Why foundations should invest in operating capacity.
The assumption that weakens the sector
American philanthropy has long operated on an assumption so deeply embedded in grantmaking culture that it is rarely examined: that the most-responsible use of charitable dollars is to fund programs, not the organizations that deliver them. The assumption is understandable. Program-restricted grants offer clarity, measurability, and the appearance of direct impact. They allow a foundation to say, with precision, that its dollars funded a literacy initiative, a food-distribution network, or a maternal-health intervention. What they do not allow a foundation to say, with equal confidence, is that those dollars built an organization capable of sustaining, adapting, and scaling that work over time.
The distinction matters more than the philanthropic sector has been willing to acknowledge. A growing body of evidence demonstrates that the prevailing model of program-restricted grantmaking, however well-intentioned, systematically undermines the organizational capacity of the very institutions upon which foundations depend to deliver social impact. The result is what researchers have termed the nonprofit starvation cycle: a self-reinforcing pattern in which funders underpay for the true costs of program delivery, nonprofits underreport their actual overhead to remain competitive, and the sector as a whole operates on a structural deficit that compromises quality, innovation, and long-term sustainability.
Foundations should make operating-cost funding a standard component of their grantmaking strategy. The argument rests on evidence from the largest natural experiments in philanthropic history, an accountability framework that is neither theoretical nor untested, and a frank recognition that the current model has failed: not occasionally and at the margins, but systematically and at scale.
The starvation cycle is not a mystery
The scale of the problem is well-documented. Research by the Bridgespan Group and others has identified a persistent gap between the actual indirect costs that nonprofits incur in delivering programs and the overhead rates that foundations are willing to fund. The gap is not trivial: the difference between verified indirect-cost rates and the rates foundations actually reimburse runs approximately 17 percentage points. For an organization operating on a $2 million annual budget, that gap represents $340,000 per year in unfunded organizational costs that must be absorbed, deferred, or eliminated.
The consequences are predictable. Organizations defer technology upgrades, underpay staff relative to comparable private-sector roles, reduce investment in leadership development, and operate with financial reserves so thin that a single delayed grant payment can trigger a cash-flow crisis. These are not signs of poor management. They are the rational responses of competent leaders operating within a funding environment that systematically penalizes investment in organizational infrastructure.
The dynamic is further reinforced by the overhead myth: the widespread assumption among donors and foundations alike that an organization’s overhead ratio is a reliable proxy for its effectiveness. In 2013, GuideStar, the Better Business Bureau Wise Giving Alliance, and Charity Navigator jointly published an open letter to the donors of America urging them to stop using overhead ratios as the primary measure of nonprofit performance. The myth persists regardless. Surveys suggest that many donors expect nonprofits to operate with overhead rates below 22%, a figure that bears no relationship to the actual cost of running an effective organization in any field.
The result is a sector-wide misallocation of resources. Foundations invest heavily in the design and launch of new programs while systematically underfunding the organizational infrastructure required to execute, evaluate, and sustain those programs. The irony is worth sitting with: the same funder who demands measurable outcomes is, through restricted grantmaking, dismantling the organizational capacity that producing those outcomes requires.
The business analogy and its limits
The comparison to business investment is, in this specific context, instructive; in others, hazardous. Phil Buchanan of the Center for Effective Philanthropy has made one of the field’s most-important recurring arguments: that philanthropy is not like business, that charitable relationships are not market transactions, and that importing private-sector logic into grantmaking wholesale has produced as many distortions as it has cured. He is right. A grantee is not a vendor. A community served is not a customer. The relationship between a foundation and a nonprofit working in a low-income neighborhood cannot be reduced to a principal-agent contract without losing something essential about why both organizations exist.
