Originally published in Stanford Social Innovation Review, June 16, 2016

This article, “Pay-What-It-Takes Philanthropy,” is a heartening sign of the growing recognition that supporting nonprofit organizations with limited, restricted funding does not work. So what can we all do to make sure this recognition leads to systemic change that sets up nonprofit organizations for success and honors funders with the results their generosity deserves?

The answer is simple in theory. As Ford Foundation President Darren Walker notes in the article, we must “encourage more honest dialogue about the actual operating costs of nonprofit organizations.” But how do we practically make that work in the absence of a mutual commitment to build trust between funders and grantees?

We are trapped in a mindset that stigmatizes spending beyond direct program work. This mindset keeps many nonprofit leaders from recognizing and pursuing the investments needed to drive long-term impacts. And too many funders underestimate the unequal power dynamic inherent in their interactions with grantees. Analysis alone cannot overcome this cultural challenge. We must commit to a process that is mutually empowering.

We agree with the premise of the article that effective grantmaking should be grounded in understanding the real costs of operating individual nonprofit organizations, rather than a single-rate, one-size-fits-all approach. Based on our experience having run, funded, advised, and/or lent to thousands of nonprofit organizations, successful approaches begin with an open and comprehensive understanding of the full costs each organization requires to achieve results. This understanding recognizes that:

  1. Full costs differ over time. A nonprofit poised to buy a building will have very different indirect cost needs than the same organization three years later. And the cost structure even of the same program can differ from, say, year one to year five. Calculations of full cost that focus on what an organization has needed to operate in the past often do little to help us understand what it needs to adapt to the future.
  2. Full costs differ by context. We have seen situations where local nonprofits operating under the same national umbrella organization have very different cost structures because each branch is responding to its local context (not because some are necessarily more “efficient” than others).
  3. Full costs are about more than covering indirect costs or overhead. Healthy nonprofits are able to save and borrow to respond to changing community needs and to safeguard services in times of crisis. Even an organization with its indirect costs covered will not necessarily develop this capacity.

Fortunately, we are beginning to understand this. In California, the Nonprofit Finance Fund, the California Community Foundation, the Weingart Foundation, and 12 regional nonprofit organizations are piloting a program to enable nonprofit and foundation leaders to explore full costs together. This project is helping nonprofit leaders and foundation program officers build a shared understanding of full cost that goes beyond indirect rates to include the full set of costs a resilient organization needs to cover. This work is bringing nonprofits and funders together for honest discussion about what it takes to fund social progress. We are unpacking the power dynamic that hinders candid conversation about true organizational needs. Early results are encouraging. As one nonprofit participant noted: “Because there were funder and nonprofit staff together around the table, I thought it was one of the most beneficial and ‘real’ convenings I had been to. I thought the perspectives and openness were so refreshing and challenging.” Ninety-seven percent of participants reported increased comfort advocating for full costs.

Although this particular process may not work for everyone, it may be worthwhile to consider testing it among funders and grantees nationally, adding to the research agenda called for in the article. Most important, all funders and nonprofit leaders can help foster more honest dialogue in these ways:

  • Funders: Reorient funding discussions and requests around the results you want grantees to achieve, rather than how you want them to spend money. Signal that you understand the constraints your grantees face. And provide general operating support. If you do not trust your grantees to know best how to use that support, how do you expect them to trust you? (And why are you funding them in the first place?)
  • Nonprofits: You must articulate clearly the impact you generate with the resources you raise, which takes time and effort you likely do not have. And we realize that it can be reckless to fully disclose organizational needs to some funders. So start by asking the hard questions internally—that will at least make you better informed about your own full costs. Then identify which of your funders would be willing to discuss the implications of these insights. There are more of them than you think.

As noted in the article, it’s time for new approaches to grantmaking. These approaches should be rooted in a practical and comprehensive understanding of what it takes to build an effective and sustainable nonprofit organization. This will require committing to honest interaction between individual funders and nonprofit organizations to overcome the mutual distrust that often overwhelms the full cost conversation.