Unrestricted Funds

Jan Harada, Executive Director, Palama Settlement
Photo: Rae Huo

The fuel that powers the engines of charity is the same as that which runs any other enterprise: money.

Nonprofit organizations, after all, are businesses. It’s true, their primary mission is to feed the poor, or heal the sick, or save the environment — all of which cost money. Just like everyone else, though, they also have to pay for rent, utilities, insurance, salaries, benefits and supplies. That also takes money — money that is increasingly tough to come by.

For most nonprofits, funds tagged for specific programs account for the bulk of the organization’s revenue. This is what buys the food for the poor, medicine for the sick or educational programs on the environment.

But these program funds rarely pay for staff training, or new technology, or program innovations, or even building maintenance. In fact, program funds operate much like pass-throughs; they help the public without providing much underlying support to the charitable organization itself. That support requires a much rarer kind of money. In the nonprofit sector it’s called organizational support, administrative funding, operational funding, unrestricted funds or overhead. Businesses know it as “working capital.”

Whatever you want to call it, it’s scarce and getting scarcer.

To understand the importance of unrestricted funds, you have to poke around in the Byzantine world of nonprofit finance. More often than not, that starts with government.

“We know that, if you look at the total revenue in the not-for-profit sector, well over half that money is coming from government sources,” says Kelvin Taketa, president and CEO of the Hawaii Community Foundation. For health and human-services agencies, that number is even higher. The bulk of government support isn’t in grants or charity; it comes in the form of inflexible contracts. Agencies like Child and Family Services and the Waikiki Health Center, for example, are paid a fee to provide services to their clients. Such fees often add up to most of the agency’s income. But again, this is money for specific programs.

While government contracts usually allow some overhead costs, they tend to be stingy and difficult to justify. As a result, the complexity of calculating overhead costs in government contracts is one of the biggest challenges nonprofits face as they seek adequate unrestricted funds. According to Norm Baker, vice president of community building for Aloha United Way (AUW), part of the problem lies in the contracts themselves. “The federal contracts vary, going from allowing absolutely no overhead,” he says, “to ‘you have to demonstrate how that overhead expense applies to that program.’” The complexity of the process tends to shut out smaller organizations that lack sophisticated accounting departments.

Baker also notes that part of the problem is in the nature of nonprofit accounting. “What is really overhead in a nonprofit is a question that’s not well-defined,” he says. “So, the talk about overhead rate is a very tricky subject. What makes the nonprofit accounting system so difficult to understand is that it’s exactly the same as the medical system.”

In other words, it’s essentially a third-party payer system — with all the complications that entails. It’s a devilish way to earn your working capital. Even for relatively large organizations, the effort that goes into accurately including overhead in government contracts is a burden.

Brian Schatz, CEO of Helping Hands (and chairman of the Hawaii Democratic Party), sketches out the problem:

“We try to build in administrative costs whenever we write a contract or a grant,” he says. “For example, we’re constantly adjusting the allocation of our salaries — my salary is paid from seven or eight sources. We try to do time studies to find out where our staff spends its hours. That’s a crucial point: The rigor with which we analyze our finances is impossible to achieve in a three- or four-person shop.”

The solution is for organizations to seek out more diversified forms of funding, particularly unrestricted funds. This calls for creativity and a fair amount of scrambling.

For example, Jan Harada, executive director of Palama Settlement, says that for her organization’s $1.8 million budget, she can tap a variety of sources. “We have a state contract for $250,000 a year,” she says. “In addition, we have grants that come to maybe $100,000 a year.” Perhaps more valuable, the center also has income from ground rent on property it owns across the street from the center as well as from renting the gymnasium and office space to other nonprofits. These rents provide an important source of unrestricted funds.

Clearly, not all nonprofits are fortunate enough to have these kinds of options. David Nakada, who, after more than 30 years at the Boys and Girls Club, may be the dean of Hawaii’s nonprofit community, readily acknowledges that smaller organizations sometimes simply can’t diversify. “Maybe their birth was done strictly through government grants,” he says. That, of course, leaves them at the mercy of each new administration. If, as now seems likely, the economy requires cuts up to 20 percent in government spending, how does a small nonprofit survive?

“When that 20 percent happens to be 80 percent of your funding, you get swept away,” Nakada says.