The business analogy, however, is precisely applicable in one narrow and important respect: no serious investor (no venture capitalist, no private equity firm, no corporate board overseeing a subsidiary) would fund a product launch while simultaneously starving the company of the working capital, talent, and systems necessary to bring that product to market. This is not because investors are generous. It is because they are rational. They understand that the quality of an institution’s infrastructure determines the quality of its output, and that an organization deprived of operating capacity will fail regardless of how well-designed its programs are. The philanthropic sector’s unique willingness to do precisely this, fund the program while starving the institution, is not a principled departure from business logic. It is an oversight that business logic would immediately correct. The analogy is not a prescription for how nonprofits should behave. It is a diagnostic for how foundations are misbehaving.
The relevant question is not whether nonprofits should emulate business. They should not, in most of the ways that matter. The relevant question is whether foundations can justify a grantmaking practice that even the most discipline-obsessed, for-profit investor would recognize as self-defeating. They cannot.
The evidence is now sufficient
The case for operating-cost funding is no longer theoretical. Two large-scale experiments—different in design, but convergent in their findings—have produced evidence sufficient to move from pilot to practice.
The Ford Foundation’s BUILD initiative
In 2016, the Ford Foundation launched its BUILD initiative, committing $2 billion over 12 years to provide flexible, institution-strengthening support to more than 560 organizations worldwide. BUILD grants were explicitly designed to fund operating capacity: organizational infrastructure, leadership development, financial reserves, strategic planning, and the unglamorous but essential systems that allow organizations to function effectively over time.
The results have been substantial. Eighty-five percent of BUILD grantees report greater financial resilience as a direct consequence of the investment. Eighty-three percent report that BUILD funding contributed to their mission impact “to a large extent.” Organizations were able to diversify their revenue streams, invest in staff retention, build the financial reserves necessary to weather economic disruption, and pursue strategic opportunities that program-restricted funding would not have permitted. Ford’s own assessment is that BUILD represents not a departure from rigorous grantmaking, but an evolution toward a more-sophisticated understanding of what rigorous grantmaking requires.
The MacKenzie Scott model
Beginning in 2019, MacKenzie Scott has distributed upwards of $26 billion through approximately 2,700 unrestricted grants to nonprofit organizations, structured as large, lump-sum gifts with no reporting requirements imposed by the donor. The approach was initially met with skepticism from a philanthropic establishment that questioned whether unrestricted giving at this scale could produce measurable impact without formal accountability mechanisms.
The Center for Effective Philanthropy answered the question. Recipients of Scott’s unrestricted funding reported sustained and, in many cases, transformational organizational impact. Organizations used the funding to invest in precisely the capacities that program-restricted grants leave unfunded: staff compensation, technology infrastructure, leadership-succession planning, and the financial reserves that allow long-term strategic decisions rather than quarter-to-quarter operational survival. The study concluded that unrestricted funding at scale does not produce organizational complacency. It produces organizational capacity.
What the convergence tells us
The Ford and Scott models differ in important respects. Ford’s approach is structured, multi-year, and embedded in a formal evaluation framework. Scott’s is high-trust, lump-sum, and deliberately unbureaucratic; rifle versus shotgun, if you prefer. Yet both produce the same core finding: when foundations invest in organizational capacity rather than restricting funding to discrete programs, the organizations they support become more effective, more resilient, and better positioned to deliver sustained social impact. That convergence across such different methodologies is not a hint. It is a finding, and foundations that continue to default to program-restricted grantmaking are now choosing to ignore it.
Accountability is relocated, not abandoned
The most common objection to operating-cost funding is accountability: if a foundation provides unrestricted support, how does it ensure results? The objection is legitimate. The answer is not that accountability disappears. It is that accountability is relocated: from the activity level to the organizational level, which is where it should have been from the beginning.
Program-restricted grants measure compliance: Did the grantee conduct the workshops? Distribute the supplies? Serve the projected number of beneficiaries? These metrics are useful, but they measure inputs and activities, not outcomes and organizational health. Operating-cost funding requires a different accountability architecture, built on four dimensions.
