Have you ever considered winning the lottery as the best and most effective option for solving your problems? Whether you have $3,000 or $3,000,000 in your bank account, if you use most of your savings to buy lotto tickets, the potential payoff if you win big could be dramatic and change life as you know it for the better.
It’s easy for most of us to understand that while winning the lottery and having the ability to throw lots of money at our problems would be great, our chances of winning are quite low and not worth the risk of what we stand to lose in the process if our numbers don’t come up. Suddenly we can’t pay our rent or mortgage, buy food, or pay for health insurance due to having blown our money on something that we knew had a statistically very low chance of paying off.
In other words, there would be significant opportunity costs to a decision to spend our money on lottery tickets in the remote and wishful hope of enjoying a big pay day instead of thoughtfully making investments for which we adequately weigh potential risks, costs, and benefits. Additionally, winning the lottery does not guarantee that our life will improve or that it will help us achieve our goals if we ultimately spend our winnings carelessly.
Now let’s apply this same logic to charities, except this time the metaphorical lottery tickets are being paid for with your donations. Have you ever considered encouraging charities to spend 99% of your donations on fundraising instead of programs on the off chance that this would allow them to raise enough money to eventually cure cancer, eliminate homelessness, or eradicate hunger throughout the world? I suspect your answer is no, and for the same reason. There is no guarantee that spending significant portions of your and other donors’ contributions on overhead would result in these lofty outcomes. In fact, there is a very low chance that it would, and the opportunity costs of homeless people not housed, hungry people not fed, and other charitable work going undone are just too high to justify.
| “Financial efficiency may not guarantee any specific outcome for any individual charity, but neither does financial inefficiency…citing the success of an extreme outlier (such as a charity with high overhead curing cancer) and suggesting that this outlier is statistically representative of the success that will occur for the entire data set (all charities) is an extrapolation error. A charity achieving an impact goal that drastically improves life as we know it is an outlier event, so suggesting that all charities can justify unreasonably high overhead costs on the basis that such an event might occur is logically flawed.” —CharityWatch CEO, Laurie Styron as quoted in her 2021 article “Busting the Myths of ‘The Overhead Myth,'” published in Taxation of Exempts, a Thomson Reuters journal. |
Ted Talk
It’s been just over a decade since charity fundraising guru Dan Pallotta gave his popular TED Talk entitled “The way we think about charity is dead wrong.” The video has racked up over a million views on the Ted Talk YouTube channel alone as of May 2024 and remains popular among charities and their fundraisers. A primary theme of Pallotta’s talk is that donors should ignore how much charities spend on overhead and focus instead on the “impact” they are having on their causes.
“What percentage of my donation goes to the cause versus overhead?”
Pallotta argues that when donors ask this question it is “dangerous” because it “forces organizations to go without the overhead things they really need to grow, in the interest of keeping overhead low.” For most charities, overhead expenses consist primarily of fundraising costs, with management expenses comprising a much smaller portion of total overhead. For this reason, when Pallotta refers to things that charities “really need to grow,” the primary “thing” he is likely referring to is fundraising expenses. It is important for donors to know that Pallotta has spent a significant portion of his career as a for-profit charity fundraiser when considering his arguments suggesting that high overhead is a good thing.
| “The less money you spend on fundraising the more money there is available for the cause. Well that’s true if it’s a depressing world in which this pie cannot be made any bigger. But if it’s a logical world in which investment in fundraising actually raises more funds and makes the pie bigger, then we have it precisely backwards and we should be investing more money, not less, in fundraising, because fundraising is the one thing that has the potential to multiply the amount of money available for the cause that we care about so deeply.” — Dan Pallotta |
Growing the Giving Pie
According to Giving USA, charitable giving in 2022 totaled to $499.33 billion. Imagine if all charities argued that their donors should have given them a blank check to spend an unlimited portion of this amount on fundraising fees and other overhead and prioritize the goal of revenue growth over providing direct services to veterans, the homeless, the sick, or the hungry. Giving has been a fixed pie, remaining steady at about 2% of gross domestic product (GDP) since the mid-twentieth century. While growing the total giving pie is a worthy goal, a bigger pie will not do much good if most of it continues to be frittered away by charities that continuously maintain unreasonably high overhead costs.
In addition, if a charity is given a blank check to spend an unlimited amount of its resources on overhead under the guise of revenue growth, it has no real incentive to find more efficient ways to conduct its fundraising efforts. Instead, a charity that needs to grow its revenue to achieve its mission should be held accountable to do so as efficiently as possible.
