Why Budget Testing is a terrible way for foundations to determine funding allocation


spiral-1081904_960_720A while ago, I wrote “When you don’t disclose salary range on a job posting, a unicorn loses its wings.” The post highlights the importance of salary transparency from the beginning of the hiring process. It also talks about one of the dumbest and most damaging hiring practices we have: Using salary history to determine the starting pay of new hires. This practice ensures that people who have been underpaid—primarily women and people of color—continue to be underpaid. We, the sector fighting for equity and social justice, must end this archaic and destructive practice immediately.

As I’ve been thinking more about how we treat individuals in the sector, I’ve been noticing that there is a parallel to how we treat organizations and even whole communities. A parallel to using salary history at the organizational level is something I’m going to call “Budget Testing.” This is when funders have rules regarding how much funding an organization can apply for based on its budget size. Many foundations, for example, will not fund an organization for more than 10% of its budget. Others have set limits, such as organizations with budgets less than $1M can only apply for $25,000, and those over $1M can apply for $100,000.

Budget Testing, like salary history, is something many of us are used to, but it is time we examine its role and harmful effects in the nonprofit sector. As I wrote earlier, in Funders, your grant application process may be perpetuating inequity, “If an organization led by communities of color has a budget of 100K, and you only fund 10% of any budget, then they cannot hope to get over 10K, whereas an organization with a budget of 1 million will be able to get 100K. Applying a rigid fixed percentage means organizations and communities that most need funding will get the least funding.” 

Budget Testing allows a larger nonprofit to be able to grow, while smaller, grassroots organizations continue to struggle. Getting 10K, while great, is not nearly as helpful as getting 100K. With 100K, you can hire a full-time exempt person, an essential element in organizational growth. With 10K, you can’t do much; if you’re lucky, you may be able to Frankenstein some other sources of funding together to get a part-time person, or pay for other elements to help your program to limp along. It’s like telling a kid, “Because you’re so little, I’m going to give you a few cheerios. When you grow big and strong, I’ll give you more and better food.” The flaw with this argument is that kids cannot grow just by being fed a few cheerios every day. (Despite my 2-year-old’s insistence otherwise)

Because of Budget Testing and other factors, organizations that are led by communities of color, women, people with disabilities, rural communities, LGBTQ communities, are stuck in a downward spiral, a Catch-22, the Capacity Paradox, where they are too small to get significant funding, so they remain small and can’t get significant funding. This runs counter to one of the very basic tenets of Equity, which our sector has been touting, which is that communities that need the most resources get the most resources. We put up the iconic pictures of the kids of different heights standing on the boxes, watching the baseball game. In Equality, all the kids get a box each, but the little kid is still unable to see over the fence. In the Equity panel, the tallest kid gets nothing, and middle kid gets a box, and the short kid gets two boxes, and everyone can see the game. The shortest kid gets TWICE the resource as the other kids.

All of us are familiar with this image. Budget testing, in complete contrast, is like saying “The maximum funding you can apply for is 10% of your height. So if you are 80 inches tall, you get a box that is 8 inches. If you are 40 inches tall, you get a box that is 4 inches.” This is not a good way to determine funding allocation. In fact, it just perpetuates inequity, leaving behind marginalized communities. Under that sort of rule, the short kid will never be able to see the baseball game.

We use Budget Testing because it is simple and easy to understand. Budgets are universal; every organization, no matter what they do or where they are, has one. It makes foundations seem objective to have a rule based on budget size. But if our sector really wants to fully realize our value of Equity, we must throw long-held rules and practices out the window. Otherwise, we need to stop complaining about the lack of organizations led by marginalized communities having capacity to do stuff, about the lack of diversity in the sector, about the lack of engagement among disenfranchised communities, about the ineffectiveness of status quo interventions, about the lack of innovation. Here are some of my recommendations for foundations:

Calculate how much fund you provide in total to organizations led by marginalized communities: If your value is Equity and social justice, but only a small portion of your funds go to organizations led by communities of color and other marginalized communities, then something is not right. This is not to say that bigger, mainstream organizations are bad. They do awesome stuff and have important roles to play, but we cannot address injustice effectively unless the people most affected by it are leading the efforts to tackle it.