Organizational health
The first dimension shifts the unit of analysis from the program to the institution. Rather than asking whether a specific program met its deliverables, the foundation evaluates whether its investment is producing a healthier, more-capable organization. The metrics are drawn from the same diagnostics that any competent board of directors would apply: staff retention and compensation competitiveness, board-governance quality, financial-reserve adequacy measured in months of operating runway, revenue-diversification trends, and infrastructure-investment levels relative to organizational need. These are not soft measures. They are the leading indicators of organizational sustainability, and they are quantifiable.
Outcome accountability
The second dimension addresses the concern that operating-cost funding might produce organizational stability without social impact. The remedy is direct: foundations that fund operating costs should hold grantees to a higher standard of outcome accountability, not a lower one. A program-restricted grant might require a grantee to report that it conducted 12 training sessions for 60 participants. An operating-cost grant should require the grantee to demonstrate what those sessions produced: employment rates, income changes, skill acquisition, whatever outcome metrics are appropriate to the intervention. When a foundation invests in organizational capacity, it is investing in the institution’s ability to produce results. The accountability question is therefore whether the organization, taken as a whole, is producing the social outcomes that justify the investment.
Relational accountability
The third dimension recognizes that the most-productive grantmaker-grantee relationships are characterized by candor and genuine strategic partnership rather than the transactional dynamics that program-restricted funding tends to produce. Relational accountability means that foundations invest in understanding the grantee’s operating environment at a depth that quarterly reports cannot provide, that grantees are expected to share bad news early rather than burying it in year-end narratives, and that the foundation functions as a thought partner rather than merely a compliance authority. The practical case is straightforward: in any principal-agent relationship, the quality of information flow determines the quality of decision-making. Program-restricted grants create incentives for grantees to present optimistic reports. Operating-cost funding, paired with relational accountability, creates incentives for honest dialogue and early problem-solving.
Milestone-based renewal
The fourth dimension addresses the concern that operating support, once initiated, becomes indefinite. Operating-cost grants should be structured in defined terms, typically three to five years, with formal renewal evaluations at each interval. Renewal is not automatic. It is contingent on demonstrated organizational-health improvement, outcome achievement against agreed benchmarks, and evidence of progress toward financial sustainability and revenue diversification. The milestone structure provides the grantee with the stability necessary for long-term planning while maintaining the productive pressure of periodic evaluation. A grantee that cannot demonstrate measurable progress toward greater capacity and effectiveness at the three- or five-year mark has not earned renewal, and the foundation’s fiduciary obligations require that it reallocate accordingly.
How to begin
For foundations considering this shift, a phased approach mitigates risk while generating the internal evidence necessary to build institutional confidence.
Begin with a portfolio assessment. Before committing new resources, conduct an honest audit of the existing grantee portfolio: How many grantees are operating with less than three months of financial reserves? What are staff turnover rates among program-funded organizations? Where is the starvation cycle already at work? This diagnostic will, in most cases, reveal that the foundation’s own grantmaking practices have contributed to the organizational fragility it now seeks to address. Conduct the assessment in partnership with grantees not as an audit, but as a shared inquiry.
Next, select a pilot cohort of five to 10 grantees. Selection criteria should include demonstrated organizational competence, a credible strategic plan, leadership quality, and willingness to engage in the relational accountability described above. Structure pilot grants as three-year commitments with clear organizational health and outcome benchmarks and an independent-evaluation component.
At the conclusion of the pilot, evaluate rigorously: organizational-health improvements, outcome achievement, and the quality of the grantmaker-grantee relationship. Compare results against a matched cohort of program-restricted grantees. If the evidence supports it—and given the Ford and Scott data, the prior probability is high—expand operating-cost funding as a standard component of the grantmaking portfolio.
The objections, addressed
“Operating-cost funding is a blank check.” It is not. The four-dimension accountability framework provides more-sophisticated oversight than program-compliance reporting. A foundation that monitors organizational health, outcome achievement, relational integrity, and milestone-based progress is exercising greater stewardship than one that merely verifies that budgeted line items were spent as proposed.
