Written by Melissa Stanz with Steve Kallann
Nonprofits in Capital at Play? Of course! Consider a few facts:
– Nonprofits are a huge part of the Western North Carolina economy. They form an important part of our regional employment base (see p. 29).
– Most philanthropic assets come from American business success. This is true in Western North Carolina as well.
– Area business leaders sit on nonprofit boards, provide counsel, and are major funding sources for mission-driven and social services nonprofits.
– Nonprofits fill the gap between what business, government, and churches cannot or will not do.
For these reasons and others, we are exploring the business of nonprofits and the ways they embrace metrics, accountability, and financial acumen while staying true to their mission. We are also looking at the ways business people take a stand (or not) to help nonprofits run more effectively, secure funding, and achieve their mission.
Focused on a broad group of mission-driven and social services nonprofits that serve the people of Western North Carolina, we are highlighting organizations that serve our culture, our children, and our environment with social services, arts programs, economic development, and job training.
Because churches, colleges, universities, private schools, or institutions like Mission Health represent unique sectors on their own, we opted not to include them here.
Steve Kallan, CEO of Kallan Strategic, is a nonprofit management consultant in Asheville, North Carolina. Steve spent decades helping national nonprofits and businesses manage change from Washington, D.C.. Moving to Asheville six years ago, he focuses his passion for building healthy businesses and his commitment to nonprofit causes to help strengthen the Western North Carolina nonprofit sector.
“When both nonprofits and for-profits embrace solid business practices there should be little difference between the two. But all too often, nonprofits ask for money only by appealing to their mission—an appeal of the heart,” said Steve.
The business world depends on the availability of capital wherein investors can recognize potential returns. The best nonprofit leaders and their boards assure that their organizations are “investment worthy,” i.e. funders making long-term commitments to the success of the organization and its impacts.
Thomas Beckett is co-executive director of Carolina Common Enterprise, a cooperative development center for the Carolinas. He is an attorney who works to form successful businesses. The combination of a law degree and a MBA from UNC Chapel Hill gives him insight into both sectors. He also serves as board chair of Accelerating Appalachia, a Western North Carolina business accelerator.
“In any kind of enterprise, cash is king. The difference with nonprofits is that they have two sets of customers. There are the people they serve and work with and then there are funders—a completely different type of customer. Nonprofits must show they are working effectively to appeal to both customer bases, but the emphasis may be different,” said Thomas.
Thomas sites Appalachian Sustainable Agriculture Program (ASAP) as a good example of a nonprofit that works. ASAP has worked for over two decades to change the food system in Western North Carolina and build a thriving local food economy. The results in the region are tangible and significant.
“There have been many positive results for ASAP as an organization because of our focus on metrics and accountability,” said executive director Charlie Jackson. “First, the response from donors, grant funders, and the board has been strong because there is greater confidence in the purpose and impact of our work.”
ASAP has embraced a metrics and research-driven approach. “Clear metrics and accountability provide clarity for staff and definitely give direction for ASAP strategy and the commitment of resources.”
“Still,” said Jackson, “this is a work in progress. We have worked hard on a concrete logic model and metrics that guide our work. Many are focused on long-term changes to the food system and it remains a challenge to articulate that. The more clear we can get about accountability for long-term change, the more successful we will be in our work.”
Jackson acknowledged that it is often difficult to distinguish between impacts that can be “attributed” to ASAP and those for which ASAP may be seen to “contribute.” But they work hard to develop clear metrics that matter.
“If our thesis is that increasing exposure to healthy food choices leads to a change in the food system, then we establish proxy measures that may tell us we are on the right track. These are variables that we can control and be accountable for,” said Jackson.
Tension Between Sectors
There is friction between the nonprofit and for-profit sectors. Some nonprofits criticize businesses for only looking at profit and return on investment, while neglecting community and environmental health. Some in the business community criticize nonprofits for not being accountable and having an entitled and unrealistic view of the world.
Case in point—a few years ago Steve attended a symposium in Asheville about community healthcare. He was struck by the absence of nonprofits in attendance given their important role in employment and the economy. Someone asked why nonprofits were not present.
