chapter 24
Setting Up an Endowment
During boom years, even the smallest NGO can be found putting money away into an endowment, a reserve fund, or just a savings account. This money is invested in mutual funds or certificates of deposit and, with a little tending, the principal grows, sometimes dramatically. Endowment income can be a reliable part of an organization’s annual needs, and for organizations with large endowments, the endowment gains can be a major part of income. During bust years and dramatic stock market downturns, putting money aside is less popular and thought to be less possible.
Just as a family or an individual saves for retirement or hard times, any organization that possibly can should put some money aside. Institutions that should be permanent fixtures in the nonprofit landscape need to start endowments. There are ways to invest the principal in an endowment safely and to ensure both long-term growth and some income.
ENDOWMENT DEFINED
An endowment is a permanent savings account for an institution. Money is put aside as principal, and a small percentage of that principal (traditionally 5 percent) is used for the annual needs of the institution. In years when the principal increases more than 5 percent, the value of the overall endowment increases accordingly, which then increases the amount the organization can use while still staying at the 5 percent figure. In years when the principal does not increase by 5 percent, the organization can still take out 5 percent of the asset without truly eroding the original principal. During huge market downturns, however, even the original principal may lose value; taking out any of it for operating expenses is not as useful at those times, as doing so further lowers the endowment’s value.
Using a mix of investments, an endowment generally can weather market instability and still be productive. Like any source of money, an endowment can lose value or even disappear, which is why organizations have to have diversified income streams so that the investment income from an endowment is not critical to survival.
BENEFITS OF ENDOWMENTS
Although the advantages of endowments may seem obvious, let’s review them:
- Just like a savings account, an endowment provides a measure of financial security and takes some of the anxiety out of annual fundraising.
- An endowment allows, indeed forces, an organization to think in terms of long-range planning, because an endowment implies a commitment to exist in perpetuity.
- An endowment provides a vehicle for people to make larger gifts to an organization than might be appropriate as an annual gift, and an endowment allows people to make one-time-only gifts with the assurance that the gift won’t be spent right away.
- An endowment gives people a way to express their commitment to an organization through their wills or estate plans; few people will leave money to an organization that does not have some kind of permanent fund. (See Chapter Twenty-Three, “Legacy Giving,” for more on wills.)
- An endowment attracts donors who perceive having one to be a sign of good planning and long-range thinking in an organization.
- Principal from an endowment can be used for capital expenses, such as a building purchase, and as collateral for loans, if ever needed.
- In extreme circumstances, the endowment can be used to keep the organization afloat until it can generate other income. (While what’s called “invading principal” is something organizations try not to do, there are circumstances in which it might be the best or only recourse, and it is nice to know you have that possibility.)
DISADVANTAGES OF ENDOWMENTS
Endowments have some serious drawbacks:
- If an endowment is large enough, it allows an organization that should have gone out of business, or at least changed the way it works, to exist permanently and to stay the same.
- The income from a large endowment can allow organizations to become unresponsive to their constituency.
- Endowments can provide a false sense of security. Interest rates vary, stock markets crash, and, of course, money can always be invested badly.
- The existence of an endowment may discourage some donors from giving who prefer to support organizations that they perceive to need the money more. However, some donors may choose to give to an endowment rather than to annual operating costs.
- As with any large source of money earmarked for a specific program, endowments that are linked to certain programs can cause the work of the organization to become driven by the donor’s stipulations rather than by its own mission. Moreover, by the time it is clear that the program needs to be changed or abandoned, the donor is usually deceased and the terms for changing how the funds are spent may not be in place. If the endowment is large enough, lengthy and expensive court cases may result.
- Managing an endowment is an additional piece of work for board and staff. This management time can become the tail that wags the dog, particularly if there are problems with the investments or disagreement about how to use the income.
There are also some philosophical concerns for social justice organizations about endowments. Money that is in an endowment has been diverted from the tax stream, but is not being used directly for tax-exempt activities. (In fact, the nature of the investments often support forms of capitalism that the organization’s work seeks to eradicate.) Organizations that are troubled by decreasing support from government funding and increasing privatization of services they believe the government should be providing with tax dollars will need to grapple with this dilemma. An organization that believes it is doing work that the government should be using tax money for (such as social services, support of the arts, support of school programs, libraries, and so on) is essentially “privatizing” that work by raising private “nest egg” funds. (A historic footnote on this point: in 1791, as part of the French Revolution, the revolutionaries seized and sold off all endowments belonging to church or private institutions, reflecting the Jacobins’ belief that the state should provide what its citizens need for quality of life and that using private intermediaries, particularly “the long arm of the dead donor,” did not promote a healthy society. A subsequent law that essentially curtailed the creation of foundations remained in effect in France until 1987.)
