What's wrong with CharityNavigator?

You'll find we have a rather heavy antipathy toward CharityNavigator and (to a lesser extent) other nonprofit 3rd party watchdog groups. It isn't that we don't believe the motives of these organizations are pure; in fact, we are fairly certain they are quite pure.

The problem is, their ratings are nonsense, and undermine the purpose they are meant to serve. This is a classic case of the old axiom of "Garbage In, Garbage Out."

Let's back up a second. I don't claim this to be a detailed history of CharityNavigator, but I believe the substance is sound: CharityNavigator was funded by high net worth investors with the goal of helping potential donors understand how "good" a nonprofit is (and by implication, how worthy they are of a donor's investment). So CharityNavigator undertook to evaluate the IRS form 990, which is an informational tax return nonprofit 501(c)(3) organizations are required to file on an annual basis. From this, CharityNavigator invented a series of ratios and measures on which it would base its "scores" for nonprofits. This led to a great deal of excitement, and many nonprofit subsectors getting up in arms about various exemptions, which led CharityNavigator to begin adding caveats and dispensations to account for these criticisms. And interesting and very telling situations began to occur - we can talk about all sorts of issues, but the single most disturbing result is that frequently the largest nonprofits with the broadest scale and scope were being dinged in favor of small nonprofits with very limited scale and scope. Compounding this is the fact that the primary data source for the "voodoo" math of CharityNavigator's scores is the IRS 990.

So CharityNavigator purports to answer some critical question that appears to be having a material impact on nonprofits. This is a great time for one of my favorite questions: "What problem are we trying to solve?"

The basic problem they appear to be trying to solve is "which nonprofits are most worthy of a donor's investment?" Let's break that down a bit more - how do we define the relevant criteria for "worthiness" in this context? In the CharityNavigator case, it would appear that the ultimate criteria is that the highest possible percentage of funds raised goes directly to mission delivery in the current year, regardless of scale and scope of the benefit delivered. I don't think that's a very worthwhile goal (I'll get to that in a minute), but even if it were, all CharityNavigator is really doing is forcing nonprofits to become less and less transparent in their IRS 990 reporting, using every loophole possible to minimize any costs that are not used for Direct Benefit. This creates a vicious spiral, because through the CharityNavigator "psuedo-science," they are forcing nonprofits away from what any savvy investor (sorry, Donor) would want to know.

If you are looking to invest in a company, what do you want to know? What I would never want to see is that every dollar of revenue goes directly to investors - that works for about 2 days, and then the company is out of business. The fact of the matter is that I want revenue and gross margin to be very healthy; I want general and administrative expenses to be the right number, not the lowest possible number. I want to see a healthy net profit.

Implicit in this is my investment horizon (I'm not a day trader, after all) - let's say I plan on investing in a chain of fast food restaurants, and that investment will be a 5 to 10 year investment. I could look at a company that jacks up its prices, while clamping down on cost of sales, and all I have is an expensive, low quality product. I could keep G&A down by reducing my budgets for cleaning and upkeep, but all I get are dirty restaurants. I can keep capital expenditures, such as periodic remodeling and updating, to $0, but all I get are beat up and dated restaurants.

This situation would be a disaster to my investment - growth in revenue for beat up restaurants selling high priced, low quality food is not going to be very high; the value of this investment will be worthless in a few years.

If rated by CharityNavigator, out of 4 possible stars, this is a 4 Star investment . . .

So what's going on here?

CharityNavigator is propagating an unsustainable view of the nonprofit industry, wrapping it under the cloak of "science." The problem here is the assumption (I believe this represents a bias of the founders and funders of CharityNavigator) that the best nonprofits spend 100% of every dollar raised providing direct benefit - this is muddled thinking at best. Let's assume for a second that if we spent every dollar raised for cancer-related causes that we could find an innoculation for cancer by June 1, 2010. Does that help the people who are struggling with the effects of a cancer diagnosis made through May 31, 2010? What about the 50, 60 or 70 years people diagnosed with cancer prior to June 1, 2010 will have to live with the disease - what do we do about them?

These are complex problems - the mission of nonprofits are measured in decades and centuries, and yet CharityNavigator would treat them as though they were measured in discrete, 1 year periods. I think the Discovery Channel is creating a new series, sponsored by CharityNavigator, called "Flip That Nonprofit" . . .

That is not to say that the nonprofits are innocent bystanders in all of this; you will see that our position is that the nonprofit industry is currently facing a sea change - the proverbial "inflection point" - where the mass of the industry is moving beyond the traditional economics and mechanics of the industry. Things that worked in 1992 will not work today; compounding this is an erosion of confidence in the industry. What is creating this situation? Quite simply, nonprofits are relatively inefficient in raising funds, and therefore, it is also in their interests not to be transparent in their reporting - they take every advantage of the latitude afforded in the current IRS reporting regulations, to the detriment of public confidence in the industry.

So let's run CharityNavigator out of town on a rail . . . now what?

Going back to my investment example, I don't want to see the largest numbers or smallest numbers theoretically possible in any category - I want to see the right numbers. I want to see that the price is commensurate with the quality, which will deliver less in gross margin but much higher revenue figures because customers will come back for good food at the right price. I want to see adequate resources being spent on care and maintenance - people will come back to a clean, well kept restaurant. And assuming I am in the investment for the long term, I want to see that the company is investing appropriate amounts in keeping the restaurant chain current, efficient and in good working order. As a businessman, I am used to looking at and making judgments about balancing a series of conflicting factors to identify a healthy, sustainable investment.

I want to see the same things from the nonprofits I choose to invest in. Tell me how long you reasonably must exist to meet the requirements of your mission. Show me that you are raising funds as efficiently as possible - I assume raising a smaller number of large gifts is inherently much more efficient than raising the same amount through direct mail or risky special events that lead to very large numbers of relatively small gifts, as well as not insubstantial overhead costs. I want to see that you are investing in your own future and sustainability. And I want to see G&A costs that are as low as they can be - to maximize Value of Direct Benefit Delivered - without being so low as to impair the capacity-building and sustainability for the nonprofit to endure through to the end of its mission.

It is time for the nonprofit sector to regain the initiative in financial transparency, and get beyond the mumbo jumbo, psuedo-science of CharityNavigator.

And for those of us on the donor side, we have to allow the nonprofits to tell us what we need to know, understanding that the picture on first blush may not look as we expected. We also need to give nonprofits the time to effectively manage through this sea change in the industry to re-tool themselves for long term viability in the 21st century.

We know what to look for - lowered cost of funds raised through more efficient fundraising methods (a focus on developing relationships leading to increasingly large gifts), general and administrative expenses large enough to support current efforts as well as long term sustainability - which may include capital intensive capacity-building efforts. And ultimately, of course, we would like to see as much Value of Benefit Delivered as possible - but let's think about that not just in terms of who we help today, but how many people we can help for as long as they need that help.

KB