Stop trying to protect organizations from themselves: This whole argument of “Well, if we fund too much of an org’s budget, it’s dangerous for their sustainability” is false, damaging, and patronizing. It’s like saying, “If we give this short kid two boxes, he might lose his balance and fall off and injure himself before he can actually see the game.” What’s detrimental to organizations’ long-term success is being forced to constantly Frankenstein funds together because no funder wants to pay more than 10% of an org’s budget. If funders are willing to fund 50% or 75% of an organization’s budget, especially in its early years, when its budget is relatively small, it allows it to spend less time fundraising and focus more time on building a strong program and infrastructure, which will increase its chances to survive and do its work. Funders’ concerns for organizations’ long-term success is ironically one of the biggest barriers toward organizations’ achieving long-term success.

Fund based on what an organization needs: Most organizations are formed to respond to critical community needs. If you believe in their work and want to help them do it, then fund them based on what they need to do their work well. An organization that has a budget of $100,000 and has only a part-time ED, but does amazing work, may need $35,000 to turn the part-time ED position into full-time. Yup, that’s 35% of their budget (or 26%, depending on your calculation), a number that might freak out some foundations. But so what? If they have a solid plan and do a good job and you trust them, then 35K will allow them to do their work effectively. That should be the only thing that matters.  

Replace Budget Testing with Equity Testing: Instead of using budget sizes to determine funding amount, how about using factors such as whether an organization serves primarily marginalized communities? Or if it’s responding to urgent emerging needs, such as serving refugees fleeing war and persecution? Or if it has over 50% of its board comprising people of color? If we want to achieve Equity, then let’s make Equity the center of decision making. It does not make sense to have inequitable practices and hope they will lead to Equity.

Take bigger risks: We as a sector need to stop being so risk-averse. We cannot fight injustice by hovering around a base of safety and predictability. I’ve said before that if you give two boxes to a short kid who has never stood on two boxes, he might not be used to it so might lose his balance and fall off. When that happens, the reaction from funders and others in power tend to be, “See?! I knew we shouldn’t have given that kid two boxes!” This is why organizations led by communities-of-color and other marginalized communities continue to get tiny fractions of funding that are not significant enough to break them out of the Capacity Paradox. If we are truly trying to achieve Equity, we must understand and accept that failure is part of it. If we don’t embrace risk and the occasional failure, we will never reach Equity. If the short kid falls off the boxes, help him get back up.

I work with many amazing grassroots organizations led by incredible leaders who struggle daily to keep their organizations afloat. They are mired in the same trap: because they are small, they continue to get small funding, which keeps them small. And yet they keep getting asked for their time and input and participation because they are best connected to the communities. It’s exhausting and frustrating and has been leading to a lot of day-drinking.

Our nonprofit sector, above any other sector, blazes a trail for a just and equitable world. But we cannot reach that unless we reexamine and abandon many of the harmful practices that undermine our work. Most of these practices, such as the medieval usage of salary history to determine pay, were not born out of a deliberate intent to perpetuate inequity. Budget Testing, like salary history, is a practice that unintentionally further marginalizes individuals and communities who are already disproportionately affected by injustice. It’s time we rethink this and other funding practices, because Equity requires us to take risks and do things differently. Let me know your thoughts.

If you like this post, you may like “Why Equality is actively harmful to Equity.” And before you say something like “That’s why everyone should abandon grants and focus on individual donors,” read “Why individual donation strategies often do not work for communities of color.” 

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  • Douglas W

    I think it’s pretty clear that foundations that fund organizations up to a % of their total budget are trying to make sure that it (the foundation) doesn’t end up in the position of deciding whether to kill the organization if they cease funding that project. Knowing you’re responsible for cutting 10% of a non-profit’s budget isn’t such a big deal. but knowing that if you cut your funding, the entire non-profit will fall apart, everyone will get laid-off and all the programs will cease is a lot to put on the shoulders of a grant officer. They may end up feeling the push to keep funding a bad program because they can’t bear to be the one to shut it down. Similar to the reason that ineffective employees can be hard to let go – it’s a very emotional thing to do that to someone. So while it may be a bad rule in general, it’s completely understandable for those reasons.