CONSIDERING AN ENDOWMENT OR RESERVE FUND
It is obvious that only organizations with strong annual campaigns are really in a position to start endowments. When thinking of starting an endowment, organizations often focus on the money: how much to raise, how to raise it, whom to ask for it. But there are two critical questions that must be answered before even one dollar is invested in your endowment.
Does Everyone in the Organization Agree That Your Organization Should Exist Permanently?
Most nonprofits involved in social change are formed with the idea that if their work is successful, they will put themselves out of business. The founders generally do not think of the organization becoming permanent, and everyone may be surprised at how long it is taking to solve the problem the organization was created to address. Arts groups, independent schools, historic preservation societies, community land trusts, parks and wildlands conservation groups, and some social services are clearly permanent, with their work always needed or wanted. In contrast, environmental, feminist, liberation, and advocacy groups, if they are successful, will cease to exist.
Sometimes the most interesting part of the endowment process is discussion of this question at the beginning: Should we always be here? “Permanence” in terms of endowment has shades of meaning. It can take its traditional meaning of “always and forever” or it can take the meaning of “fifty years from now.” But endowments do imply existing well past the lifetime of anyone in the organization, and they require the leadership of the organization to imagine the day when people who are not yet born are sitting on the board of directors and working as staff. Will your work be needed then? What is the evidence of that need?
It is important to make sure that everyone among board, staff, key volunteers, and donors agrees that permanence is a value. When people don’t agree on that condition, the fundamental reason to have an endowment and the driving force of endowment fundraising are already in trouble.
What Will Endowment Income Be Used For?
Just as couples may have differing ideas about how and when to use savings, so may board and staff differ about using endowment income. Some will see the income stream as a relief from constant fundraising; others will see the endowment income as paying for particular programs or doing things the agency has not been able to do before.
What you use the income for is related to how large you want your endowment to be. An organization with a $250,000 budget simply looking for a little financial relief along with some financial security will be happy to start with a $100,000 endowment that yields both $5,000 a year and the knowledge that there is principal that can be borrowed against or added to. This money can be used toward increasing staff health care benefits, buying better equipment, or office needs. It is not enough money to change the direction of the group in any way, but it is enough to make life easier. A community-based organization looking for enough endowment income to open a satellite office or explore new program directions will need an endowment of $1 million or more from which they can safely draw $50,000 a year.
Once these two questions are resolved (which can take as much as a year of discussion), you are ready to begin the initial logistical steps. These steps involve authorizing the endowment, determining what gifts will be accepted, and deciding on investment policies.
THE AUTHORIZATION
First, the board agrees to create an endowment fund and to hold this money in perpetuity. This fund will be reflected in all financial reports as a separate line item. Once this decision has been made, the group should consider and decide on a series of policies about the endowment money.
Use Policy
Policies detailing how the interest income from the endowment will be used can be couched as broad statements, but they should not be so broad that they are subject to a variety of opposing interpretations. For example, one organization’s policies stated: “Endowment income is to be used for operating costs.” Later, that group opened a second office and added new programs. Some board members thought the endowment income should be spread to include all operating costs for all programs; others felt the income was limited to operation of programs in place at the time the policy was created and that new programs were therefore on their own to raise all the money they needed.
Invasion Policy
Are there any circumstances under which the organization would use (invade) the endowment principal? There are no right or wrong answers to this question, but in most cases endowment principal is only invaded under the most dire circumstance or when the endowment is going to be used to pay for another long-term asset, for example, as the down payment for a building.
The organization will need to decide on the categories of “dire.” Most board policies establish that endowment principal can only be used if the organization itself is in danger of closing and that the amount taken from the principal must be paid back within a given time period. Some boards rule that the principal cannot be touched even if drastic cuts are required, whereas others decide that the principal can be used to balance the budget, but not for more than two years in a row.
Although no organization can think of every contingency, and certainly you don’t want to spend hundreds of hours on your policies, you do need to spell out in the authorization the most common things that could happen. I know of several instances in which a board of directors and staff worked hard to build an endowment; then years later, after all those people were gone, another board with too much latitude to invade voted to use endowment principal to balance the budget, gradually burning through the whole corpus in just a few years. At the other extreme, I once knew an organization that lost most of their funding, forcing them to lay off staff and move to a board member’s garage. A look at their financial statement showed $400,000 in an endowment. When I asked why they weren’t using that money, they said, “It is for a rainy day.” To me, they were in a hurricane, but to them, the skies were not yet dark.
