Myth

On June 17, 2013, the CEOs of GuideStar, Charity Navigator, and BBB Wise Giving Alliance signed a letter to the Donors of America denouncing the “overhead ratio” as a valid indicator of nonprofit performance. Leading commentators applauded the move even while some noted that charity ratings organizations, like some of the signatories to the letter, were in no small part responsible for perpetuating the "overhead myth." Meanwhile, nonprofit executives and Dan Pallotta collectively said, "It's about time."

What is overhead?

Overhead generally refers to an organization's administrative and fundraising expenses. Overhead Ratio is the ratio of overhead expenses to total expenses. A 30% overhead ratio indicates that 30% of an organization's total expenses went to overhead; the corollary is that 70% went to program expenses.

Why do donors want to fund programs instead of overhead?

Understandably, donors have equated funding programs with impact. But investments in infrastructure and public education/support may have as much to do with impact as investments in the direct provision of goods and services. Donors want to see their dollars produce the most charitable impact possible. It is overly simplistic, and in most cases, flat out wrong, that the more dollars that go to programmatic expenses, the bigger the charitable impact. This is best explained with a simple example:

Charity A spends 10% on overhead and 90% on programmatic expenses to provide charitable services to children with cancer and their families. With a $1 million budget, Charity A helps 90 families with 8 hours/month of direct services. Charity A's programs, and donor base have remained relatively static for the past ten years, but it has suffered from frequent turnover of managers, low employee morale, outdated technology, and weak systems.

Charity B pursues the same mission as Charity A but last year spent 40% on overhead and 60% on programmatic expenses. With its $1 million budget, Charity B helps 200 families with 20 hours/month of direct services. Charity B has strong leadership, makes smart use of outside experts, and invests in infrastructure and technology to leverage continued growth. As a result, Charity B is rapidly expanding its operations with a much broader and engaged group of donors and funders, and sharing and collaborating with other organizations to create greater impact beyond the communities it directly serves.

Charity A may have a much lower overhead ratio than Charity B, but a donor's investment in Charity B will result in a much greater impact on the lives of children with cancer, their families, and the braoder community.

Does the law have anything to say about overhead?

Not explicitly. But 501(c)(3) organizations are required to be operated primarily to further one or more 501(c)(3) exempt ("charitable") purposes. Additionally, they must not be operated to benefit private interests, except incidentally in furthering the public's interest. If a 501(c)(3) organization is using a high percentage of its resources on activities that are not charitable, the IRS may charge that the organization is not using charitable assets in a manner that is commensurate with its charitable purposes and revoke its 501(c)(3) status. The underlying rationale is that such use of charitable assets is evidence that the organization is not operated primarily for charitable purposes and likely operated with the primary intent to benefit private interests (like those of a commercial fundraiser or highly paid insiders).

What are our thoughts on overhead?

The amount of overhead and the ratio of overhead to programmatic expenses are by themselves poor measures of a charity with few exceptions. As we noted above, the overhead ratio may have little to do with impact. This is not to say, however, that the overhead ratio should not be considered at all. Particularly when looked at over a period of years in relation to several other impact-related factors, the overhead ratio may indicate whether or not an organization is making good use of its funds, is well managed, and is serving primarily public rather than private interests. Consider the following example:

Charity C has spent 70% on overhead for each of the last 5 years but its overall revenues, net assets, persons served, infrastructure, programs, and public outreach have remained static and uninspired the entire time. Charity C pays its founder/CEO top dollar (to the extent permissible), engages in costly fundraising efforts that produce relatively small amounts of net revenue, and has a board that is composed solely of the founder's close friends and business associates.

Charity C may not be the ideal organization for a donor wanting his or her contribution to have the greatest impact possible. Its high overhead ratio doesn't appear to be justified by progress in its performance or impact, and its leadership doesn't inspire confidence that these factors will improve.

Other Resources

It's Time for Real Talk About Real Nonprofit Overhead Costs – HuffPost Impact

Getting Clear About Overhead – The Center for Effective Philanthropy