“The response from one prominent business leader was ‘Yes—let’s get them in here so we can teach them some accountability!’ I was incredulous. In my experience most Western North Carolina nonprofits are highly committed to accountability, and their mission, members, and sustainability,” Steve explained.
But there is a kernel of truth to the business leader’s reaction. It raises several key questions: How are nonprofits accountable? How do they measure success? And, how can the business community encourage and reward nonprofit leaders?
Metrics and Accountability
Financial results cannot be ignored in nonprofits. But financial performance alone doesn’t determine success.
“I think ROI [Return On Investment] is inappropriate to use in a nonprofit and cooperative context. There may be a social return, and it may be an investment of sorts, but there is no concrete financial return to the investor,” said Thomas.
So if ROI is not the primary nonprofit measure, what could be? Among other things, Thomas emphasizes that every nonprofit needs a business plan. They also need revenue, cash flow, income to cover expenses, and a positive cash flow to achieve their mission and get the work done.
“An investor wants confidence in a set of people running the business as a management team, and you need to have a solid plan, know where the money is coming from, and what it will cost to run the organization,” said Thomas.
Funding Restrictions and the “Fiscal Year” – The “No Deficits” Myth
In nonprofit accounting a donor may restrict use of a grant for a specific program purpose or a specific time period. Sometimes the cash comes in when the grant is made; sometimes at a later date and sometimes not until program spending occurs. How is that accounted for, and how is “break even” determined?
Many business people and funders are skeptical of any nonprofit organization that runs an audited deficit. But think about this in real terms:
For example, a nonprofit receives a cash grant of $200,000 near the end of 2014, allowing the organization to build a high-impact program in 2015. The 2015 expense budget includes work funded by the grant received the prior year. Audited financials show the income of $200,000 in 2014 that is likely to result in an audited surplus.
Although the organization does great work in 2015 based on income received in 2014, the audited financials may show a deficit. This is logical and perfectly sound management. But if people look only at simple annual financial results, they may conclude the organization is financially irresponsible.
In the business world, operating deficits are perfectly acceptable. That’s why we have bridge loans and debt financing. But in the nonprofit world, if results are based only on financial metrics, all break-even years are “good” and deficit years are “bad.”
The Overhead Myth
A particularly tricky metric is a focus on overhead percentage and overhead costs. The commonly accepted view is that the more that funds are used for direct program expenses, the better the organization must be. At the extreme this may be true since no one would support an organization that funneled most of its assets into overhead and administration.
But we also know that no business board or investor would strip a business of its ability to function and still expect strong ROI. Why would so many funders and boards reinforce the low overhead culture for nonprofits?
Shaun Paul is currently the managing director of Reinventurecapital located in Boston. He founded the EcoLogic Development Fund and served as president for 20 years. He also now serves as an advisor to Accelerating Appalachia – a Western North Carolina business accelerator.
“I’m a big believer in unrestricted operating support. The best organizations need an effective, long-term vision, and therefore they need unrestricted multiyear support. In exchange we need to hold them accountable to the most effective measures of success,” said Shaun.
“Many boards, funders—and sometimes executive directors—are proud of reducing overhead expense. Unfortunately, that kind of frugality forces organizations to live in the same kind of poverty as the people they serve. In many cases I think they should be embarrassed. They seem to be in a race to the bottom,” said Steve.
A national movement is beginning to address this issue. In 2013 a public letter was written to the “Donors of America” signed by the BBB Wise Giving Alliance, GuideStar, and Charity Navigator, which are rating and information agencies in the nonprofit community. Some highlights:
“The percent of charity expenses that go to administrative and fundraising costs—commonly referred to as “overhead”—is a poor measure of a charity’s performance… We ask you to pay attention to other factors of nonprofit performance: transparency, governance, leadership, and results… focusing on overhead without considering other critical dimensions of a charity’s financial and organizational performance does more damage than good.
“When we focus solely or predominantly on overhead, we can create what the Stanford Social Innovation Review has called “The Nonprofit Starvation Cycle.” We starve charities of the freedom they need to best serve the people and communities they are trying to serve.”
