We’ve heard lately from several small nonprofits asking whether they’re too small to start an endowment. The quick answer is, no! The choice to start an endowment is not based on size but more on purpose. An endowment is a pool of funds set aside for a medium or long-term spending need, regardless of size or mission. When a nonprofit maintains an endowment, it indicates that it is committed to uninterrupted community enrichment, thus encouraging prospective donors to give larger gifts.
The IRS identifies three types of endowments.
Term endowments or temporarily restricted endowments include funds established by donor-restricted gifts that are maintained to provide a source of income for either a specified period of time or until a specific event occurs.
Permanent endowments are funds that are established by donor-restricted gifts and are maintained to provide a permanent source of income, with the stipulation that principal must be invested and kept intact in perpetuity, while only the income generated can be used by the organization.
Board-designated endowments or quasi-endowments are generally not donor-restricted and the governing board has the right to decide at any time to expend such funds.
An endowment is NOT an emergency or rainy-day fund or funds allocated for immediate, unbudgeted needs, but are for specific, future programmatic needs. Regardless of the type of endowment, the nonprofit organization should be prepared to maintain and monitor the funds in a robust manner that fulfills the ultimate mission.
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If the endowment is funded by donor-restricted gifts, the fiduciaries are required to adhere to the Uniform Prudent Management of Institutional Funds Act or UPMIFA for short. UPMIFA is the law in 49 states, the Washington, D.C and the U.S. Virgin Islands and clarifies spending and investment guidelines for the management of an endowment.
There are three key provisions of UPMIFA.
- Spending and investment guidelines dictated by the donor supersede any standards set forth in UPMIFA.
- The board must use prudence in selecting an investment professional, establishing investment guidelines reviewing performance.
- Spending policies are established to ensure the original intent of the donation is maintained. In CA, spending over 7% of the value of the endowment is considered imprudent unless the organization can demonstrate that excess spending is acceptable.
Learn more about UPMIFA here.
Create an Investment Policy Statement
In its role as a fiduciary, the board must execute an Investment Policy Statement (IPS) to establish clear objectives and management policies. In essence, the IPS sets out standards for the endowment that are maintained throughout the life of the endowment, keeping fiduciaries accountable for its supervision.
The Investment Policy Statement can be broken into two major parts. First, the Introduction spells out the purpose of the endowment, the roles, responsibilities and standards of conduct expected of the board and any hired investment professionals. The Introduction also sets out the investment goals and the return expectations of endowment. Second, the Investment Management Principles stipulate how much risk the endowment will accept, what investment are permitted and how these principles will be monitored.
How Fairlight Can Help
Launching an endowment can be a complex process even if starting small. Fairlight’s disciplined, investment endowment services are tailor-made for small and midsized endowments but don’t require a big budget.
Fairlight works with nonprofit leadership to develop and implement the critical investment policies, procedures and reporting tools necessary for organizations to fulfill their endowment’s mission. The engagement consists of
- investment policy creation,
- investment analysis,
- portfolio construction,
- regular investment performance monitoring and
- board education.
To learn about how Fairlight can assist your nonprofit organization grow and thrive, contact us.
Talk to the financial experts at Fairlight Advisors to learn more about managing your nonprofit’s investments. Schedule a free consultation today!