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In Part 1, we made the case that operational infrastructure is the single biggest variable determining whether nonprofit funding produces real impact – and that closing the infrastructure gap is a shared responsibility between funders and nonprofits. Now it’s time to look at how the two dominant funding models in the sector are actually working in practice, and where each one falls short.
There are two main approaches to institutional funding, and most funders lean heavily toward one or the other. Both have real strengths. Both also leave impact on the table – just in different ways. The goal of this section isn’t to declare a winner. It’s to understand what each model gets right, what each model gets wrong, and what we can learn from a sector that has spent decades figuring out how to make capital and operational support work together: venture capital.
There are two dominant approaches to institutional funding, and most funders lean heavily toward one or the other: restricted grantmaking and trust-based philanthropy. Each one has real strengths. Each one also leaves impact on the table – just in different ways.
The important thing to understand is that the problems we’re about to describe aren’t unique to one model. Whether restricted or trust-based, if the funding relationship doesn’t invest in the organization itself – not just its programs – it’s limiting the return on impact for everyone involved.
The goal isn’t to pick a side. It’s to take the best of both and build something stronger.
At its best, restricted grantmaking provides structure, accountability, and clear expectations. Metrics give both funders and nonprofits a shared language for evaluating progress. Reporting requirements, when done well, can actually help newer organizations develop discipline around tracking outcomes and managing finances. For early-stage nonprofits especially, some structure from funders can be a valuable learning tool – as long as funders are actually reading those reports and providing feedback, not just filing them.
Where it leaks returns:
• The compliance burden consumes mission time. A single small nonprofit may juggle 20-30 applications and reporting requirements from 10-20 funders, each with its own format, timeline, and metrics. Research estimates that most nonprofits spend 40 or more hours per quarter assembling grant reports (Sopact). That’s staff time being spent on paperwork instead of programs.
• Infrastructure is chronically underfunded. The normal overhead rate for delivering services effectively is 25-30% (National Council of Nonprofits), while actual indirect costs often run as high as 40% (Bridgespan). Most funders cap overhead at 10-15%, and 70% of nonprofits report they can only charge 10% or less (NFF 2025). That means most organizations are absorbing a 15-20 percentage point gap – or simply going without the infrastructure they need.
• The starvation cycle perpetuates itself. Funders hold unrealistic expectations about overhead → nonprofits feel pressure to conform by underreporting true costs → organizations underspend on infrastructure → results suffer → funders blame the organization → the cycle repeats (SSIR, “The Nonprofit Starvation Cycle”). This has been documented for over 15 years and it’s still the sector’s most damaging structural pattern.
• Short timelines prevent strategic investment. You can’t hire quality employees on a six-month runway. You can’t implement new technology systems knowing your funding expires in a year. Short grant cycles force organizations into survival mode, where every decision is about getting through the next quarter rather than building something that lasts.
• Contractors replace employees out of necessity, not strategy. When budgets are tight or runways are short, organizations default to contractors because they can’t justify a full-time hire. But contractors are inherently less invested in the organization – and the organization is less invested in them. The result is constant turnover, lost institutional knowledge, and a cycle of onboarding and retraining that consumes the very time and money the organization was trying to save.
• Reimbursement-based funding creates cashflow crises. When grants are structured as reimbursements rather than advance funding, the organization needs cash on hand to start the work before getting paid for it. For small nonprofits already operating with razor-thin reserves, this creates an impossible bind – they need money to spend money, and they don’t have it.
• Reporting without feedback is a one-way street. When funders require detailed reports but never respond to them, reporting becomes compliance theater. The organization spends significant time producing something that nobody reads, learns from, or acts on. The time would be better spent on the mission.
• Trust is never built. Even organizations with years of strong performance find themselves re-proving their worth annually. At some point, a track record should earn an organization graduated trust – lighter reporting, longer timelines, more flexibility. When it doesn’t, the message is clear: no amount of performance will change this relationship.
What this looks like in practice:
• An organization gets funding for a program but not for the software to run it efficiently – the result is more internal chaos, not more impact
• An organization is asked to report with detailed metrics but isn’t given funds for the tools or staff to track them – so reporting becomes guesswork
• An organization can’t invest in infrastructure without a solid runway – leadership is too busy fighting to be “fed” to focus on building something sustainable
• An organization gets access to funding but can’t hire the right people because the runway is only six months – so they either hire no one or hire someone they’ll lose
• An organization uses contractors for key functions because the funding timeline is too short to hire staff – every six months they’re retraining someone new, losing continuity, and spending more on the churn than a salaried employee would have cost
At its best, trust-based philanthropy is a powerful corrective to the problems above. It gives organizations the flexibility to allocate resources where they’re most needed, reduces administrative burden, respects the expertise of nonprofit leaders, and creates space for innovation. The data supports this: 93% of recipients of large unrestricted grants reported that the funding strengthened their ability to achieve their mission, and 80% encountered no challenges managing the funds (Center for Effective Philanthropy, three-year study).