More recently, the California Association of Nonprofits (CalNonprofits) expressed concern about what critics call the “overhead myth”; the concept that charities that devote more spending to programs and less to fundraising and administrative costs are more efficient.
“A factory that underinvests in overhead,” the CalNonprofits letter to Charity Navigator said, “will soon find its roof is leaking, its electrical systems failing, without adequate insurance, and without the investments in staff compensation and training that are key to success. As we work toward measuring results, financial health will potentially play an even smaller role in each charity’s rating.”
Two well-known and respected nonprofits have exploited donors emphasis on overhead costs. The Robin Hood Foundation in New York, and the nonprofit charity: water, both tout that 100% of donations goes to program delivery. In truth large funders are supporting the management, marketing, and overhead costs of these excellent organizations. It is not free. Unfortunately, it reinforces the myth that the best charitable contributions go only to “program” and not to the management of the organization that gets the work done.
The Shift In Nonprofit Metrics
Metrics and evaluation measures for nonprofits and government services date back to the 1960s. PhD programs evolved and program evaluation experts now partner in measuring the impact of nonprofit and government work.
In the 1980s venture philanthropy was born, fueled later, in part by the dot-com boom. These entrepreneurs wanted to see results and also wanted more control over the use of their philanthropic dollars. They often demanded clear measures of results, but also put their money where their mouth was. They knew that no business could succeed without the right infrastructure and capacity to deliver.
Venture Philanthropy Partners (VPP) in Washington D.C. is a prime example. Mario Morino of VPP helms the movement. With his book Leap of Reason, he challenges the funding community to invest so that nonprofit organizations can succeed.
From his perspective as a business investor, Shaun Paul knows that businesses focus on a single bottom line as a measure of success. “We are quick to forget that it took about 60 years to come up with an accounting system that would establish a common foundation for investment accounting. What’s new in philanthropy is that we are coming up with standards of what impact is and how we can measure it. Social return on investing is still relatively nascent.”
Shaun references the Gates Foundation as a good example of how philanthropy is moving toward bringing business acumen to the nonprofit sector.
“Gates is pushing and challenging these issues; looking for scalable and measurable change. In the business sector we expect three to five year solutions, but for important social issues like eradicating poverty and cancer—that time horizon is just not long enough.”
What Other Nonprofit Metrics Should Be Measured?
Accountability starts with clear expectations and commitment to results. Many nonprofits with visionary leaders and boards have fully embraced accountability. In some sectors metrics of impact are logical and straightforward.
One of the best-known nonprofits in the region is Manna Food Bank. The public generously contributes to Manna because of its mission to feed hungry people. But behind the scenes, and central to major funders and partners, are sophisticated business practices and metrics.
“Beyond these food distribution goals, Manna is beginning to establish metrics associated with overcoming hunger and improved nutrition in the region,” said Cindy Threlkeld, executive director.
Mountain True, the regional conservation organization, demonstrates concrete accountability to metrics of impact.
For example, a core goal is to secure a forest plan for nantahala-pisgah national forest that includes protections for old-growth forest, backcountry, and natural areas meeting multiple use objectives for timber, wildlife habitat, and young forests through ecological restoration. One metric is that lands not set aside as protected old growth forests provide opportunities for sustainable logging and that < 50% of lands have ecological restoration emphasis.
waste and spoilage: This is a metric on the efficient use of food contributions and funding stewardship.
“inventory turns”: Like grocery and retail – a function of speed of getting the product to market.
pounds of food distributed per person in poverty: Connected to the number of meals served.
food distributed as function of people in need: Equitable distribution.
The metric of “overhead expense” ratios
If you are looking for a single statistic about a nonprofit’s performance, there really isn’t one. It is more useful to measure results and impact than it is to focus on various ratios of overhead-related expenses.
overhead there is not a consistent definition
Typically, overhead includes administrative expenses that are not directly related to programs or services. For example, accounting and human resources, information technologies, and governing board expenses. But cost accounting methods will allocate expenses differently from one organization to another.
Some examples of ratios useful and not (from guidestar)
The “program ratio” (Administrative Expenses ÷ Total Expenses) is a commonly used metric. A number of factors such as size, age, and location affect a nonprofit’s expenses. Some organizations and funders see that at least 65% of total expenses should be dedicated to “program expenses.”
