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The Importance of Endowments: Should Your Nonprofit Build One?

The Importance of Endowments: Should Your Nonprofit Build One?

The reach of your nonprofit will always be dictated by the balance in your bank account.

There are more revenue streams available to you than donations, and if you know how to navigate working with different types, you’ll have less to worry about should one prove particularly challenging at any point. Here, we discuss endowments. While easily confused, an endowment is distinctly different from a reserve fund. Where a reserve fund is a savings account or other highly liquid asset that is set aside to meet future expenses that arise, an endowment is a financial asset in the form of a donation made to a nonprofit. It consists of investment funds or other property that may or may not have a specifically stated purpose, depending on the wishes of the donor. The majority of endowments are set up in such as a way as to keep the principal amount stable while using the investment income for the organization’s charitable efforts. This means that some significant portion of an endowment is restricted in some way to allow the principal to grow over time.

Questions You Should Ask

If you are considering establishing an endowment fund, there are a few questions you need to ask to make sure it is appropriate for your nonprofit’s situation.

  • How much will it cost your nonprofit to manage the endowment?
    • If you manage it on your own you will be looking at various bank and brokerage fees, and if managed by a professional fund manager you will need to pay for their services.
  • Do you need more immediate funds, or is it more advantageous to put assets into a less liquid form to grow for use later in the future?
    • An endowment is excellent for later use, but will do little to help with immediate funding needs.
  • Are you comfortable allowing endowment donors to restrict the use of endowment earnings or should you allow more flexibility in how the income is spent? If there are restrictions, how will they be documented?
  • If you have an endowment, will it become more difficult for the nonprofit to meet its annual fundraising needs?
    • There is a chance that having an endowment creates the perception that there is no longer a need to donate to a nonprofit. Is this a risk for your organization?

If you can answer these questions comfortably, an endowment may be a good option for your nonprofit.

Thoughts to Consider Before Creating an Endowment

  • The growth of your endowment, and the amount of income from it that is available to the nonprofit each year will all depend upon how well the initial investments perform. The board of directors may not want to take full responsibility for all oversight of the market performance of your fund. It is in cases like this that nonprofits typically hire professional investment managers to provide administrative support for the endowment.
  • Having your nonprofit establish an endowment can send the signal to your community and donors that you are looking at the long term and building the necessary assets for future sustainability. It shows your community that you are dedicated to the long term support of your mission.
  • Some endowments are so large that they cause the public to wonder why the funds channelled into the endowment are not spent on immediate needs, questioning why the organization still needs regular donations.

Laying Bricks

Let’s say you’ve considered the above stipulations, answered the questions comfortably, and still believe an endowment is right for your nonprofit. You’re going to need to know the right steps follow so that you can start laying the bricks to create your nonprofit’s endowment fund.

Structure and Planning

First, decide on how many funds you want to have in your endowment. You can begin an endowment with any amount of money, large or small, so it’s a matter of where the investment money will come from. It is often recommended that your endowment be at least three times the size of your annual budget.

Endowment gifts are often a significant investment driver for endowments. You will need to take the time to look at the long term in raising endowment gifts as opposed to the immediate pressure of the short term needs. These often come as the result of a bequest when a donor dies.

Your board is going to need to establish the rules of the endowment. This includes the restrictions of its use, investment policy, the guidelines for how much of the generated income may be used (spending policy), under what circumstances the principal may be tapped (this is referred to as invading the corpus), and what to name the endowment.

You can organize the endowment to be within your already existing nonprofit, or you can build it into its own separate 501(c)(3).

It is not necessarily difficult to start an endowment, but it is recommended to ask for assistance and be aware of all of your legal requirements before you start fundraising.

Funding your Endowment

We discussed this in brief above, now let’s look at the recommended strategies and notes to keep in mind.

Be certain to explain why you are setting up the endowment to any potential donors. They need to understand how you intend to use the funds and all of its earnings.

Answer any questions that may come up in your fundraising materials for the endowment. Have these questions and answers provided on your website, and supply them to your volunteers, including those who “sell” the endowment to your potential donors.

If there are other organizations in your community that have endowments established, learn how they use them. This is helpful to show that what you are doing is a common practice, and may give you new ideas and successful strategies to follow.

Be certain that you still have a separate “rainy day” savings fund for when immediate needs do arise. You do not want to dip into the principal of your endowment as though it is a safety net fund.

Your endowment should still take second place to fundraising for your immediate needs. What happens in five years doesn’t matter if you can’t fund past the next six months.

Endowment donors are often interested in leaving a legacy that provides for the long term future of your nonprofit. Organize planned-giving systems to maintain your endowment fundraising over time.

You need to both explain how your organization will act as a good steward to the gift your donor’s provide, and explain how and why their donations are going to change lives both now and in the future.

If you need any assistance or guidance with the process, it is always helpful to talk to a professional.

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