But – and this is critical – those results come from organizations that were extensively vetted before receiving funds and that largely already had the operational infrastructure to deploy large grants strategically. For organizations without that foundation, the picture is more complicated.
Where it leaks returns:
• It assumes operational competence that often doesn’t exist. This isn’t a criticism of nonprofit leaders – it’s a recognition that most founders started their organizations because they’re passionate about a cause, not because they have training in financial management, HR, compliance, or organizational design. Nobody taught them what operational excellence looks like for a nonprofit, and the funding model doesn’t require them to learn.
• There’s no early warning system. Without any accountability structure, problems that could be caught and corrected early – a budget shortfall, a compliance gap, a staffing misalignment – go unnoticed until they become crises. By the time anyone realizes something is wrong, the damage is done and the funded impact is lost.
• Nonprofits don’t know what they need to ask for. This is one of the most underappreciated dynamics in the sector. Org leaders don’t request operational support because they don’t know it exists, don’t know they need it, or don’t think they’re allowed to spend funder dollars on it. The funders don’t check for it because they’re trusting the organization to know what it needs. The result is a gap that neither side sees – and funded impact that quietly disappears into it.
• Nonprofits artificially lower their costs. Organizations trying to look like attractive investments strip their budgets down to the minimum. But funders who are committed enough to invest in a program would almost always prefer to fund the extra 5-10% that makes the organization effective – they just don’t know it’s needed because the conversation isn’t happening.
• Many funders skip both the vetting and the support. The strongest trust-based models combine flexibility with rigorous upfront evaluation and ongoing relationship. But many funders who adopt the trust-based label do only the easy part – removing restrictions and reporting requirements – without doing the hard part: understanding each organization’s operational readiness and providing the support needed to succeed. That’s the worst of both worlds.
• Backsliding shows shallow commitment. During the pandemic, 66% of foundations loosened grant restrictions and 64% reduced reporting requirements. But only 21% sustained all of those changes, and only 7% of foundation leaders say the most visible trust-based grantmaking model has influenced their own approach (Chronicle of Philanthropy). For nonprofits that restructured their operations around the expectation of continued flexibility, this reversal creates real instability.
• The funder’s own investment is at risk. When grantees aren’t implementing best practices for HR, legal, compliance, or multi-state registration, it creates liability exposure that neither party sees coming. An organization operating out of compliance isn’t just hurting itself – it’s creating risk for every funder whose name is associated with it.
What this looks like in practice:
• An organization requests funding for a fiscally sponsored research project but forgets to include the fiscal sponsorship fee – now salaries are short and the program is compromised before it starts
• Payroll taxes and multi-state compliance costs are left out of the budget entirely – the organization is technically out of compliance and doesn’t know it
• No line items for bookkeeping, financial reviews, legal counsel, insurance, or marketing – because nobody told the organization these were things they should be budgeting for
• An organization receives a large unrestricted grant but has no strategic plan – dollars get spent reactively on whatever feels most urgent, with little lasting organizational improvement
• An organization scales its programs with new funding but doesn’t hire operations support – the founder is still wearing six hats, now with twice the workload, and becomes the bottleneck for every decision
The three knowledge gaps that drive these problems:
Across both models, the same underlying dynamic shows up again and again. Nonprofit leaders commonly don’t know:
• What norms they should be following – operational, financial, legal, and governance standards that are well-established but never taught
• What type of expertise they should be requesting and paying for – bookkeeping, legal, HR, compliance, strategic planning, technology implementation
• Whether it’s even responsible to use funder dollars to pay for these things – leaders self-censor their own budget requests because they feel guilty asking for infrastructure support
That third one is the most damaging. It means the starvation cycle isn’t just structural – it’s psychological. Organizations are voluntarily underfunding themselves because the sector has taught them that operational investment is something to hide rather than something to be proud of.
The bottom line: Neither model is wrong. But both are incomplete. Restricted grantmaking provides accountability without investing in the capacity to deliver. Trust-based philanthropy provides flexibility without ensuring the infrastructure to use it well. The sector needs a model that does both – and that’s where venture capital comes in.
If the funding relationship between institutional funders and nonprofits feels broken, it helps to look at a sector where the investment relationship works – and ask why.