The two goals of increasing contributions while simultaneously directing the majority of donated dollars to programs are not mutually exclusive. Many charities successfully do both. And given that the total giving pie is relatively fixed, eliminating exorbitant and unnecessary overhead is an important variable in charities’ collective ability to maximize the impact of the nonprofit sector on the whole. Growth of the giving pie, if and when it happens, should be spent on funding more charitable activities, not on funding an unlimited amount of fundraising costs in perpetuity with no committed end date in sight.
What is Overhead?
As video has become a primary medium for consuming information, it’s easy for us to believe what someone is saying in spite of the underlying facts, not because of them. For example, in UnCharitable, Pallotta defines charity “overhead” as a “demonic label,” saying it includes spending that is essential for charities to carry out their missions. He proceeds to assert that a charity’s overhead is defined as including any expenses a charity incurs to pay for “chief executives, support staff, furniture, utilities, receptionists, phones, computers, legal counsel, insurance, rent… you know, the basics, the basics of management…print, radio, tv advertising, PR and social media staff, website designers, postage for direct mail, everything you need to strategize…things like impact assessment, data analysis for improvements, special event expenses, the fundraising staff to actually ask people for donations so you can grow to approach anything close to the scale of the problem you’re actually trying to solve.”
When making arguments for why donors should enthusiastically pay for a charity’s high overhead spending, charities, for-profit fundraisers, and the nonprofit trade associations that support their interests, often try to confuse donors about what “overhead” is. They like to claim that the expenses a charity incurs to pay for the staff to carry out its programs or to cover basic operating costs like rent and utilities is considered “overhead,” and that donors are unreasonable to criticize high overhead on this basis since a charity’s programs would not exist without the staff needed to run them.
While Pallotta and other nonprofit leaders may choose to describe charity overhead this way when attempting to convince donors that high overhead spending is a good thing, this is not how it is reported in a charity’s audits, tax filings, or in the pie charts typically included in its fundraising and marketing materials.
| “The best way to gauge the quality of someone’s ideas isn’t to listen to them talking. It’s to read their writing. Compelling speakers can mask weak logic with strong charisma. Putting key points on a page exposes flawed reasoning. Compelling writing requires clear thinking.” —Adam Grant |
In their audits and tax filings, charities are required to report their expenses by natural classification and by function. Natural classification simply refers to describing what was paid for, like salaries; insurance; rent; postage, printing, and mailing costs; grants; professional fundraising, legal and accounting fees; and other operating expenses.
Function refers to the way in which each of these costs supports the mission of the organization. Charities report the total they spend on each expense during the reporting year, then tell you what percentage of each line item was incurred to support the charity’s programs, its management of the organization, or its fundraising efforts. The latter two categories of management and fundraising are the two functional expense categories that are considered “overhead” in a charity’s financial reporting.
| Expense Type | Total Expenses | Program | Management | Fundraising |
| Salaries | $1,500,000 | $1,300,000 | $150,000 | $50,000 |
| Insurance | $22,000 | $4,000 | $18,000 | – |
| Rent | $60,000 | $52,200 | $6,000 | $1,800 |
| Legal Fees | $15,000 | $10,000 | $5,000 | – |
| Professional Fundraising Fees | $1,200,000 | – | – | $1,200,000 |
| Totals | $2,797,000 | $1,366,200 | $179,000 | $1,251,800 |
In this example we can see that this hypothetical charity reports that its staff spends just under 87% of their time operating the charity’s programs ($1.3 million), 10% of their time managing the organization ($150,000), and 3% ($50,000) of their time on fundraising efforts. Its salary expenses are allocated among these three functions commensurately in its audits and tax filings.
Similarly, the rent the charity pays on its office space is used by staff to conduct the charity’s programs (87%), manage the organization (10%), and conduct a small amount of fundraising (3%), and its rent expense is allocated commensurately in its financial reporting.
The charity paid $10,000 in legal fees during the reporting year related to carrying out its programmatic activities (a common program expense for a legal aid society, for example). Another $5,000 in legal fees were incurred for management costs like paying an attorney to review amendments to the charity’s bylaws or to negotiate a contract with an investment manager. As you can see, legal fees are allocated to program and overhead based on which functions they served.
All of a charity’s other operating expenses are allocated in a similar way based on whether they are related to carrying out its programs, managing it, or conducting its fundraising activities.
