Why overhead ratios are meaningless for Kiva and Acumen Fund

Matt Flannery, the CEO of Kiva, wrote an excellent post on nonprofit overhead over on the Social Edge blog.  Kiva has been a game-changer in the poverty alleviation space: they use Kiva.org to connect donors to microfinance loan recipients in the developing world.  What’s important is the loan part — rather than getting a grant the borrower has to pay back the microfinance organization, which in turn pays back the funder.  Conceptually, this is similar to Acumen Fund, where I work – we raise philanthropic donations and then make debt and equity investments in enterprises that serve the poor in the developing world.  When we’re paid back, we recycle that capital into new investments.

One of the challenges that Acumen Fund and Kiva both face is that our models – focused on innovation, accountability, investment, and better leverage for each philanthropic dollar – are in direct opposition to the traditional metrics that rate nonprofit efficiency.  This is because invested capital (loans and equity), unlike grants, don’t factor into ratio of “overhead costs as a percentage of total cost.”  It just stays on the balance sheet but is not part of the annual budget.

The conventional nonprofit wisdom is that “best in class” nonprofits will spend no more than 20% on “overhead,” breaking down roughly to 10% on fundraising and 10% on administrative costs.

As Bridgespan, one of the leading consulting organizations to the non-profit sector, reports, “Many organizations and their funders are locked in a vicious cycle in which nonprofits are pressured to under-invest in overhead and to under-report their true overhead costs, even when those costs are still below what their senior managers feel is needed.”  Worse still, Bridgespan reports that “The majority of nonprofits [75-85% they studied] under-report overhead on tax forms and in fundraising materials.”

If we’re going to break the cycle, we have to uncover how flawed the underlying logic is.  Here’s where the logic falls apart:

An example: Both the Grameen Bank and BRAC in Bangladesh are world-class organizations that have changed the lives of tens of millions of poor people (mostly Bangladeshi women) through the provision of microfinance services.  Both organizations were founded by visionary leaders upon whose shoulders my generation stands in our work to bring an end to global poverty.

Yet, if forced to choose, I would argue that Grameen had the greater impact on the world because Mohammed Yunus, Grameen’s founder, won the Nobel Prize.  This was a major marker that “mainstreamed” microfinance and allowed the world, and not just the development community, to understand that lending money to poor people could change their lives in new and exciting ways. The result was a huge influx of commercial capital, and significantly more growth in the sector – ultimately leading to millions more served.

My question is: in the 30 years prior to Yunus receiving the Nobel Prize, does it sound right to you that every meeting Yunus had with a world leader, a powerful donor, or a leading journalist would have been counted in Grameen’s “overhead” cost, as separate from the “program” cost of delivering microfinance services to Bangladeshi women?  Should Grameen have “stuck to its knitting” in delivering microfinance services and not wasted money on all the “overhead” of external communications and building a community of friends, advocates, advisors, and supporters, which ultimately led to a global movement in support of microfinance?  (and yes, I know it wasn’t all Yunus, but without him, I don’t think we’d be where we are today).

My point is: it’s not just a little wrong to try to separate out “program” from “overhead,” it’s an outdated (or maybe it was never right) mode of thinking that is based on the premise that nonprofits are primarily delivery mechanisms for pre-determined services.  In reality, nonprofits play an active role in shaping our collective understanding of how to solve important social problems.

And getting back to Kiva and Acumen…: There’s a whole new segment of hybrid organization – encompassing the likes of  Kiva, Acumen Fund, Root Capital, E+Co, Agora Partnerships, sitawi, and others – that deploy mostly non-philanthropic capital for social ends.  Much as we’d like not to worry about the conversation, people do often ask about “overhead ratios” when making philanthropic decisions.

In closing, here are four (more or less related) thoughts:

• Until “social investors” like Acumen et al. can develop a common vocabulary to  assess how efficient and effective we are (or are not), we will be at a disadvantage in the philanthropic marketplace
• The nonprofit sector as a whole would be significantly stronger, and better positioned to weather economic downturns, if nonprofits didn’t rely on annual funding cycles.  But raising money over 18 months to pay for costs over 5 years requires an upfront investment – one that will look “inefficient” based on traditional ratios
• If you care about fundraising efficiency, ask how much it costs an organization to raise a dollar, not how much they spend in total on raising money.
• Even when asking this question, take the answer with a HUGE grain of salt – raising money, teaching, inspiring people, changing attitudes, motivating people to act….there’s huge overlap in these activities. If you don’t agree, please read my NonProfit CEO Manifesto and let me know how we can all do this better.