of Arts Management Newsletter has a translation of a piece written by Wolfgang Lamprecht about the death of corporate sponsorship.

Citing the number of corporations disengaging from their support of a host of international venues and events, Lamprecht says the days of sponsorship as publicity is past. The value of sponsorships to a corporation needs to be framed in different terms.

Just as many artists are rebuking job opportunities that provide “exposure” as the only stated benefit, so too are companies no longer interested in arrangements that simply puts their logo in front of eyeballs.

Here’s the thing: today, entrepreneurial cultural engagement is less about image or about customer loyalty than it is about the central asset of trust. Our current crisis of confidence cannot be overcome with programs for the needy, nor by logo placements.

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Art and culture have the particular advantage that, on the most part, they generate a basic element of trust. Trust and confidence are crucial for securing the stability and legitimacy of the economic system, but they must be produced discursively. The disadvantage of culture lies in the fact that art and culture are viewed as being marginally important and therefore have to fight for their social relevance.

Lamprecht notes that as the concept of Corporate Social Responsibility has gained currency, it has expanded to encompass the concept of Corporate Cultural Responsibility (CCR). He takes pains to emphasize that “CCR is therefore part of the social (= societal, not charitable) responsibility of a company.” So conversations soliciting support should focus more on social good and responsibility versus charity and tax benefits.

Of course, this also means that the organization soliciting the support needs to make sure they present an image that embodies cultural asset.

In short, cultural engagement of a company has to follow the belief that the support of arts and culture is not simple fun and communicatively truly brings all that which impact research and marketing departments have so eagerly argued for in the past (image, customer loyalty, employee motivation, etc.). Above all, it is an important contribution to social responsibility that a company should, if not must, provide to maintain a balanced and civilized society, as well to the long-term sustainability of its own success.

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The goal remains the same: against the backdrop of a massive lack of trust through saturated markets and products that are similar, corporations are, in the competition for clients, forced to approach their stakeholders differently than by common means. CCR presupposes the desire to stand out from the competition and, particularly in the field of corporate communication, to secure confidence, competitive advantages and verifiable income. The following measures have been defined for CCR: corporate sponsoring, corporate giving, corporate secondments / corporate volunteering, events, cultural commissioning, product-/image placement, cause-related marketing, public private partnerships, impact investments.

My only concern with this approach is that it starts to smack of artwashing/culturewashing and greenwashing. An arts organization can damage their image long term by having an association or accepting a gift from an unsavory individual or company. It would be worse if they were perceived as openly courting anyone who wanted to remove a blemish on their reputation.

Something Lamprecht wrote seemed to suggest this approach should be used with individuals as well as companies.

“…a key advantage of the model described here is no longer the need to decline and perpetuate the terminologically worn demarcations (CCR measures) between sponsorship, patronage, donations, etc. as a prerequisite for entrepreneurial legitimacy of individual cultural support measures.”

If individuals are not widely solicited for support in Austria, I may be misreading this to suggest that the idea of social responsibility should be applied to all efforts to garner support, including individuals. I know from reading other pieces in the Arts Management Newsletter that fundraising in Germany is conducted in a different manner than in the US. It may be similar in Austria where Lamprecht works.

But it is interesting to consider that rather than saying individuals donate and corporations sponsor, a single term and rationale for giving might be used.

Is there any benefit to trying to recast the rationale for why an individual in the US should donate? My impression is that different people are motivated to donate by different arguments. But if you change the message from donate to help a poor child experience art (charity) to donate to help a child develop into a better cultural citizen (social responsibility), is that better?

My suspicion is that “cultural citizen” will work with foundations and governments whereas “charity for the under served” is more compelling to an individual. But maybe I haven’t thought of the right terms yet.

Investing In Social Outcomes

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Non-Profit Law blogger Gene Tagaki had a post on LinkedIn a couple weeks ago about Social Impact Bonds. These bonds are a fairly new approach to funding non-profit activities. While I think they could be a viable tool for funding the arts, I had some reservations about them as well.

The biggest difference between a social impact bond and the current practice of government entities providing grants to solve the same problem is that a private investor is involved in the process.

Here’s how that might work using social impact bonds:

  1. A government agency identifies a social problem and commits to making a payment, but only if the targeted social outcome goal is met.
  2. An investor interested in addressing the social problem makes an investment which will may result in repayment with an additional return on its investment, but only if the social outcome goal is met.
  3. A nonprofit organization is paid by the investor, delivers services to achieve the social outcome goal, and provides a report back to the other parties.

Typically, an intermediary develops the SIB, raises capital from the investor(s), selects the nonprofit service provider(s), and selects an independent assessor that will determine if the social outcome goal is met.

Among the benefits to this approach that Takagi lists are:

  • Government payments only for agreed upon social outcome results, generally shifting government funding from short-term relief to longer-term impact.
  • Greater development and use of metrics for impact assessment, which may contribute to a favorable change in the way government funding works in its selection of service providers, models of service, and evaluation criteria and protocols.
  • Investors screen nonprofit service providers for those most likely to deliver the targeted social outcome result.

The shift toward long term impact rather than short term goals would definitely be a boon for most arts organizations. But the potential for service providers to be chosen on the basis of independent analysis using different criteria can be very appealing.

Arts organizations which are well positioned in communities investors wish to impact and who specialize in providing the services desired have the potential for receiving all the funding they need to do the job rather than funding in proportion to their budget. If organizations are chosen based on effectiveness rather than prestige, smaller arts organizations may be more likely to benefit as well.

The potential downside of this approach is that because it is an investment, the desire for a return may dictate many elements of the program.

  • Diversion of more cost-efficient direct government and philanthropic funding of sure-bet programs to address social problems…
  • Investors may dictate strategies of service provision to maximize their opportunity for a high economic return on their investment instead of a high social return.
  • Funding will be restricted and likely prevent nonprofits from using such funds to build the necessary infrastructure to support new or expanded programs to achieve the social outcome result.
  • Funding for innovative and long-term strategies may be stifled by investors willing to fund only the strategies with the most proven track records of success and/or easily measured, short-term returns.

Even if your organization doesn’t participate in a Social Impact Bond program, I foresee some potential repercussions in government granting and funding taking their cues from investors. If a government entity sees that companies are investing in certain programs, they may either view it as a type of imprimatur of those programs without doing any research or developing any criteria of their own. Or the government entity may wish to curry favor or stimulate greater investment in the community by supporting investor agendas with grants and favorable rules.

Part of the process to be qualified to invest in a Broadway show is that your personal wealth be such that you can afford to lose money. That is essentially what Takagi suggests in the analysis at the end of his piece. Only true social investors who are prepared to lose money or only gain a small rate of return in order to effect a social good should be allowed to participate in the Social Impact Bond program.

I bring up the Broadway investment scheme because the same potential for damaging investor influence exists there but the agreements have been structured so that it is clear the majority of investors don’t have any say in the way the show is executed. A basic framework exists that could be applied to Social Impact Bond funding.