By Laurence A. Pagnoni, MPA
Anything worth doing cannot be done in a single lifetime.
What is an Endowment?
Nonprofit endowments are donations pooled together and invested in the stock market. At the end of the year, a portion of this money goes to the charity, but the principal amount remains in the market. Many smaller nonprofits may think of endowments as a pipe dream, but any size organization can start an endowment fund.
Endowment gifts mainly come from individual donors who already know you and have the capacity to give. We call these donors “value aligned.”
Why Should a Nonprofit Have an Endowment?
Nonprofit endowments represent a long-term commitment to your nonprofit. Nonprofits need them to support their future goals and build trust within the organization. Donors and foundations check to see if you have them because it means the charity will stay around longer.
Types of Endowments
There are five types of endowments:
- A True Endowment
True endowments, also known as permanent endowments, are most commonly made to large institutions like colleges and hospitals. Major donors make these endowments and restrict them only to allow the charity to spend investment income. The principal gift must remain invested for long-term support. Major donors may look at this type of endowment as an aspect of their legacy.
- An Unrestricted Endowment
When a donor gives a true endowment gift, they may allow nonprofits to use the investment income any way they choose. Unrestricted access enables nonprofits to spend, save, invest, and distribute the annual gift according to their immediate needs.
- A Restricted Endowment
Restricted endowment gifts mean that the primary amount remains in the market, and the investment income can be reinvested or spent according to the donor’s wishes. Endowments can be restricted to a specific program, service, or purpose, such as individual scholarships.
- A Term Endowment
With term endowments, the donor determines when the organization can access the principal amount and leaves it to the nonprofit to decide whether to spend it or keep it in the market.
- A Quasi Endowment
The organization’s board of directors may establish this type of endowment to support the nonprofit’s long-term goals. Quasi endowments allow the board to invest some of the organization’s funds to realize an element of a strategic plan or to sustain the charity over time. The board determines when the principal amount can be taken out and spent.
From these varied types of endowments, you would logically deduce that nonprofit organizations can have more than one type of endowment, and you will also correctly deduce that donors can contribute to your existing endowment(s), or even start a new one of their own.
How big should your organization’s endowment be? Simple. It should be two times the amount of your annual budget. If your annual budget is $5 million dollars, your endowment should be $10 million.
But it also depends on your reasons for having it. Some reasons justify a larger endowment.
That’s the first consideration. Secondly, you can set all the big hairy audacious goals you want, but if you don’t have a pipeline of donors with the capacity to give and can’t convey a clear understanding of the importance of the endowment, then it’s just a pipe dream. Prospect research can help you grow your donor base toward establishing or growing an endowment.
Third, the Better Business Bureau allows you to have cash reserves up to three times your annual budget. Build up your cash reserves before, during, and after the build-up of your endowment.
Pros & Cons
Pros: A nonprofit endowment builds trust with donors, volunteers, and staff. An organization’s future must be built in the here and now. This is probably the most vital part of creating an endowment for your organization, but there are several other advantages.
- It gives donors another way to give and remain connected with the cause for a long time.
- Donors have control over their major or principal gifts: a good reason for them to give those kinds of gifts to your organization.
- The organization can designate endowment funds towards an on-going need, like capacity-building, scholarships, or community improvements.
- Grant-makers love endowments. Foundations are always interested in investing in nonprofits with an eye to the future. Organizations with one or two endowments will often catch the eye of a foundation.
Cons: Nonprofits are unfortunately often strapped for cash. Some donors, board members, volunteers, and staff may see endowments as lost money for the organization. People who support or partner with the organization, or are watching from the outside, may find it difficult to understand why your nonprofit would want to start an endowment when you’re having trouble paying salaries or keeping the lights on.
Other cons include…
- You must invest in the stock market – The reality is that the market is not entirely safe, and your organization could lose a significant amount if you take too many risks. It’s best to keep most of your endowment in the form of cash reserves.
- You may have to pay for professional financial expertise – Investing is tricky, and only an expert financial advisor can direct you to make the best choices for your organization.
- Endowments are only for long-term investments – An endowment is not the best choice if your organization doesn’t have long-term goals and doesn’t plan to be around in a few years.
Be careful not to put too much revenue in your endowment. If your board wants to start an endowment fund, help them understand how it will look from the outside. Make sure most of your funds are used for the organization’s primary needs first.
To listen to Laurence talking about endowments with his colleague, Tony Martinetti, here’s a recent webinar.
What’s holding you back from starting or advancing your endowment? Let us know in the comments below. Please share this post with colleagues who may be interested.