    And I’m sure there’s also a bit of “I don’t want to fund an organization that can’t convince at least a few other people to fund it too” going on too. Kind of like a VC who will only invest in a startup if another VC is willing to split the deal. A rather conservative CYA feeling, but one that is also understandable from an organizational psychology perspective.

    • Douglas, most organizations don’t expect foundations to fund more than 3 years of any given project. It’s usually a miracle if a funder decides to fund for more than one year, an important topic for another post. Even if a foundation funds 20 or 30% of an org’s budget, the org knows it won’t last and will continue to find fundraise, but at least it’ll be in a more stable condition to do so. We are not talking about two or three other VCs willing to split the deal. Imagine if a start up company has to raise money from 20 or 30 VCs, each one with their own restrictions (“Don’t use my money to pay for rent!”). This is the reality of what nonprofits face. As I mentioned, this misguided “We don’t want to screw you over if we give you more than 10% and have to remove it” is sweet, but paternalistic. It’s like saying, “We don’t want to place a big order with your catering business because if we do that and then don’t order next year, that will hurt your business.” How about if the food is good, you place a big order, and that will help keep the caterer in business.

  • Excellent! Once again you nailed it, Vu!

    • Thanks, Stephanie.

  • Kevin Murphy

    There are different rules at play here for private foundations and community foundations. If a private foundation provided an organization with 50%-70% of its budget it would almost certainly cause the grantee to fail the Public Support Test and result in the grantee being classified as a private foundation. At our community foundation, we don’t generally apply a budget test and have often been a very high percentage of an organization’s budget, but we can. Grants from a public charity (like a community foundation) cannot “tip” a grantee organization into private foundation status.

    • Kevin, thank you for weighing in from a foundation’s perspective. But I am wondering what percentage of these fears foundations have actually ever come true. Yes, an org with a budget of 100K getting a 50K grant from one foundation who really believes in its work and wants to support it during its start-up phase might get labeled a private foundation itself. But this slight possibility has been paralyzing the sector. The 5% chance of that actually happening has been leading to the 90% reality of organizations led by marginalized communities not getting the support they need to do their critical work.

      • Kevin Murphy

        First of all, let me say that in our office we greatly enjoy your blog and its blunt assessment of things in the sector. I urge you to continue to point your darts at those of us in the funding world because the truth is, we mostly deserve it.

        To answer your question, I have seen four organizations “tipped” into private foundation status, in each case because neither they nor the private foundation they were dealing with understood the public support test. In each case, well intentioned and exactly what you’re arguing for and in ¾ cases, with very bad results.

        This is one of those things that doesn’t happen very often because private foundation staffs (at least competent ones) specifically limit the percentage of an organization’s budget that they fund (again, these rules do NOT apply to grants from community foundations or governments).

        The public support test is complicated and involves a lot of math that makes me wish I had paid more attention in Mrs. Hogue’s seventh grade class, but in the case you posit (50% of an organization’s budget) by year three, there is more than a “slight possiblity” that the organization would be tipped. Assuming that the other 50% came from a second foundation, there would be a mathematical certainty. It really all depends on what the other 50% is comprised of.

        Only if that number is above 10% would the IRS even have discretion. At that point the chance maybe “5%” or “slight” I just don’t know. The IRS is supposed to look at all of the “facts and circumstances” in those cases. I have only ever seen one organization tipped because it failed on the facts and circumstances test.

        To make it even more complex, a different set of rules comes into play if the organization is in its first five years of operations.

        Again, I’ve over-simplified a bit here as the public support test is best explained in books, not paragraphs. There are ways to dodge the bullet and tricks to get around these problems. There’s a decent explanation of the public support test here, though it may still make a reader’s head hurt. http://goo.gl/NepkwB

        While I seldom run to the defense of the practices of my colleagues (which I sometimes find horrendous) I do think it would be unfair to think that private foundations don’t consider deeply the issue of the public support test when deciding how much of an organization’s budget to fund. Those policies are baked pretty thoroughly into most review processes to protect the grantee organization from the bad consequences of being reclassified as a private foundation themselves.