Long story short, it is not the case that all or most charity salaries and other operating expenses are considered “overhead.” In this example, the charity’s program spending efficiency is not an abysmal 49% due to it adequately paying its staff to carry out its programs or paying rent on its office space. It’s abysmal due to the extraordinary amount it paid professional fundraisers during the year to solicit the public for donations.
| “When a charity falsely claims it is being unfairly judged on the basis that common program expenses are considered overhead, this is at best a reflection of ignorance about very basic nonprofit financial reporting rules. At worst, it is an intentional bait and switch tactic intended to manipulate donors into thinking that material amounts of its program spending are reported as overhead, and that donors should ignore a charity’s financial efficiency ratios on this basis.” —Laurie Styron |
Some History
In a 2002 publication for Harvard Business School, Allen S. Grossman and Elizabeth Kind presented a case study (the Study) on Pallotta’s former company, Pallotta Team Works, describing it in the following way:
“Pallotta Team Works is a for-profit, privately owned company that produces multiday fundraising events for nonprofit organizations. Dan Pallotta…founded the enterprise in 1992. The company has grown rapidly, having raised over $200 million for charities.”
While an impressive amount of money was raised by Pallotta Team Works for AIDSRides, Avon breast cancer walks, and other charitable causes before it went out of business in 2002, “at several times during its history, the company was criticized by beneficiaries and charity spokespeople,” according to the Study:
“The criticism usually focused on the amount of money netted for beneficiaries, but it also focused on other areas—such as marketing and administrative expenses—as well. The company’s first negative publicity occurred in 1996, when the Philadelphia-to-Washington AIDSRide netted 19% for local AIDS charities. The ride was investigated by the Pennsylvania attorney general, and Pallotta Team Works—who admitted no wrongdoing—was required to pay the AIDS charities a $93,000 fine.”
In another example presented in the Study, seven designated beneficiaries of a Midwest AIDSRide organized by Pallotta Team Works were expected to split $1 million in projected proceeds. Instead, the event grossed only $800,000, and “each of the seven agencies ended up receiving $52,000 in net proceeds.”
| “So, in the for-profit sector, the more value you produce, the more money you can make. But we don’t like nonprofits to use money to incentivize people to produce more in social service. We have a visceral reaction to the idea that anyone would make very much money helping other people.” —Dan Pallotta |
“I felt ripped off,” said Nancy Harbert in her November, 2002 New York Times article, “Charity on Wheels; Riding Your Heart Out, Then Feeling Betrayed,” when describing a ride in which she participated. “[L]last March, when I finally received the tally from my ride, which was lumped into the results of two other AIDS vaccine rides, I was outraged and embarrassed to tell my friends who had given so generously. Of the $18.8 million raised in the three AID’s vaccine races, only $4 million was going to the researchers…”
In the article, Harbert cites a “class-action lawsuit filed on behalf of the riders, charging that Pallotta led them to believe that a minimum of 60 percent of the rides’ proceeds would go to research, rather than the embarrassing 16 percent that actually did. Other Pallotta events were reporting equally low proceeds.”
In 2001 Pallotta Team Works filed a breach of contract lawsuit against two charities that broke ties with the company over high overhead costs, San Francisco AIDS Foundation and the Los Angeles Gay and Lesbian Center, which opted to organize their own events in an effort to keep more of the funds for the cause.
In a November 2013 New York Times interview, Pallotta was described as urging “a corporate model for charity.” When asked “what revenue percentage of a nonprofit should go to overhead,” Pallotta argued that to “generate scale” charities need to play “a long-term game.” He cited an example of a corporation operating for six years without returning any profit, saying that a charity should be encouraged to spend “100 percent” on overhead for whatever time period it deems necessary to achieve its strategy. “If, on the other hand, you are running a local scholarship fund and don’t have any dream of solving some systemic problem, then your overhead ought to be zero,” he also said.
Presenting overhead spending in terms of all or nothing, 100% or 0%, creates a false binary that suggests to donors that overhead for most charities can exist only in extremes. In practice, a scholarship fund would reasonably need to spend some funds to responsibly manage itself and to raise money from donors, in addition to providing scholarships. Likewise, a charity attempting to scale up its revenue would reasonably need to spend money operating its programs in addition to spending on management and fundraising expenses.
