Nonprofit organizations usually prefer receiving unrestricted donations and allocations from foundations. Such unrestricted grants give nonprofits the ability to use that money for their capital projects or programs or to add to their endowment funds. However, donors often limit how their funds can be used by identifying a specific purpose for them or by making the funding dependent on the organization’s raising additional funds for the same project.

Recently an organization I am familiar with received a sizable allocation from a foundation for a capital project, but its receipt was dependent on its raising additional funds from other sources. This kind of donation is referred to as a challenge grant. It means the nonprofit is challenged to raise a certain amount of money, and receiving the pledged funds depends on the organization’s ability to identify, cultivate and secure additional sources of funding.

If the agency agrees to a challenge grant process, its executive staff and volunteer leadership must plan to participate wholeheartedly. This process is not something that can be implemented immediately. Both the organization’s leadership and the community need to prepare for an innovative and exciting approach to raising funds that has implications for the nonprofit’s financial sustainability.

On one hand, the challenge grant approach can be perceived as questioning the organization’s ability to raise needed funds; its current donors may ask, “Doesn’t the foundation trust that we can raise the funds? Why do they make their awarding of the grant dependent on other people providing funds to us?” They may think, “Obviously, the foundation is not sure the agency has appeal to enough people in the community, and it wants to make sure that it will not be the only one to provide funding?”

On the other hand, a challenge grant can be perceived as a motivational tool for the nonprofit and its leadership. It provides them with an extra incentive to secure additional contributions. Knowing that the foundation will reward everyone involved in the fundraising effort with an additional dollar for each dollar they raise strengthens their enthusiasm for securing the necessary funds. At the same time the challenge grant gives a powerful message to donors. Every time donors are solicited they can be told that their contribution is worth double because a foundation will match what they are giving. This often motivates donors to give more than they were planning to because they know their contribution will leverage the foundation’s support.

Once a nonprofit organization’s leadership decides to initiate a challenge grant campaign, it has to successfully solicit a foundation, corporation, or other donor who is willing to pledge a significant sum of money that will encourage other to join the campaign. If the amount is too large it will be overwhelming for the leadership, and other stakeholders (i.e., those interested in supporting the organization) will not feel the need to make their donations. If the announced goal for the campaign is too small, people who are committed to the agency’s growth and development will not take it seriously.

A depressing outcome of those challenge grants with a time limit attached to the raising of matching funds occurs when the organization is unable to meet the challenge. This generally happens when a nonprofit is unprepared to respond to the funder’s grant offer. An organization in the throes of a reorganization or coping with its own expansion should not necessarily consider receiving a challenge grant.

Recently an organization planned a capital campaign for an expansion of its building, including its offices and the program space, and a complete renovation of the physical plant. Initially the nonprofit was very excited when a foundation pledged about half the necessary funding. However, enthusiasm quickly turned to anxiety when the agency was informed that receipt of this allocation would be dependent on its ability to raise at least 50% of the funds from other donors.

For many years the organization relied on government reimbursements, client fees for service, modest annual contribution from its American friends, and occasional unexpected windfall donations to balance its budget. The director of financial resource development (FRD) had successfully recruited a core of loyal contributors whose ongoing support was crucial for the nonprofit’s continued existence. However, these contributors were not in a position to step up and provide the funds to match the foundation’s challenge.

The CEO and the FRD director were afraid the American friends would be wary about accepting the foundation’s offer because it meant raising funds on a much larger scale than had been done in the past. The agency was clearly overwhelmed by the challenge to mobilize its staff and volunteer resources to achieve what needed to be done, but obviously it did not want to miss this very special opportunity.

The organization could have avoided this dilemma if it had taken the time to explore the possibility of a challenge grant when it began to plan its capital campaign. That would have been the time to educate and train the professional staff and volunteer leaders to the implications of receiving funding in this way. It would have enabled the campaign leadership to consider their options and not be swayed by something that could be seen as an innovative and exciting opportunity.

A challenge grant is a way to invigorate both the leadership and the contributors and to strengthen the financial sustainability of the organization. However, it should only be initiated after the organization’s volunteer and professional leaders have been trained to successfully support it. The results of this effort will be felt by the organization for many years to come if the campaign is successfully completed.

Stephen G. Donshik, D.S.W., is a lecturer at Hebrew University’s International Nonprofit Management and Leadership Program. Stephen was Director of the Israel office of the Council of Jewish Federations (CJF), 1986-94, and Director of the Israel office of UJA Federation of New York, 1994-2008.