A related question is: Who will have the authority to decide whether to use endowment principal? Most boards rule that the whole board would have to approve of such a use. Others stipulate that up to a percentage of the principal can be used on the vote of the executive committee; beyond that percentage, the decision must go to the whole board. At the full board meeting, some boards require unanimous agreement; others deem that a simple majority is sufficient. Some of these procedures will be determined by how the organization makes decisions on other matters.
Gift Acceptance Policy
Another broad category of decisions involves determining what types of gifts you will accept, who has the authority to accept them, who will draw up contracts with donors about them, and under what circumstances the organization will accept or decline a gift. (Most organizations should have some gift acceptance policy in place, even if you don’t have or never intend to have an endowment. As you can see from the examples that follow, any kind of fundraising effort could raise these types of questions.)
For example, will you accept the gift of a house? “Well, why not?” you ask brashly. One NGO discovered that the owner donated his house because he could not sell it, even at a huge loss. Another accepted a house with a lien on it. Another accepted a duplex with low-income tenants in place, intending to convert the building into an office. When they sought to evict the tenants, they faced a public relations nightmare, including this headline: “Single mothers evicted for ‘social justice.’ ”
Will you take jewelry, art, or antiques? You have to think about what you will do with this stuff. How will you sell it? Do you have access to appraisers and buyers of fine art? These items may be worth a lot of money, but you may not be able to sell them. You can spend hours of staff and volunteer time trying to get a fair price for these items; in the end, they will have cost you more than they were worth.
Will you accept stock from companies that make weapons, degrade the environment, or use sweatshop labor? (Because stock should be sold immediately, most organizations have decided they can accept stock from companies they disagree with without feeling that they are supporting the company, but it is still important to discuss this in theory, before the actual stock is being given to you.)
Will you accept endowment gifts that are restricted in use? For example, if someone wants to endow your children’s program forever, will you accept that restriction? If someone wants to create a new program and endow it, will you consider that?
To keep things simple, at the beginning most grassroots organizations should accept only cash, appreciated securities (stocks and bonds), and life insurance—all with few or no use restrictions. Other kinds of assets can be negotiated on a case-by-case basis.
Your published gift acceptance policy can be quite simple: “The board of directors of People for All Things Good reserves the right to turn down any gift that it believes will not be in the best interest of our mission or that we cannot handle appropriately.” What you publish is not as important as the occasion to have this conversation with your board and staff, with everyone understanding what you are getting into. The tendency of most organizations is to accept all gifts (“Don’t look a gift horse in the mouth”), but you need to be clear that some gifts can be burdensome beyond their value.
If you have difficulty defining the types of gifts you should accept and what is involved, hire a consultant with experience in creating endowment policies to help you. This may save you money and time later.
Investment Policies
Finally, your organization needs an investment policy. Will you invest entirely for income, or will you have a mix of investments that allow for growth of the principal and income? Will you require socially responsible investing and, if so, what screens will be put in place? For example, some nonprofits specify that they will not invest in certain kinds of products or businesses, such as tobacco, national chain box stores, nuclear power, or logging. Others require evidence that the company does not engage in union busting, has a racially diverse staff and board, or offers health and other benefits for domestic partners. If you do social screening, you need to set priorities. If you try to screen out everything bad, you will have few places in which to invest.
Once the organization begins receiving endowment funds, the board will need to create an investment committee. This committee can include people who are not on the board. Friendly bankers, your biggest donors, and program officers at foundations can help with recommendations for candidates for this committee and sometimes may serve themselves. For many grassroots board members, their biggest investment is a new car; investing endowment funds requires learning a number of new concepts. Even if the board delegates responsibility for investment decisions to others, it must still educate itself in order to monitor the management of the endowment. It is not always easy to tell what is a good or bad investment, nor is it always easy to tell whether someone is using your lack of investment knowledge to their (and not your organization’s) financial advantage. Although you may want to hire an investment professional, don’t ever trust your investment decisions to just one person or a group of people who are all friends with each other.
Here is a checklist to help you determine whether you are ready to start an endowment.
Do not short-circuit these steps in creating an endowment. They do not have to be monumentally time-consuming, but they allow you to have some in-depth discussions about the future of your organization that you should be having anyway. Once you have agreed on a case for needing to exist far into the future and you have in place the policies you need, you can announce your endowment and encourage people to contribute to it as an ongoing part of your fundraising. You can direct your bequests and other legacy gifts to it, and then, if you want, you can conduct an endowment campaign, as discussed in Chapter Twenty-Five.