CharityWatch rates hundreds of charities that raise millions of dollars per year while also keeping their fundraising and other overhead costs reasonable—not zero, but also not outrageous. It’s not the case that it’s impossible for a charity to raise a lot of money without paying for-profit professional fundraising companies and other fundraisers a huge cut of the donations raised.
Charities Are Not Businesses
In UnCharitable, Pallotta asserts that charities are discriminated against for the “taking of risk in pursuit of new ideas for generating revenue,” saying, “So Disney can make a new $200 million movie that flops and nobody calls the attorney general.” He then cites three movies that lost between $140 million and $200 million, lamenting that when a charity does “a little $1 million community fundraiser for the poor and it doesn’t produce a 75% profit to the cause in the first 12 months…your character’s called into question. So nonprofits are really reluctant to attempt any brave, daring, giant scale new fundraising endeavors for fear that if the thing fails their reputations will be dragged through the mud.”
In the for-profit world, it would be unheard of for an investor who is approached with an opportunity to invest in an expensive, high-risk project to not be provided with a very detailed business plan outlining how the company intends to spend investors’ money, how long they expect to lose money before generating a profit, and what returns they can expect for investors in the future and on what timeline.
And yet, when the general public is solicited by charities via direct mail, telemarketing calls, email, social media, or at special events, they are rarely, if ever, provided with information suggesting that all or most of what they donate will be spent on more fundraising and not on the charity’s programs. In fact, it’s typically the opposite. Charities will highlight their programs to encourage people to donate, either not mentioning their overhead expenses at all, or obfuscating them.
| “If charities with high overhead were up front with donors about how little of their donations will be spent on the charity’s programs, many donors would refuse to give. Any system that relies on either intentionally misleading donors or withholding decision-critical information from them is not an ethical system.” —Laurie Styron |
If a charity wants to be viewed more like a business when engaging in expensive, high-risk fundraising efforts, it should be willing to provide a detailed business plan to potential donors any time it approaches them for donations in the same way that a for-profit company would be expected to do when asking for capital from investors. This way, donors can assess the potential risks, costs, and benefits of that charity’s business plan and decide if they think it’s a worthy investment or not. Like investors, donors should get to decide if they want to donate to a charity that expects to lose money prioritizing revenue growth over its programs, or if they believe their donations would be better spent elsewhere by other charities that are using those donations to feed the hungry, rescue injured animals, protect the environment, fund cancer research, or help injured veterans in the here and now.
| “An investor measures the success of their investment based only on how much money it generates, and those returns inure to the benefit of the investor. A donor measures the success of their donation based on the extent to which it is efficiently and effectively used to forward the cause the donor is intending to support.” —Laurie Styron |
The Charities of “UnCharitable”
One charity featured in UnCharitable, charity: water, aka, Charity Global, keeps its overhead reasonable, spending the majority of its cash operating budget on programs while also raising significant revenue. CharityWatch analyzed its fiscal 2022 consolidated audited financial statements and IRS tax Form 990 and determined that the nonprofit spent 82% of its cash budget on programs that year and kept its fundraising down to $12 to raise each $100 in cash support, earning it an “A” grade on CharityWatch’s “A+” to “F” rating scale.
In UnCharitable, charity: water disagrees that any donations from the general public are used to cover overhead expenses, also making a claim on its website that “100%” of donations go directly to charity due to a small group of designated donors covering all of the charity’s overhead. CharityWatch disagrees with this logic on the basis that money is fungible. The charity could just as easily say that 100% of what the general public donates will be used to cover overhead so that 100% of the donations of a small group of large donors gives to the charity can be spent of programs. Depositing donations from different groups of donors into different accounts doesn’t magically make overhead costs disappear.
Another charity, Wounded Warrior Project (WWP), has received CharityWatch ratings ranging from “B-” to “D” on our “A+” to “F” rating scale since fiscal 2007 when we began evaluating the organization. It was the subject of a U.S. Senate Judiciary Committee inquiry in 2017. The inquiry, catalyzed by news reports of the charity’s “lavish” spending, centered on what the Senate report described as “exorbitant” costs for things like domestic and international first class or business travel ($2.2 million) and programs of questionable utility, such as thousands of expensive “alumni” events the charity continued to host despite low participation rates, according to the Senate Report. Wounded Warrior Project’s most current CharityWatch rating is “C+” as of the date of this article.
Conclusion
When encountering compelling charity fundraising and marketing language, CharityWatch encourages donors to consider the following before deciding whether or not to donate:
Visit our blog to read more CharityWatch articles and tips for giving wisely.
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