When a venture capital firm invests in a startup, they don’t just write a check. They provide board representation, operational advisors, access to fractional executives, financial oversight, and introductions to talent and partners. They do this not because they don’t trust the founder – but because they understand something that the philanthropic sector has been slow to learn: capital alone doesn’t produce results. Capital plus operational capacity does.
The numbers are telling. In the VC world, the ratio of people making investment decisions to people helping portfolio companies succeed is roughly 5:1 (Power of VC Platform). For every person deciding where the money goes, five people are working to make sure that money produces a return. And the first hire on most portfolio support teams? Hiring support – because getting the right people in place is the single highest-leverage operational investment you can make.
Now compare that to institutional philanthropy. A program officer evaluates an organization, recommends a grant, and moves on to the next one. The nonprofit receives the funding and is expected to figure out the rest on its own. There’s no operational advisor. No fractional executive. No help building the financial systems, hiring processes, or governance structures that will determine whether the funded program actually succeeds.
VCs think of their capital as an investment that should produce returns. Every dollar they deploy is a dollar they expect to see multiplied – and they actively protect that investment by ensuring the company has what it needs to execute. They don’t see operational support as a cost. They see it as a multiplier.
Funders, by contrast, tend to think of grants as donations to a cause rather than investments in an organization’s capacity to deliver impact. That mindset difference shapes everything – how much due diligence happens upfront, how much support is provided after the grant, and how much attention is paid to whether the organization has the infrastructure to succeed.
Shifting from a donation mindset to an investment mindset doesn’t mean funders should start treating nonprofits like startups. It means they should start asking the same question VCs ask: “What does this organization need – beyond capital – to deliver the return we’re both hoping for?”
And the professionalization needs to happen on both sides of the table. Better grant decision-making processes, yes – but also better post-grant support. That means:
• Providing templates and tools that help organizations build budgets, track outcomes, and manage compliance – rather than expecting them to figure it out from scratch
• Giving actual feedback on reports and financials, not just collecting them – so reporting becomes a two-way learning process rather than a one-way compliance exercise
• Connecting grantees to resources, partners, and consultants who can help with the operational challenges funders aren’t equipped to solve themselves
• Automating what can be automated (checklists, templates, shared resources) and investing human time where it matters most (relationships, strategic conversations, problem-solving)
Some funders are already moving in this direction – building embedded operational support into their grantmaking strategy and funding shared service providers across their ecosystems. They’ve recognized that funding a service provider who supports ten organizations is often a better investment than giving each of those ten organizations a slightly larger grant and hoping they figure out operations on their own.
It’s worth naming what the VC parallel makes obvious by contrast. A venture capital firm would never:
• Fund a company without looking at the team’s operational capacity, financial systems, and growth plan
• Assume the founder knows how to build organizational infrastructure just because they have a great product idea
• Provide capital and then disappear, checking in only when it’s time to decide whether to re-invest
• Cap the company’s spending on operations at 10-15% of the investment and expect it to scale
• Require quarterly reports but never read them or provide feedback
And yet this is standard practice in institutional philanthropy. If a VC treated their portfolio companies the way most funders treat their grantees, they’d be out of business in a year.
The point isn’t that philanthropy should become venture capital. The missions are different, the incentives are different, and the measures of success are different. But the underlying principle is the same: if you want your investment to produce returns, you have to invest in the organization’s ability to deliver them – not just in the work you want them to do.
For funders, this means building operational support into the grantmaking model – whether that’s direct support, funded access to service providers, or a dedicated capacity-building fund that grantees can draw on. For nonprofits, this means recognizing that accepting help with operations isn’t a sign of weakness – it’s what every successful startup founder does, and it’s what will make your organization stronger.
The VC world learned this decades ago. The philanthropic sector is just starting to catch up.
Both restricted grantmaking and trust-based philanthropy are responses to real problems – and both contain real wisdom. But neither model, on its own, addresses the operational capacity gap that determines whether funding actually produces impact. Restricted grantmaking provides structure but starves organizations of the resources they need to build it. Trust-based philanthropy provides flexibility but assumes a level of operational maturity that many organizations simply don’t have.
The venture capital world has spent decades figuring out how to combine investment with operational support. Philanthropy doesn’t need to copy that model wholesale – but it can absolutely learn from it. The principle is simple: if you want your investment to succeed, you invest in the organization’s ability to deliver, not just in the work you want them to do.
In Part 3, we’ll pull all of this together into a better model – one that combines the values of trust-based philanthropy with the operational rigor of venture capital. We’ll lay out what funders and nonprofits each need to do to make it work, and what the payoff looks like when they do.
