WHAT IS THE CORRECT FUNDRAISING EXPENSE RATIO?
Updated: Feb 1, 2021
Dear Friends and Colleagues:
I would like to explore a sensitive and widely misunderstood subject which often impedes non-profit success. Having lived and worked in South Florida all of my life, I believe it is especially relevant to the success of our young but maturing non-profit sector.
Non-profit boards are in a constant struggle to define the correct level of fundraising and operational expenses. Most advice is based on word of mouth discussion by well-meaning volunteers. Regrettably, misinformation is more prevalent than facts. The result is humanitarian organizations routinely using incorrect measures to assess success, leading to stunted growth and impact.
Or rather, the result is that thousands of people who could be served by our fabulous non-profits and generous donors, are not!
We can understand that a board may celebrate a 12% expense ratio that raised $1 million. But what if their charity had a 17% expense ratio with $2 million raised and a steady growth curve over the next five years? Especially if twice the number of people were served. Wouldn’t that be a better outcome? Yet these discussions rarely happen on our non-profit boards.
Let’s deal with this sensitive dilemma head on, despite the fear of criticism that often accompanies this discussion.
The Non-Profit Rulebook
Ethical capitalism is celebrated throughout most of the modern world. The benefits are obvious: investment and competition lead to efficient organizations that meet human demands. But in the non-profit world the rule book is perceived differently. The thinking goes that donors only want to see their donations directly impact those in need. And that other expenditures are somehow “extra” or wasteful.
As a result, the concept of effectively investing funds in salaries, marketing and operations, or “overhead”, is not openly addressed. The conversation is often driven by fear of disapproval rather than by transparent and honest discussion. Yet it is self-evident that charities must be able to spend money on the things needed to achieve lasting change.
A well-meaning contributor may state that “100% of my funds must go to the children”, and of course, we must respect his or her wishes. But underneath, most of us realize that this is merely a right-pocket, left-pocket scenario which sidesteps the real issue. Without “overhead” the charity would simply cease to exist. And the money to pay the bills has to come from somewhere!
Fortunately, most donors understand that short-term spending is needed in order to achieve long-term results, even when desired outcomes aren’t immediately achieved in a given fiscal year.
But few donors and board members really understand how to evaluate fundraising expenditures.
So what exactly is normal?
A 15% fundraising expense ratio is often cited as the “expected average”. So let’s start with the most elementary of analyses. Would this be the right standard for a small, new charity? Or would it be a better measure for a large established charity? Is it the perfect standard for a charity supporting a popular and well-known cause that attracts donors easily (i.e. breast cancer)? Or would we expect it from a charity that is struggling with a relatively new or emerging disease (i.e. remember when autism was relatively unknown?).
Are the donations received by a hospital or performance hall, where donors receive VIP healthcare or upgraded seating, equally expensive to achieve than those raised by a small social service charity that can only return a sincere thank you? Or let’s compare fundraising expenses for a local zoo with expenses for an international university with thousands of loyal alumni.
Let’s make this contrast really simple. Would it be reasonable to compare the expense ratio of the Mayo Clinic with a small and recently-established youth charity which may be struggling to help hundreds of children in an underserved community?
No, of course not. Yet we do.
In each of the above scenarios the acceptable measurement of success must be carefully considered. Size, organizational maturity, popularity of the cause, scope of the charity, and much more must figure into such an assessment.
So why does incomplete evaluation routinely happen?
Again, let’s start with the basics. We are human, and we repeat truisms in the absence of knowledge. And when no one argues against the ordained axioms, they become “fact” (I still wonder why my abuela wouldn’t let me go swimming after lunch).
Audits and board retreats often fixate on feel-good measures which are missing the context that would lead to reliable and helpful conclusions. That is not to blame the auditors and accountants, who are often responding to the feedback and existing biases of their client boards. I have seen frowns and dismay at such meetings when expenses approach 20%, and wide smiles at 10%. But no contextual discussion as to why it was higher or lower than expected, or what increased investment might have accomplished.
Nor can we blame the volunteer board members who wish only to serve and support. They are making their best efforts to apply what they've learned from others. But everyone must do better than to merely compare expense ratios against national averages. And we must find a way to start the conversation.
While there are analytical standards within categories – there simply is not one golden standard of investment and return for non-profits. An average fundraising expense ratio without considering other causal factors is just plain wrong.
Sometimes 2 + 2 is equal to 1.7, or perhaps 3.1.
How many non-profit board members understand that fundraising expenses can be (and are) internally allocated in endless ways? Here’s a well-known disclosure: every non-profit uses a wide and creative range of allocation possibilities to determine where costs are counted (just ask any non-profit CFO). Is 50% of the CEO’s time spent on operations, or on fundraising? Is a fundraising brochure a program marketing piece, or a fundraising brochure? Was the food served at the presentation a fundraising expense, or an educational program expense? Is a temporary staff member an event expense, or an operational fundraising expense? ( just guess which one will be chosen 99% of the time). All these and much more provide variability for real expense decision making.
