One of the hallmarks of financial health and sustainability for any organization is the existence of an endowment. For nonprofits, an established endowment acts almost as a status symbol – Your organization has an endowment? You made it! – and some organizations even look at endowments as if they’re the ultimate financial end-goal.
What is an Endowment?
You probably already have a pretty good idea of what an endowment is. In this context, an endowment is an asset (usually cash) that is invested by a nonprofit for the purpose of generating income from the interest. Usually, the endowment’s primary assets (also known as the corpus) are restricted, and since they cannot be used, they grow over time. As this ‘pot’ of assets increases, the gained interest on those assets also increases. While the corpus funds remain untouched, the income from the interest on the endowment can be used to support the programs and/or operations of the organization.
The catch? That interest income typically must be used in a predetermined way.
Generally the goal of an endowment is to allow the corpus investment to remain free of withdrawals and continue growing, leaving the annual interest available to be spent on whatever it was initially intended for – a purpose typically left up to the decision of the donors, or in some cases, the Board.
Ultimately, endowments can be a beautiful thing providing reciprocal benefits to donors and the organization itself. For organizations, endowments can make program expansion possible, generate an ongoing stream of income for the organization, and enhance the financial security of the organization by building reserve of gifts to be used in the future. Add to that the allure and prestige associated with a nonprofit endowment, and it’s no surprise that this is what so many organizations are striving for.
But not so fast! Establishing an endowment is a big decision, and it needs to be strategic one. Before we jump into the how, let’s first determine if your organization is ready for an endowment.
When an Endowment is a Good Idea
You are currently able to amply meet your operation’s financial demands with funds to spare.
This one is critical. Is it worth it to forego current fundraising opportunities in favor of future ones? If your organization is operating off of a tight budget as it is, this is the question you will first have to answer. There is hardly an argument to be made against having some money set aside for a rainy day, and while that’s great for being prepared for unexpected expenses or change in revenue, a cash reserve and an endowment are two separate things. There should be little concern for whether or not your organization can afford it’s operating expenses, along with an existing financial cushion for your organization, before an endowment is on the table.
You have a steady flow of unrestricted funds.
Remember, endowments are usually restricted funds. The principal asset is essentially inaccessible, and the interest earnings that you can spend are often limited to predetermined purposes. This means that endowment funds cannot easily be put to different use in response to new community needs, and can ultimately limit your organization’s ability to innovate. Does your organization currently have enough sources of unrestricted funds with which to be flexible?
You have enough money to manage the endowment.
This is an often overlooked or underestimated expense. Fees may come in the form of bank charges or the hiring of an investment manager, a cost which is usually well worth the ROI. Remember, the amount of endowment income available is directly related to how well the investment performs, and in all likelihood the Board may not be willing (or equipped!) to take that responsibility on. Having the funds for the endowment is one thing, but you must also have the funds to manage it.
Your donors are likely to continue funding you despite the endowment.
Endowments often send the message that the organization is doing well financially. While this may be true, the continued support of donors is still required for sustainability and future growth. An endowment means that not only will you have to be vigilant about regularly engaging with all your donors, you may also find yourself juggling separate engagement efforts between annual and endowment donors while also having to consistently cultivate new donors in both categories.
How to Create an Endowment
Now we know what an endowment is, we’ve looked at a few of the pros and cons, and we know where your organization should be before establishing one. If you’re truly considering an endowment, start by first taking some time to focus on your organization’s unique financial positioning and overall capacity for taking this on.
If you’re a nonprofit leader who has done your homework and is ready to create an endowment, here are your next steps:
Familiarize yourself with the basics, and start identifying banks and/or investment managers with competitive rates and strategies.
Like any other investment, endowments can come with a great deal of risk. While you’ll likely rely on your financial institution and/or investment manager to make the best decisions for your investment, you should still have a basic understanding of potential risks and general best practices. Take some time to develop that knowledge and understanding first. Doing so will help you identify trustworthy and reputable financial institutions or investment managers and recognize competitive rates and strategies more easily.
Create appropriate documentation.
Name the endowment, and clearly document the objectives, policies, and protocol for the fund. This should outline objectives for growth, targets, and goals, and include comprehensive guidelines surrounding allowable investments, asset allocation, donations accepted and their specific use, investment policies, communications to current and potential donors, fund maintenance, and a liquidity disclosure or circumstances for surrender.
Incorporate the new endowment account into your existing fundraising efforts.
Educate your supporters about the long-term commitment you’ve made to serving your community by establishing this endowment and how donations to the endowment are used, emphasizing how they are maximized through future investments. Your donors and supporters believe in the goods and services you provide to your community. They want to be excited about the impact your organization is making on your community (with their donations!) and what’s next for your organization, and learning about the specific outcomes of their contributions is likely to fire them up, reaffirm their commitment to your organization, and encourage them to spread the word to others. Keep your donors engaged and excited by keeping them informed!
The well-designed and strategically executed creation of an endowment has the potential to take your nonprofit organization to the next level, IF your organization is ready for it.
Still not sure if creating an endowment is the right move? Let’s talk! Schedule a free 30-minute consultation today!