Many grantmakers looking to help their grantees escape the “nonprofit starvation cycle” have turned their attention to their own policies and practices that may perpetuate this cycle. One area in which funders can fail to support the true costs of grantee projects, setting unrealistic expectations and potentially endangering grantee financial health, is coverage of indirect costs.
A 2019 study found that “over half of the 15 largest US foundations…have a flat-rate indirect cost reimbursement policy of 15 percent or less.” Researchers (including BDO) also found that among a sample of grantees of five major foundations, “verified indirect costs exceeded what the foundations actually paid by an average of 17 percentage points.” Such underfunding of indirect costs can cause grantees to forego investments in administrative and fundraising infrastructure, weakening them financially and in mission impact.
While, of course, flexible funding such as general operating support is always particularly helpful to grantees, adequately covering indirect costs is an important part of being a better funder in cases where project grants are a necessary or preferred option. We at BDO have been privileged to work with grantmakers seeking to revise their indirect cost policies to properly support grantees. From this work, we have established 5 tips to enacting policies and practices that meet grantee needs and align with funder goals.
1. Start with Values
Every element of a funder’s grantmaking, from broadest strategy to the details of grant reporting, should reflect its values. Indirect cost policy, despite its seemingly dry and technical nature, indicates how a funder relates to its grantees. Policies that underfund the costs of grantee work, force those grantees to make up the difference, while policies that ensure adequate cost coverage signal a commitment to sharing the work of achieving impact.
The details of an indirect cost policy should thus be informed by the values that a funder wishes to advance. A funder focused on equitable grantmaking may craft a policy that bases rates on grantees’ operating budgets (as smaller nonprofits tend to have higher indirect cost rates than larger ones). Funders looking to maximize flexibility may offer grantees support in understanding and presenting their rates in the way that makes the most sense for them. A funder focused on reducing grantee burden may seek to accommodate the policies of other funders (for example being open to recognizing a federally negotiated rate from grantees with US government funding), minimizing the budgeting, compliance, and operational requirements on grantees managing multiple grant sources. There is no one “correct” indirect cost policy, but rather a range to be considered based on a funder’s values and its relationship with grantees.
2. Understand grantees’ true costs
An indirect cost policy should be informed by the reality in which grantees operate, including their true costs. Publicly available data from the IRS Form 990, which includes a breakdown of how much a nonprofit spends on programs, administration and fundraising, can be an (imperfect) indicator of the “indirect” costs a grantee incurs. It can also show whether a funder’s policy is generally adequate to its grantees’ cost structures.
In our work, we use Form 990 data to conduct a “grantee portfolio analysis” looking at costs across a funder’s 501(c)(3) grantees, as well as analyzing other measures of financial health to identify opportunities to strengthen grantees financially.
3. Ensure buy-in, internally and externally
As an aspect of grantmaking with real implications on budgets and relationships with grantees, indirect cost policy can raise questions and concerns for a foundation’s staff and board. It is therefore critical to involve stakeholders throughout the policy design process. Our experience with this work has been most successful when including representation from across the grantmaking team—program, finance, grant management, legal, and executive and board leaders—in designing and implementing policy.
The process also offers an opportunity to engage with grantees on their ideas and challenges. Surveys, focus groups, and one-on-one conversations to solicit grantee input can ensure that the results reflect the experiences of those most directly affected.
4. Align practice with policy
A policy is only words unless it is backed up by the practice to support it. Specifically, an increase to indirect cost rates requires one (or more) of three practice changes. Either 1) overall grantmaking budgets must increase, 2) the grantmaking budget must be spread among fewer grantees to accommodate higher indirect rates, and/or 3) the relative share of direct vs. indirect costs in grants must be balanced to allow higher indirect rates on those grants.
In our experience, most funders primarily choose option #3. But again, changing the numbers on budget lines won’t impact a grantee’s ability to cover indirect costs unless the grant also accounts for the higher indirect rate (and thus lower direct portion of the grant) in the scope, scale or timing of the funded project. A grantee can’t be expected to deliver the same project outcomes on a $80,000 project budget with $20,000 set aside for indirect costs as it did on a $90,000 budget with only $10,000 for indirect costs. Clear communication and expectation-setting between funders and grantees are essential to ensuring that a policy’s aims are reflected in practice.
5. Learn and iterate
It’s hard to get any policy perfect on the first try, and some nuances will only become apparent once an approach has been rolled out and tested. Funders should invite ongoing feedback—from grantees as well as grantmaking staff—and be willing to adjust as necessary. Success lies in approaching change in a spirit of reflection on what can be done better.
Several funders BDO has joined in reconsidering indirect cost policies have shared about their changes, including: Annie E. Casey Foundation, MacArthur Foundation, Robert Wood Johnson Foundation, and California Health Care Foundation. Each foundation devised an approach reflective of its unique values, goals, culture and grantee portfolio, illustrating that one size need not fit all. We encourage all funders to reflect on whether their policies represent their values and the needs of the grantees who advance their shared missions.