Restricted Grants vs. Operating Support

In the foundation world, there are two types of grants. “Program support” refers to grants that support a particular program of a nonprofit, for instance supporting the after school program at a Family Service Agency. “Operating Support” refers to grants that support a nonprofit, which the nonprofit can use in any way they see fit.

My last post, “Do Donors Know Better Than Nonprofits?” touched on the story of an individual donor who made a grant to Yale’s music school, rather than to Yale’s capital campaign because he believed the money was more useful to the music school. Restricted grants are very common in the foundation world, but not so common from individual donors. My point in the post was that I didn’t see the individual donor’s action as an act of tactical philanthropy. Instead, I think that this kind of action from an individual donor is the outcome of donors having limited understanding of what good their money does. Without convincing communications from the nonprofit back to the donor, donors don’t gain trust in the nonprofit’s actions and so take it upon themselves to direct their money in the way that they believe is best. This pattern is the opposite of the for-profit world, where companies consistently report their results and investors almost exclusively provide “operating support” to the company.

My post, although directed at the behavior of individual donors, stirred up a response from my friends in the foundation community.

Eugene Chan, who blogs for the Community Technology Foundation wrote:

The first point that I would like to make is that framing it in terms of "trust" is an ad hominem. Who would argue against the idea that trust is an essential element to any relationship?

Here’s my argument about program versus general operating support.

Foundations don’t necessarily make grants to support a nonprofit’s mission.

Foundations make grants to support their own missions.

The ideal, of course, is when both the mission of the funder and the nonprofit are in perfect alignment and synchronicity. That doesn’t always happen, though, or it is not always explicit. I applaud the universe of donors and funders that have the wherewithal to make general operating investments.

So if the mission of the funders is tightly focused–oh like say on investing in technology or telecommunications to throw out a hypothetical–then that focus has to cascade down to the grantees. And unless a funder wants to only fund nonprofits that have "name your issue area" explicitly in the grantees missions–then you must resort to having clear agreements which are then codified into program restricted grantmaking.

Bruce Trachtenberg agrees saying:

I don’t think restricted grants are all that bad if they support an organization’s mission. For instance, for the nonprofit I oversee, I frequently raise both restricted and unrestricted dollars. The restricted money is project–and often projects I initiate and then seek funders to underwrite. At the end of the day, all we are doing in such cases is entering into a contractual relationship. I ask for and receive support and in return promise to deliver something for it. Clearly, I’m only going to agree to do things that advance my organization’s work.

Holden Karnofsky, says he use to be against restricted grants, but has had some second thoughts. He suggests that his mission as a grantmaker may only fit with a subset of a nonprofits mission and so restricted grants can make sense. However, “With investing, everyone is aiming for the same thing – dollars – but with charity there are a lot of overlapping but different "end goals". He also agrees with Bruce’s “contractor” metaphor, but has a different take on the implications:

So they really do work like contractors (executing the funder’s wishes), rather than how I’d like them to work: having a complete view of the best way to help people, and inviting donors to fund them or go elsewhere… [this] is something I see as a problem with the sector, but others would disagree.

One more note to those who donate restricted. A charity generally has a pool of unrestricted funds. If you donate restricted, they’ll shuffle their unrestricted funds out of the thing you funded and put them somewhere else. So you need a LOT of restricted money before you’re really influencing their activities, and the extent to which your dollars are funding "only your project" is probably less than you think.

So how do we make sense of all of this? One way is by reviewing the excellent report “In Search of Impact” by The Center for Effective Philanthropy. You can download the report for free. I’ve excerpted some key points below:

Do foundations make a lot of restricted grants?

Most of the grants made by even the large foundations whose grantmaking is analysed in our study are program restricted, small, and short term.

Why?

CEOs see operating support as more likely to make a positive impact on grantee organizations, but most place other priorities higher in their decision-making… Nearly half [of CEOs] prefer to provide program support to grantees – often because they feel it is easier to connect their grants to specific outcomes.

Here’s some quotes from individuals whose views are presented in the report:

Sharon King, president of the F.B. Heron Foundation: “In the long run, we can’t have strong programs in weak organizations.”

Clara Miller, CEO of the Nonprofit Finance Fund (She appeared on the Tactical Philanthropy podcast here): “Anything but unrestricted grants generally creates costs within the grantee’s operations.”

Then why don’t foundations provide operating support? According to the report:

Some refuse to fund any overhead whatsoever, “We deal with a few organizations whose idea of overhead is quite inflated,” said one CEO. “There is no reason we should agree to their ‘formula’”

Another CEO whose foundation does not fund overhead wrote, “Maybe grantees should be more honest in helping funders know their financial realities and constraints.

Some CEOs strike a middle ground:

Another group of CEOs sees the question of type of support as highly dependent on the particulars – and other the programmatic goals of the foundation…

This argument is similar to the one that Paul Brest, president of the William and Flora Hewlett Foundation, has made in a variety of public statements on the issue. “The primary determinant of the kind of support that a funder gives to an organization is the alignment of the organization’s activities with the funder’s goals,” Breast said. But he went on to suggest that “all things being equal, a funder should have a presumption in favor of general operating support.”

There are almost half a million 501c3 nonprofits in the United States. I find it hard to believe that most donors (especially individual donors) can’t find nonprofits whose mission is aligned with the donor’s own mission. To the extent finding nonprofits whose mission aligns with the mission of funders is a major issue, I would suggest that this is a market failure issue. It may be that if funders made their mission clear and offered unrestricted operating grants to nonprofits who shared their mission, the market would respond and we would see the creation of a number of “mission aligned” nonprofits emerge.

Look, I’m not suggesting that restricted grants are universally a bad thing. But I don’t like the idea that by making restricted grants, donors (either individuals or foundations) are being more “tactical” or smarter with their dollars. If we are to truly tackle important problems, we need ultra high performance nonprofits backed by the capital resources of funders who recognize the superiority of these organizations’ operating models. I believe this day will come to pass. When it does, it is likely that these high performance nonprofits will attract more money then they actual need and the job of funders will become a mission to find the nonprofits who can put their grants to the best possible use.