        • Kevin, thank you for the feedback and encouragement, and for this very informative and thoughtful explanation. I think you make a valid point, and I would love to learn more. I think overall that many of these practices are not working, and they are leaving behind many organizations. I’ve seen enough mainstream organizations that manage to get through these rules; for example, start-up organizations having one or two main funders who “angel fund” operations for the first several years; often, these orgs have no idea how to reach communities of color that they claim to serve, so they subcontract to ethnic organizations, leading to Trickle-Down Community Engagement. If the rules don’t apply to community foundations and government funders, then maybe these entities need to focus on equalizing the funds to organizations led by people most affected by injustice, because they are often left behind while everyone else scrambles to engage marginalized communities. I’d love to talk further about this.

  • Excellent article. Thank you, Vu. This is what small organizations go through, and every postmortem for fund denial is littered with these arguments. And, thank you for introducing a new verb; to Frankenstein the program funding is amazingly apt. 🙂

    • Thanks Mona. Frankensteining is not fund. We spend way too much time doing that.

  • Epsilonicus

    I just had this discussion with a funder. For my org, there is a foundation that is our only foundation funder (we raise the other 3rd of our budget through individual donations, in-kind gifts, and sponsorships). They offered operations support but it had so many conditions that our all-volunteer org cannot handle the due diligence.

  • “Because of Budget Testing and other factors, organizations that are led by communities of color, women, people with disabilities, rural communities, LGBTQ communities, are stuck in a downward spiral, a Catch-22, the Capacity Paradox, where they are too small to get significant funding, so they remain small and can’t get significant funding.”

    This is such a huge thing. Theoretically, we want programs to evolve organically as solutions to a problem. But when that happens, program development becomes highly transactional: “We need this money to do this thing, so let’s go out and get it.” And if you’re a good community problem-solver, more and more people want you to solve more and more problems. This is good–you have purpose and you’re having impact! We say we value that.

    The challenge, however, is to avoid becoming fragmented as your purpose-filled program becomes an organization with regular bills to pay. The danger is that, as you give more of your time to organizational development, you give less of your time to community problem-solving. As the organizational demands become more pressing, your impact slowly gets diluted. Without an influx of (mostly) human resources, you will never ever get ahead of it. Eventually, you will just start treading water until you drown. Unless, of course, you happen to be a magician who can conjure a herd of dolphins to carry you to shore.

    There’s very little mystery around why these things happen. The only mystery is why we insist on perpetuating systems that keep making these things happen. Why are we consistently pushing the risk and responsibility downward where it tends to carry the most weight and then seem flabbergasted when the problems keep bobbing back up? Do we really want a social sector dominated only by magicians, charlatans, and people with rich friends? (Asking for a friend.)

  • treadlightly

    This is where HEALTHY collaborations can be very helpful. In my previous organization I pulled together a 14 agency collaboration to apply for a multi-million dollar grant even though my agency had never received anything remotely close to that. While we didn’t get nearly as much as requested (due to the amount available and the number of applicants), we still got a couple million dollars and had one of the highest funded applications in the program. In my current organization we’re working with a neighborhood group to do a grant application that would come with some much needed grassroots training and additional grant funds. Our role is simply to help them navigate the process and do whatever they need us to help with. They get to develop the project that they want to pursue. By working with us, they will likely get access to some larger funders to support their project that wouldn’t have ever considered helping them without our presence. We won’t really get anything from it except good will, but I view that as an important long-term benefit. I don’t know if or how that good will can help us, but it certainly might come in handy some day when we least expect it. A number of years ago my predecessor walked into a meeting where he really needed community support but he didn’t know if he’d get it. As soon as the meeting opened one of the community leaders stood up and told everyone that he deeply loved the organization and was going to write a check in support of the project right there in front of everyone. He then challenged everyone else to do the same. That is when the little things that “don’t benefit us” in the short term really come back to be beneficial.

  • I just wonder how much of this practice is driven by a desire on the part of the CGO to appear as supporting “sucsessful” NPOs, in order to placate their primary funders. By most for-profit definitions, the bigger a budget a company has, the more successful it is but that model doesn’t really translate for nonprofits. We always get stuck in the for-profit paradigm, even by those who should know better.