This creative allocation process can sometimes get out of hand.
One highly regarded 2004 study shockingly reported the following through an analysis of IRS 990 forms:
• Thirty-seven percent of nonprofits with at least $50,000 in contributions reported zero fundraising costs.
• One-fourth of nonprofits reporting $1 to 5 million in contributions reported zero fundraising costs.
• Thirteen percent of nonprofits reported zero management and general expenses.
Source: Special Issues in Nonprofit Financial Reporting.pdf
Really? Zero fundraising expenses?!
So in the end, board members and management alike are faced with decisions based on financial benchmarks which often are misunderstood to begin with, and with data that is carefully crafted to provide the best snapshot possible. And you can't blame the charities. As common sense and research has shown - how can Charity A not engage in presenting the best snapshot possible, when Charity B, C, D, and E are doing it?
The result is that we struggle to define the true measures of non-profit success. And not exploring and openly discussing the core issues just promotes more of the same.
The impact on charities
The effect of these misunderstood standards on non-profits, especially new or small non-profits, can be dramatically negative. While the following two scenarios are worthy of discussion on their own, both are influenced by the pressure to achieve low fundraising expenses.
The first is staff retention. Most studies show that development officers move jobs an average of once every 18 months. Yet these same studies show that the loss of a good development officer can cost the charity hundreds of thousands of dollars, if not millions over the long run.
Yet many non-profit will lose a good development officer for lack of a $10,000 investment in salary, training or benefits. They just can’t afford it. Or so they believe.
A recent client provides a typical case in point. A young, mid-level development manager was earning a below market rate - despite her strong performance. The constant financial demands on program services were just too great and the organization could not “afford” to invest more. This hard working, college-degreed professional remained almost two years, honing her skills and creating trusting relationships with donors. And then, just when she was nearing the pinnacle of donor credibility and trust, she was picked off by another charity who could “afford” to pay her market rates!
In reality it was the smaller charity that could least “afford” to lose this development officer - and the net loss was surely far more than $10,000. It was a pattern that had existed for years at this organization (and many others). But the organization proudly celebrated their audit showing that their expense ratio was only 12%. And the management beamed at the praise.
What they might have considered instead was the long-term relationship between low investment, staff turnover, and other factors that heavily influenced growth and long-term stability.
What they could have been discussing instead was the opportunity cost of “saving” $10,000.
Timid Fundraising Rewarded
A second challenging trend is fear of risk-taking. In a typical for-profit organization, risks are accepted while new and worthy ideas are explored. Some work, some don’t.
But whether it is a for-profit or non-profit organization, not every new effort can be guaranteed to succeed. And even the most successful fundraising effort often takes time to mature and provide returns. A fabulous fundraising idea may produce $50,000 in its first year, with a gut-wrenching 70% expense ratio. Ten years later, this same idea may be producing $1,000,000, with a 20% expense ratio. Or it may have proven to be a losing concept. But how many charities shy away from risk due to the fear of expanding their overall fundraising expense-ratio in a given year?
As Elon Musk recently said “If things are not failing, you are not innovating enough”.
So What is the Norm?
Extensive discussion and research exists on this difficult issue, including norms and standards that provide context for board members to make sound judgments. The recent works of Dan Pallota in particular have highlighted the extent of the challenge, through numerous books and articles and a Ted Talk that is worth a watch.
Successful charities strive to develop analytical models with care, transparency and respect, but not with fear. The value of an engaged board in this process is immeasurable. Wise investment in growth and success, overseen by informed and caring board members and educated donors, is a great thing. A low fixed percentage of expenses, judged independently of overall value, is not.
Clearly, all humanitarian organizations must secure the funds needed to achieve their primary mission. The needs are endless. But along with implementing the mission, these organizations must also face that without money there is no mission. Thoughtful investment is more important than sticking to outdated ratios and overly conservative, feel-good practices.
A Maturing South Florida Philanthropic Scene
In the past 10 to 20 years, South Florida has evolved into a community with an international reach and reputation, with transformational cultural and community activities. But some say that our non-profit organizations continue to lag far behind the curve. Who is teaching our potential new board members the acceptable standards of success? Where should these balanced discussions happen? We need to find a way.
It’s time we took a good look at how we measure our non-profits, and reach well-researched and thoughtful conclusions that make maximum impact. Let’s start with our own boards.
A humanitarian organization should be measured through the quality of its services and the quantity of people served, and not primarily through how low it keeps operational costs. The thousands of South Floridians touched by our important non-profits deserve nothing less.
What are your thoughts or ideas on this issue?
Are there other important challenges facing our South Florida non-profit community that you’d like to see discussed? Please feel free to share your thoughts and concerns.
Let’s move the needle.