Every so often, one of my non-profit clients will see a small windfall in unrestricted funds, such as a large gift or bequest, proceeds on the sale of an asset, or loan forgiveness. Wanting to protect funding for mission-driven programs into the future, some will start discussing the possibility of setting up an endowment. But this begs the question:
What exactly is an endowment, and are they always the best thing to do?"
A primer on endowments
For this article, I am focusing on endowments set up for or by an organization, excluding endowment funds held in donor-advised funds. On the most basic level, an endowment is money set aside (and invested) to earn revenue to fund charitable activity. The endowment's principal value (or corpus) is (usually) kept intact. At the same time, investment earnings can be granted or transferred to fund an organization's operations or programs, in theory, into perpetuity.
Donating to an endowment may appeal to donors because they are tax deductible upon donating. However, funds may not directly benefit the organization until earnings are generated for the designated purpose. They could also see their gift as having more reach, generating more extended gains for an organization. Institutions and individuals can also donate cash and non-cash assets, such as stock, to the endowment.
An endowment can be structured as a trust, private foundation, or charitable organization. Within this, there are restricted endowments, with the principal held in perpetuity while investment earnings are granted per the donor's recommendations. Term endowments may allow for the disbursement of the principal but only after a specific period or particular "event." Unrestricted Endowments consist of assets that can be spent, saved, invested, and distributed at the discretion of the institution receiving the gift. Typically, you would still see the principal held with earnings distributed per policy.
I have recently seen some clients talking about "quasi-endowments," also known as "board-designated endowments." The non-profit organization funds quasi-endowment funds, and their principals may be used or granted at the board's discretion. Again, the intent remains largely that the principal would be held and earnings used to support programs into perpetuity.
Typically, most endowments are governed by an Investment Policy, a Withdrawal Policy, and a Usage Policy. These outline types of investments allowed and investment manager restrictions in meeting return targets; establish the amount an organization can take out from the fund each determined period; and identify the endowment's purpose and ensure the use is adhering to its purpose, respectively. Except in a few circumstances, the terms of endowments cannot be violated.
Who has endowments, and what are they good for?
When one thinks of an endowment, aneducational institution such as a university comes to mind. This is not surprising as universities hold nearly $600B of assets in endowments. Churches, hospitals, community foundations, and non-profit organizations can also have endowments. Some organizations, such as non-profit cemeteries, may be required by states to maintain an endowment.
As with anything, endowments can have pros and cons. The big upside for organizations is potentially unrestricted income into perpetuity or ongoing funds to support a specific program or activity. Given shorter-term funding cycles many non-profits operate, whether grants or donations, the desire for stable funding in the long term is understandable. Having donors give to an endowment supporting an organization can signal long-term stability and build confidence in some donor "investors."
So, what is the potential downside? One big one is an organization can have a lot of money in the bank and not be able to spend it. The principal can be permanently restricted, which could leave operations or other programs underfunded if other funding declines while the endowment is locked in. Organizations that need to be more agile with their funds or cash can be put in a bind. Managing an endowment well may also take time and money to get right. While smaller organizations could potentially benefit the most from a stable source of ongoing funds, they also may be the least able to afford to manage them well.
A subtle con could also be that if donors see that an organization has an endowment, they may not need as many donations because "they are fine." With its $35B in assets, universities like Harvard find their donors willing to fund future programs or scholarships and continue to grow their endowments. Charities, with donors who are used to seeing non-profits be scrappy or see most of their dollars go to those who directly benefit from the services provided by that non-profit, may see the opposite happen to them. A donor may redirect their contributions to an organization "that needs it more."
When is an endowment a bad idea, and how to get out of it
From the cons, we may understand when it is not a good idea for an organization to set up an endowment. A smaller organization with more volatile funding would rightly be tempted by receiving donor funds requiring an endowment or setting one up to stabilize future funding. Still, if they cannot adhere to the endowment policies, they jeopardize their charitable tax status and harm relationships with donors. Cash flow can be challenging when there are swings in funding, tempting an organization to dip into the "corpus" of its endowment, again jeopardizing its status. The irony is that an organization's efforts to stabilize future funding could actually destabilize the organization.
