Is an Endowment the Right Solution For a Non-Profit Organization?

by Sloan Smith, CAIA, MBA, CPWA?

Many feel that endowments are financial structures that are only used by large non-profits such as hospitals and universities. This concept may appear overwhelming and unattainable for smaller non-profits who believe endowments are a place where capital from donations can be saved and invested once they have achieved financial success and stability. However, a non-profit of any size can start an endowment. Endowments should be viewed not only as an insurance policy for the future but also as part of a financial plan that ensures an organization will be able to continue to carry out its mission.

What is an Endowment?

An endowment is an investment vehicle that is restricted where the corpus is typically unaltered and invested to generate income to be spent on a specific purpose. It is formed when the non-profit and its donors decide to build a reserve of capital with the objective of establishing a financial bedrock for the organization. Ultimately, there are three types of endowment structures: Permanent, Quasi, and Term.

• A Permanent endowment has funds that must be held in perpetuity and invested to produce a spendable payout to help fulfill an organization’s mission.
• A Quasi endowment are reserves set aside by management or the board of directors, where the principal or income may be used at their discretion.
• A Term endowment is similar to a permanent endowment, except that, upon the passage of a stated time period or the occurrence of a particular event, all or part of the donation may be exhausted.

The Pros and Cons of Establishing an Endowment

Before any non-profit makes the decision to form an endowment, the advantages and disadvantages must be clearly outlined. Smaller or even newly formed non-profits tend to concentrate on their annual expenses such as payroll. However, the goal for these newer organizations should be to reduce these financial stresses and diversify their income. Though non-profits often face demands that far exceed their resources, an endowment reduces its vulnerability to economic cycles and risks. The benefits of establishing an endowment can be substantial. It portrays to the community and donors that the organization is financially sound and intends to be around for a very long time. This message alone has the ability to assist fundraising.

But it must be understood that endowments do not make sense for all organizations, and not everyone thinks highly of them. A valid argument against creating an endowment is current needs. Some may argue that contributions should be used to fund immediate projects such as renovating a church facility, purchasing materials for an underprivileged school, or providing meals for the less fortunate.

In some extreme cases, an endowment may be viewed as unethical considering capital is restricted when there are ways to use the money right now. Another concern is the time-consuming nature of endowment management. Non-profit organizations require resources to manage both money and people. Universities, hospitals and other large non-profits usually have a team that is focused on running the endowment both from an operational and investment standpoint. Non-profits without endowments do not have to deal with these issues.

How to Determine Whether to Build an Endowment

So, when would it make the most sense for a non-profit to establish an endowment and how could they do it? Unfortunately, there is no easy answer but there are a few steps that can assist in this decision-making process.

The first is to develop an organizational plan that focuses on responsible financial planning and management. It should be discussed whether income from fundraising or donations should go directly to operating expenses. It may be appropriate to use this capital to enhance the organization's reputation by holding it in an endowment. Another important step is to talk to the non-profits board and donors about the potential need for cash reserves.

Board members are responsible for making sure that these organizations have the necessary financial resources to achieve its mission both in the present and future. If the non-profit has sufficient reserves to handle an economic downturn without cutting back on services and staff then there should be a discussion about how to manage this excess capital. Ultimately, if the cash reserves continue to grow over time and there are limited concerns about expenses then it may make sense to direct these funds toward an endowment or potentially establish longer-term cash/operating reserves which may provide more spending flexibility.

Next, if the non-profit has the ability to establish a cash reserve account and an endowment fund then hiring an investment manager may be suitable. Small to medium-sized non-profits have the option to create a diverse portfolio in a cost-efficient manner that provides a much better return profile than simply holding all the reserve and endowment capital in cash.

Lastly, the cash reserve and endowment efforts should be mentioned in capital campaigns and fundraising events. These components can be used to deliver a message of strength, where donors can understand the positive difference their contributions can make to the organization and that their donation creates more value than if it were given elsewhere.

Overall, there are many factors to consider before establishing an endowment. However, it is important to understand that you do not need to be a large non-profit entity to establish one. Educating the non-profits’ board of directors and leadership on this investment structure and having an in-depth discussion about the additional value it can bring is key. Either way, it should be a crucial talking point for non-profits as they try to grow their organization and enhance their fundraising efforts.

Undivided. Innovest Portfolio Solutions is a trailblazer, a steward, and a true innovator in serving our clients from our offices in Colorado, California, Arizona, and Florida. A house divided cannot stand, as the adage goes. Nevertheless, most financial investment houses try to do exactly that. They serve more than one master. We serve only our clients. Our interests and the interests of our clients are one. Faith is a foundational value at Innovest. We specialize in helping faith-based organizations meet their investment goals and objectives and keeping their investment portfolio aligned with their values.

Sloan Smith, CAIA, CPWA? will speak at the Arizona Society of CPAs ' Not-for-Profit Conference in June. Tickets are still available to earn CPE and stay up-to-date on the latest trends in not-for-profit accounting: www.ascpa.com/npc.