“We cannot justify overhead to our board.” The framing is the problem. Operating-cost funding is not overhead funding. It is investment in the institutional capacity necessary to produce social returns. No corporate board would describe investment in a company’s talent, technology, and financial infrastructure as overhead. The nonprofit sector’s unique stigmatization of organizational investment is a cultural artifact, not a fiduciary principle. Boards that understand the starvation cycle will recognize operating-cost funding as a corrective.
“Grantees will become dependent.” At the organizational level, milestone-based renewal directly addresses this risk: operating support is contingent on demonstrated progress toward financial sustainability and organizational capacity, not indefinite entitlement. The deeper question of whether sector-wide adoption of general-operating support might create structural dependency at the field level, shifting the burden of organizational maintenance from diversified private revenue to concentrated philanthropic capital, is a legitimate one that deserves more study. It is, in my view, the most-serious open question in the operating-support debate, and foundations adopting this approach should build into their evaluation frameworks explicit inquiry into revenue-diversification trends over time. Operating support that produces stronger organizations seeking multiple funding sources is the goal. Operating support that substitutes foundation capital for earned revenue or individual giving is the failure mode to avoid.
“The evidence is still emerging.” This is true, and the honest response is to pilot, evaluate, and scale based on accumulating evidence rather than to wait for certainty that will not arrive. The Ford Foundation’s $2 billion BUILD initiative and MacKenzie Scott’s $26 billion in unrestricted giving are the largest natural experiments in operating-cost funding in philanthropic history. The early evidence is positive and convergent. Foundations that wait for perfect evidence before adjusting practice will wait indefinitely. The more-prudent course is precisely what the phased approach above proposes: measured adoption, rigorous evaluation, and honest reporting of both the successes and the failure modes.
A more-sophisticated form of rigor
The philanthropic sector stands at an inflection point that makes this argument more urgent than it has ever been. Federal funding to nonprofits is contracting at historic scale. Donor behavior is shifting toward cause-driven, platform-mediated giving that does not sustain institutions over time. The organizations most likely to survive this environment are those that have built the organizational capacity (reserves, talent, systems, and governance) to adapt, pivot, and endure. The organizations least likely to survive are those whose foundations funded only their programs while the infrastructure beneath those programs quietly deteriorated.
Foundations that adopt a broader funding strategy, one that includes meaningful investment in grantee-operating capacity alongside program support, will not be abandoning rigor. They will be applying a more-sophisticated form of it. They will be recognizing what the evidence from Ford and Scott has demonstrated at a scale beyond dispute: that investing in organizations, not just their programs, is among the highest-leverage uses of philanthropic capital available.
The case is not for reckless generosity. It is for measured, intelligent investment grounded in organizational reality. The four-dimension accountability framework ensures that operating-cost funding is neither a blank check nor an act of faith. It is a disciplined strategy for building the institutional capacity that sustained social impact requires. Foundations that embrace it will discover what the evidence already shows: that the organizations they have been starving were not the problem. The funding model was.
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Sources
Bridgespan Group. “The Nonprofit Starvation Cycle.” Stanford Social Innovation Review, 2009.
Buchanan, Phil. Giving Done Right: Effective Philanthropy and Making Every Dollar Count. PublicAffairs, 2019.
Center for Effective Philanthropy. Study on the Impact of MacKenzie Scott’s Unrestricted Giving, 2023-2025.
Ford Foundation. BUILD Initiative: Program Design and Evaluation Reports, 2016-2025.
Gregory, A. and Howard, D. “The Nonprofit Starvation Cycle.” Stanford Social Innovation Review, Fall 2009.
GuideStar, BBB Wise Giving Alliance, and Charity Navigator. “The Overhead Myth: Moving Toward an Overhead Solution.” Open Letter to the Donors of America, 2013.
Liechtenstein Philanthropy Talks. Knowledge and Attitude, Venture Philanthropy, 2026.
National Council of Nonprofits. “Costs, Complexity, and Barriers to Nonprofit Effectiveness.” Policy Briefs, 2022-2025.
Trust-Based Philanthropy Project. Principles and Practice Guides, 2020-2025.