Endowments also require time, expertise, and costs to manage effectively. If an endowment is too small, an organization may find the earnings of the endowment inadequate to meet the costs of managing the funds. And this way, the endowment may not be able to fill its purported purpose of funding a program or activity within the organization in any meaningful way. Organizations may find they need every dollar received to go toward their current programming and operations or to be nimbler in the future to keep their programs going.
An organization needs to evaluate its short-term and long-term financial prospects and understand the compliance matters when considering an endowment option. For some organizations who are ready, internally or with their willing donor base, an endowment can be a strong instrument to build sustainability. But for some, it could bind up funds too tightly when they need to be able to use the funding more freely to meet their budget and program needs. Also, an organization may want to feel solid about building and managing some operating reserves in balance with restricted funds before approaching the endowment conversation.
For an organization that figured this out a bit too late, how does one get out of an endowment?
To unwind is relatively easy for an organization that has set up a board designated or quasi-endowment.
"Unlike with permanent and term endowments, the board can end its restriction for any reason and remove any or all funds from the quasi-endowment at any time it chooses (typically through a simple majority vote)." – Armaninollp.com
For other types of endowments, this is more complicated. If the donor is available, the donor may agree in writing to lift restrictions on spending. If this is not the case, only a court may lift the restrictions.
"Cy pres is a court proceeding to lift or modify a donor-imposed restriction on the spending or using a charitable gift. Cy pres relief requires notice to the Attorney General and the donor's consent if the donor is alive. Cy pres petitions should be submitted to the Attorney General's Charities Bureau for review and comment before being filed in court." - charitiesnys.com
- I have had one client who determined their endowment was too small to be worthwhile, and they petitioned with the state Charities Bureau to dissolve and filed a Cy pres to close successfully.
- Another was dreaming of an endowment for one of their internship programs, and we determined it would be more pertinent to establish an operating reserve with additional funds raised.
- Another has a cozy small endowment from a donor's bequest slowly growing, while their annual funding stays relatively stable due to ongoing fundraising efforts. This may benefit them later as intended, as a rainy-day fund. Endowment funds of universities, compared to many charities, may remain things of envy.
There is no one right-size-fits-all when building out sustainability for a non-profit organization. But in approaching the question of an endowment, an organization would benefit from evaluating the pros and cons, building out a business plan for the endowment (does it pencil out?), understanding short-term and long-term cash impacts, and fully understanding the policies and requirements of overseeing an endowment fund.
If an organization finds an endowment wasn't the right fit or didn't serve them anymore, the good news is an organization doesn't have to be "trapped" in one. They can ask permission or petition for the release from the restriction of that endowment. It may take additional donor stewardship to navigate the wind-down of an endowment fund, but most donors want an organization to succeed.
We will be happy to schedule a complimentary consultation to discuss your needs and business challenges. To receive more information creating an endowment, or speak with a CFO Selections® Partner, you can also contact us directly at 206-686-4480.
About the Author
Vega Tom brings fourteen years of non-profit accounting, finance, and strategic leadership experience. After starting her career as a construction bookkeeper and office manager, she quickly shifted gears to pursue non-profit work. Driven by a passion for social justice and equity, she transitioned to be the bookkeeper and human resource coordinator for the Hospice of Washington County.
Expanding her leadership skills and experiences with mission driven staff, Vega grew in her roles to become Director of Finance for a non-profit daycare center and on to Chief Operating Officer of a women's empowerment organization called World Pulse. She also worked with 211info as CFO and the Native American Youth and Family Center as Director of Finance. Additionally, she has experience providing consulting services to small businesses and non-profits on financial systems, budgeting, human resources, and strategic planning.