  • C4NPR

    I love your blog posts, Vu. But I feel strongly that I just have to respond to this one. Unless we are talking some multi-year grant for operations with built-in mentoring that is going to allow that new ED, volunteer coordinator or program person to generate some sort of additional revenue to sustain the position, grant funding is simply putting small nonprofits at risk. An organization hires a terrific person for one-year and then that person gets laid off because grant funding is not a sustainable source of income. I have seen this happen to scores of nonprofits and to myself, hence I am on my fourth position at a nonprofit (Thanks, grant funding!). While seeding a new position is wonderful – without healthy soil, gobs of Miracle-Gro and an attentive gardener to keep it growing, that grant really didn’t help at all. Sorry to get all “Being There” on you.

    • No apologies needed, C4NPR. I love having these conversations and appreciate your weighing in. I would love to hear your thoughts on what we should be doing instead of seeking grant funding though. As I’ve argued, individual donations take time (years) and resources to become a viable strategy. Who is going to support the org’s individual donor strategy until that happens? (I’ve laid out arguments regarding individual donations in http://nonprofitwithballs.com/2015/09/why-individual-donations-strategies-often-do-not-work-for-communities-of-color/ and would appreciate hearing your thoughts) Meanwhile, 50% to 90% of businesses fail, so earned-income is also challenging; and even on the rare occasional these earned income ventures do succeed, they need an initial start-up investment, which needs to come from somewhere.

      • C4NPR

        I wish there was a simple alternative. I completely agree with you about the time and effort it takes to implement a successful donor strategy. I’ve spent a lot time watching Ken Burn’s The Roosevelts lately and FDR seems to be the only government official who not only understood government’s role in serving its people but was the only one able to make sweeping changes to help people who can’t just “help themselves”. Kim Klein recently said we have returned to a “medieval patronage society”. That’s also true. Because we can’t depend on our government or people of wealth and power to support and sustain us, our only hope is “the little guy”, the you and me who are convinced our $5 can make a difference. Then, we have to find tools to help us effectively collect and manage those $5 donations, so they keep coming and hopefully growing. Remember, George: no man is a failure who has friends.

      • Maybe it IS about multi-year commitments as C4NPR suggests. If you really want an organization to grow – to grow to the point it can take the training wheels off (sorry, introducing a different metaphor!), then maybe the wise thing for foundation funders to do is offer longer-term grants.

        This would also have the advantage of saving the time and money to write essentially the same grant year after year. And allow the funder to really evaluate the organization – using the baseline year of that org, instead of generic information.

  • Isaac Lopez

    Fantastic article!

    I’m a newer reader to your blog and a first time poster. As a musician and a bandleader, this article resonated with me and my current struggle to get my ensemble “off the ground”. I’m constantly bouncing back and forth between roles as I work to compose music, rehearse a team of musicians, and work with a small team of people who help bring our music to multitude of social media platforms. I would love to work with organizations to help fund our efforts and allow us to focus our efforts on creating quality music to bring to new audiences, but the resounding response I tend to hear is that: you need to have x amount of followers, you need x amount of views per video, etc. Leaving me to Frankenstein a budget together to try and pay for the videos, photos, album on our own until we are “large enough” to warrant the help. This fear you talk about from foundations sounds a lot like companies I’m in contact with, and I assume their reluctance to work with us is tied with the fact that as a younger organization we don’t (as of yet) have proof to show that we would be able to allocate our funds in an appropriate manner to achieve potential mutual goals. Do you think this is could also be a reason foundations thus far are reluctant to give more than 10% to smaller organizations/organizations of marginalized communities?

    Another point this article led me to is that currently, my s/o is working for a foundation helping fund organizations led by women. I think it’s a fantastic band-aid for a system of inequality until we are able to institutionally get the “right amount of boxes of support to the right people.” Leading me to wonder if a potential solution to this question of inequality is that instead of looking for change from foundations who only want to prop up the big guy, is to help create more foundations to actually give support to those who need it until we can create change or if it would have the opposite effect, allowing big guy foundations to continue on their merry way without a second thought?

  • Another brilliant post, that should be read by every funder. Throw away the rules that are working against what you are trying to achieve! I’m so glad to have found your blog; I look forward to every entry.