Context is critical as ratios taken on their own can be misleading. Guidestar advises that ratios are helpful:
When you are comparing organizations of similar size and age, that are located in the same area or similar locales, and that have similar missions and programs;
When you are tracking an individual nonprofit’s progress over time.
Frequently, an “overhead ratio” is calculated as Administrative Expenses ÷ Total Expenses. But a single metric is potentially misleading. The “overhead ratio” for an effective organization could range from 7-10% to 25%. Here are two additional ratios:
contributions and grants ratio (contributions + grants) ÷ total revenue
The contributions and grants ratio indicates the extent of the organization’s dependence on voluntary support by calculating the percentage of total revenue made up by contributions and grants.
fundraising ratio fundraising expenses ÷ total expenses
The fundraising ratio is perhaps the least useful of the ratios for a couple of reasons. First, there is ample evidence that nonprofits do not report fundraising expenses reliably—about 60% of the public charities that file a Form 990 report no fundraising expenses at all. Second, unique circumstances facing a nonprofit might make its fundraising ratio higher or lower than that of another organization.
Derived from BBB Wise Giving Alliance, GuideStar, and Charity Navigator.
What You Can Do
Business leaders can provide leadership needed to strengthen the nonprofit sector by supporting two major principles of governance. The first is accountability for results. The second is building the capacity to get there.
Many leaders are beginning to push in this direction and organizations like Western North Carolina Nonprofit Pathways are helping with valued training and support. But business minded board members and funders must lead the way.
some specific ideas
1. reward the best leaders for success.
If an organization can present a cogent multiyear business strategy and a plan to build the capacity to get it done, the funding community can reward this leadership with generous multiyear funding.
2. select the right leadership.
Among the most important role of any nonprofit board is the selection of an executive director. Board members can help ensure that the organization chooses the best leader to pursue a businesslike path. This is not to say nonprofit leadership must come from the business world or have a MBA.
3. encourage business literacy.
Board members from the business community are particularly well-positioned to support stronger business literacy for key nonprofit staff. This includes budgeting and projection skills, project management and team leadership skills, marketing and communication skills, people management skills, and effective use of technology. Boards and funders can commit to investing in recruitment and training of staff with an emphasis on these characteristics and skills.
4. encourage the use of strategic level dashboards.
Many businesses have used executive dashboards for decades. The idea is to report regularly on a handful of metrics that matter the most to success. Board members can ask for periodic reporting in a dashboard format that distills an overwhelming amount of information down to the handful of factors that really matter at a macro level.
5. get educated.
Business leaders on boards and in funding institutions should dive deeper into the nuances of nonprofit financial management. The differences are important.
6. encourage partnerships and mergers.
Funders and board members can encourage stronger strategic partnerships and mergers of nonprofit organizations.
In the business world unique products and service, scale of operations, and other business factors quickly reward the best organizations. Nonprofit leaders and funders can encourage partnerships and mergers to reduce mission overlap, create scale and impact, and reduce some of the competition for scant resources.
two successful examples of mergers in our region include:
1. The creation of mountaintrue: through a merger of the Western North Carolina Alliance, eco of Hendersonville, and the Jackson Macon Conservation Alliance.
The result is a stronger and more diversified organization serving the conservation mission in Western North Carolina.
2. The mediation center in asheville: successfully merged with Henderson County Mediation Center and the Transylvania Center for Dialogue in October 2011.
“The merger has made a huge difference in helping us to meet our operational budget and to continue to provide these needed services to the community,” said Laura Jeffords, executive director. When nonprofits achieve their missions we all benefit—it’s what community is about.
In honor of North Carolina Nonprofit Month, Capital at Play has invited regional non-profits to contribute to this issue. With columns from Junior League of Asheville, Inc., and the Asheville Humane Society, we hope to raise awareness of area non-profits and their important work, while encouraging productive conversations at the intersection of our state’s public and private sectors.
Have something to say? Curious about how non-profits are driving change? Join the conversation on Twitter with @ncnonprofits using the hashtag #npaware.
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