For many Hawaii nonprofits, contributions from AUW add up to a big chunk of their organizational support. In fact, AUW gives unrestricted grants to over 60 local nonprofits. As a percentage of their overall budgets, these AUW grants are often quite small — typically less than four percent, according to Baker — but, because those dollars aren’t tied to any particular program, they’re a much more significant part of the budget than the numbers would suggest. “They’re worth 10 times the regular dollar,” Baker says. “Because they’re flexible.”

This year, though, the AUW begins a long-planned shift in focus to five core service areas that will inevitably mean a loss of unrestricted funding for many long-time grantees whose work does not fit into one of those five areas.

One of the agencies losing its AUW funding is the Hawaii Association of Nonprofit Organizations (HANO), an intermediary organization that provides workshops and professional training for the nonprofit sector. “We’ve been a grant recipient since the beginning,” says its executive director, Lisa Maruyama. In fact, HANO long served as a kind of adjunct to AUW. But, because they offer no direct services, intermediaries like HANO are particularly vulnerable to a shortage of unrestricted funds. The loss of those unrestricted AUW dollars — nearly 40 percent of the organization’s budget — will pose a real challenge to Maruyama and her board. “For us, it’s about rethinking our model of sustainability,” she says.

Of course, HANO is uniquely qualified to face this challenge. For example, as a membership organization, it has a built-in revenue stream, all of which is unrestricted. HANO may also be able to offer fee-for-service programs, charging for consulting and management services. In addition, as it downsizes, HANO may be able to sublease part of its office space. In the end, though, HANO may have to rely on foundation grants to carry it through these hard times, and foundations are notoriously averse to providing operational support.

Hawaii’s certainly not unique is this regard. Last year, Grantmakers for Effective Organizations (GEO), a national research group, conducted a survey of 800 foundations and other private funders around the country. Its report notes that only 22 percent of foundations nationally reported increasing the amounts they gave for general operating expenses, and the majority provided fewer than 20 percent of their grantees with operating support. Curiously, this trend continues despite considerable theoretical support for operational grants among foundation leaders and professional philanthropic organizations like GEO. As Sharon King, president of the H.B. Heron Foundation, puts it, “In the long run, you can’t have strong programs in weak organizations.”

Yet, few Hawaii foundations support general operating expenses. It’s true that many program grants include overhead costs, such as salaries and benefits. But here’s the irony: Even the most generous program grant may have a negative impact on the overall health of the agency.

In the GEO report, Clara Miller, president and CEO of the Nonprofit Alliance Fund, puts it bluntly: “Anything but unrestricted grants generally increases the costs in the grantee’s operation.” Nevertheless, foundations usually balk at this type of funding.

One problem is that the work-a-day costs of doing business simply don’t appeal to funders. Schatz gives an example from Helping Hands: “Our sewer runs slightly uphill,” he says. “But we’re just not confident that a private foundation will find it in their hearts to pay to fix a sewer.” Instead, sewer repairs likely will absorb some of the organization’s precious unrestricted funds. Yet, as Schatz notes, “Without a functional building, none of these programs work.”

One reason foundations are more comfortable funding programs or projects than operations, quite simply, is that with programs, it is easier to measure success. Many also worry that funding basic operations may make the nonprofit too dependent. Others are wary of handing out money with no strings attached. Alfred Castle, treasurer and executive director of the Samuel N. and Mary Castle Foundation, takes a slightly different view. “To me, the lack of operating funds is more a symptom of something else that’s going on. I think there’s a lack of trust.”

The Samuel N. and Mary Castle Foundation is one of a handful of local foundations that do provide unrestricted funds — albeit with a very narrow focus. “We actually do more today than ever before,” says Castle. “In particular, we put a lot of operating support into the Good Beginnings Alliance (GBA).” GBA, like HANO, is an intermediary organization. It provides no direct services, acting instead as a statewide coordinator and advocate for early childhood education. In short, its mission is nearly identical to that of the foundation, which has a long history promoting preschools and kindergartens in Hawaii. To Castle, finding that synergy is the key to overcoming a foundation’s reticence about unrestricted funds.

The shortage of unrestricted funds is a chronic one, long predating the problems associated with the current economic crisis. While the evolving views of people like Castle may offer a glimmer of hope, nonprofit professionals tend to be pragmatists. They scrounge and hustle and make-do. The problem of organizational support, after all, is as old as charity. The only answer is just to keep trying. As Jan Harada puts it, “Be sad. Lose some sleep. And then figure out how we’re going to solve it.”

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