Nonprofits have the power to do amazing things for the communities they serve, but like all endeavors, they require funding. Traditional fundraising is a necessary part of continuing day-to-day functions, but you’ve likely already experienced the challenges of maintaining a steady stream of donations. While people often associate endowments with large universities and hospitals, nonprofits with smaller budgets, say of $5 million, can benefit from an endowment. Launching an endowment as an additional funding resource is not only critical for the sustainability and growth of nonprofit organizations, but endowments also have some other unexpected and noteworthy benefits worth considering.
But first, what is an endowment?
The term “endowment” is often used to describe a fund established by a nonprofit organization where the original amount or “corpus” is kept largely intact and invested, while the income and investment growth generated from this fund is used to support the organization’s operations, programs, or specific projects. The primary goal of an endowment is to provide a long-term source of funding, safeguarding the financial stability of the organization.
Endowments are typically created through donations from individuals, corporations, or foundations. The management of endowment funds involves careful investment strategies to balance growth and income, ensuring that the fund can support the organization indefinitely.
There are several types of endowments, each with its own characteristics and purposes. What differentiates an endowment from other pools of nonprofit assets is that it comes with specific donor-imposed restrictions on how the fund can be used. Donors can specify programs, scholarships, projects or even types of expenses that the endowment supports, and these stipulations are legally binding.
It is believed that the first endowment was established by the Roman emperor Marcus Aurelius who endowed chairs for major schools of philosophy in Athens around AD 1761. In Medieval and Renaissance Periods endowments funded religious institutions, universities, and hospitals.
In the modern era, endowments have become a crucial financial strategy for nonprofits in a wide variety of sectors. Endowments today are typically governed by specific policies, most importantly restricted by a donor on how the endowment funds can be used.
There are two general types of restricted endowments.
Permanent or True Endowments:
Permanent endowments are designed to last forever such that the rate at which funds are withdrawn never exceeds the fund’s long-term growth rate. Permanent endowments provide a reliable, ongoing source of income for the organization by supporting general operations or specific programs as designated by the donor. Permanent endowments are common in larger institutions like universities and hospitals, where major donors provide funds that are invested to generate long-term support. However smaller institutions can use endowments to fulfill the ongoing mission of the organization.
For example, a donor offers a gift of $3 million to their local museum of flight to fund a new interactive exhibit on the history of space exploration. The investment growth from the permanent endowment will be used to design, build, and support ongoing operations of the exhibit, making it a permanent feature of the museum. This not only enhances the visitor experience but also aligns with the museum’s mission to educate and inspire.
Term Endowments:
Unlike permanent endowments, term endowments have a specified duration. The funds can be spent for a fixed number of years or upon the occurrence of a specific event, such as the death of a donor. Term endowments are useful for funding projects or initiatives that have a defined timeline. They provide flexibility while still offering the benefits of an endowment.
For example, a long-time donor of an education nonprofit provides the organization with a gift focused on launching a new after-school program for disadvantaged children. The donor establishes a term endowment to kickstart the program for the first five years, covering costs such as supplies, staff salaries, and activity fees during this time. The gift could stipulate that the term endowment be depleted or become unrestricted after funding the after-school program for five years.
Quasi-Endowments or Board-Designated Funds:
Board-designated funds, also called “quasi-endowments”, are funds set aside by the organization’s board of directors. The sale of property owned by the organization, or a large unrestricted gift typically seeds a board-designated fund. Some board-designated funds are launched with the nonprofit’s cash accumulated over and above the organization’s emergency reserves. The board-designated funds can be used at the board’s discretion, giving the organization the greatest flexibility since they are not subject to donor restrictions, allowing the organization to respond to changing circumstances.
For example, an animal welfare nonprofit received an in-kind gift of a commercial building with no donor-imposed restrictions allowing the organization to either use the building or sell it, as the board saw fit. Financial analysis demonstrated maintaining the building would be unnecessarily costly and selling the property would be a better option. The animal welfare nonprofit invested the $5 million proceeds to launch a board-designated fund to support programs and operations as needed.
Conclusion
Endowments play a vital role in the financial health of nonprofit organizations, providing a stable and sustainable source of income. Understanding the different types of endowments and their unique characteristics helps organizations make informed decisions about their financial strategies. While endowments and board-designated funds share similarities, their differences in source, restrictions, and use of funds highlight the importance of strategic financial planning. By leveraging these financial tools effectively, nonprofits can ensure their missions are supported for generations to come.
In the next chapter, we’ll discuss the prerequisites to establishing an endowment and whether it’s a fit for your organization.
Other Resources
Endowment Fund – Overview, How It Works, Types (corporatefinanceinstitute.com)
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