Critically Low Reserves Require Funding “Reboot”

More than half of surveyed nonprofits have frequent or chronic budget deficits; 40 percent have fewer than three months of operating reserves; and, 10 percent showed no reserves, making that group technically insolvent.

“Given the prominence of the nonprofits we looked at, the results came as a surprise. Something is deeply wrong when a system so consistently leaves nonprofits struggling and we want to help change that,” according to Michael Etzel, a partner at Boston-based Bridgespan.

Investment in organizational capacity and financial resilience provides a crucial foundation for nonprofits to advance their missions but that funders and grantees too often neglect to focus there, according to Hilary Pennington, vice president, education, creativity, and free expression at the Ford Foundation.

Bridgespan examined the financial health of nearly 300 grantees that account for one-third of the combined spending of the top 15 U.S. foundations. Examiners reviewed nearly 1,500 financial statements spanning the years 2009 to 2014 from organizations with big budgets, professional staffs, and successful programs. Given the prominence of these nonprofits, many of which are household names, the results came as a surprise, according to a report written by Etzel and Pennington titled “Time To Reboot Grantmaking.”

They assert in the article that investment in organizational capacity and financial resilience provides a crucial foundation for nonprofits to advance their missions but that funders and grantees too often neglect to focus there.

The Bridgespan Group and The Ford Foundation developed a “Grantmaking Pyramid” aimed at building strong, resilient nonprofit organizations that can achieve results. According to Etzel, the “Pyramid” offers a systematic approach to helping organizations be successful. The Ford Foundation has made the “Grantmaking Pyramid” the centerpiece of its new BUILD Initiative, a $1 billion investment over five years to strengthen the resilience and effectiveness of key grantees.

    The “Pyramid” illustrates a sequential hierarchy of needs:

  • Nonprofits need to build strong foundational capabilities to cover actual costs of core functions such as technology, rent, staff development, and other capabilities specific to their service and business model;
  • Nonprofits need organizational resilience based on financial health, which implies accumulating unrestricted net asset balances; and,
  • Nonprofits need to deliver effective programs, a springboard for scaling and sustaining impact.

“By focusing attention on an organization’s foundational and financial needs, the Pyramid aims to prompt a discussion that leads to making investments in the right order,” said Etzel.

“We are encouraged that for our first batch of BUILD grant recipients, the “grantmaking Pyramid” is having the desired effect,” said Pennington.

Shoring up foundational capabilities and balance sheets won’t be easy. Funders too often leap to invest at the top of the pyramid, whether it’s a sexy innovation in scaling or sustaining successful programs and services. But overemphasis on the top of the pyramid effectively hollows out the rest, according to the authors.

Organizational capabilities too often fall into a catch-all indirect-cost category typically limited to a 10–15 percent reimbursement cap, all but guaranteeing a shortfall. In Bridgespan’s research, median indirect costs are almost triple the typical grant allowance. Without a strategy for recovering actual costs, organizations are forced to spend scarce unrestricted dollars to fill funding gaps rather than meet other critical priorities, such as staff development, collaboration with sector partners, or IT infrastructure. The inability to cover operating costs shows up in persistent annual deficits. Those deficits tap, and quickly deplete, the modest operating reserves nonprofits manage to squirrel away, which can force borrowing from restricted funds.