Are You Ready for Endowments?

With the expectation that baby boomers — the largest and wealthiest generation in U.S. history — will transfer trillions of dollars worth of assets in the next few decades, this could be the perfect time to begin establishing an endowment. Nonprofits have long utilized endowments to help them obtain the necessary financial resources to accomplish their missions in the future.

Endowments are not all created equal. A permanent endowment only allows access to the interest generated by the assets to use for your organization’s operating expenses. A term endowment generally lets you also use the assets themselves once the designated term has passed. Either way, you should consider several key issues prior to making the move.

Balancing the Pros and Cons

Endowments are appealing to nonprofits for various reasons. For example, the funds provide financial stability and enable better management of your organization’s risks. A solid endowment can also reduce headaches and uncertainty experienced when forced to rely mostly on annual campaigns, special events and fundraising — resulting in less event planning and more time being devoted to your actual mission.

Endowments can result in attracting additional donors. They demonstrate that your organization has earned the trust of other donors and will be viable for the long haul. Additionally, they allow you to approach donors from a position of strength and confidence, rather than struggle and neediness.

However — be forewarned — an endowment can turn off potential donors who may feel your organization doesn’t truly need their contributions. Administrative and communication tasks could also consume staff time, diverting from the organization’s current needs.

Managing Assets and Spending

Of course it’s no surprise that endowments come with some restrictions and regulations. The Uniform Prudent Management of Institutional Funds Act (“UPMIFA”) specifies the standards for managing and investing endowments. Your organization will need to establish a written investment policy for its endowment that complies with those standards, by addressing, among other things, asset allocation and spending.

The board and appropriate staff should determine the best allocation among asset classes (for example, stocks, bonds and real estate) to earn the desired return on investment. Each investment decision must be made in the context of the endowment’s total portfolio, taking into account the risk and return objectives of both the endowment and the organization.

When it comes to spending, UPMIFA lets you spend or accumulate as much as the board determines is prudent for the endowment’s uses, benefits, purposes and duration — subject to seven specific criteria, including the purposes of the organization and the endowment, general economic conditions, and the organization’s other resources. UPMIFA also allows you to base your spending rate on the expected total returns of the endowment principal, including appreciation, instead of only on interest income.

Taking A Different Route

If a traditional endowment doesn’t seem a good fit for your organization, you’re not necessarily out of luck. Another option is to establish a “quasi endowment,” otherwise known as a board-designated endowment, or funds functioning as endowments. A quasi endowment could work well if your organization isn’t ready yet for a full-blown endowment campaign, but is seeking the financial stability and other benefits associated with endowments.

Unlike traditional endowments, quasi endowments are established by the organization itself — rather than a donor. They’re funded by donor or organizational funds, usually unrestricted donor bequests, or excess operational funding or revenue. A quasi endowment may be found to be more flexible than permanent or term endowments, since the board can end the restriction(s) it imposed at any time and for any reason. More importantly, they aren’t subject to UPMIFA.

Planning for the Complexities

If your organization decides to pursue an endowment of any kind, it should keep in mind that the arrangements are more complicated than ordinary fundraising or capital campaigns. Make sure you have, or can acquire, the requisite expertise in areas such as estate planning, investment policies and financial reporting.

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