Monday, January 23, 2012

What Are Endowments or Endowment Funds And Does Our Nonprofit Need One? Probably...

Nonprofits raise endowment funds (usually a larger singular amount of money that is raised and then sits over a large amount of time in the organization's bank or other financial institution of its choosing to earn investment capital), in order to have a nest egg sitting in the organization's back pocket because an endowment fund (once in place) provides that nonprofit with many different smart and even strategic benefits.

In "The Nonprofit Handbook Third Edition Fundraising" the author, James M. Greenfield, defines an endowment (also called an endowment fund) as, "...funds permanently set aside by a not-for-profit organization to fulfill a designated purpose....Endowment funds are invested and generate income to to support the charity's mission.  Endowments establish quality and permanence for the charity.  The income can be used to offset funding shortfalls caused by unforeseen economic events.  Endowments can be board-designated funds set aside for future financial needs." (Page 93).  (I explain in detail the meaning of this definition, below).

Endowment money used or spent by the nonprofit's board is traditionally not the endowment's principle but rather interest earned on that principle.  For example, a given nonprofit may have a $2 million endowment (the principle raised) and has earned $100,000 in interest over the past ten years (the amount of time the organization's owned the endowment).  The $100,000 is usually what a board will use (if any of the endowment) and only as needed in unusual (usually emergent) circumstances.  To be clear, endowments are generally created to exist in perpetuity. I say generally because just recently a New York court ruled that one New York nonprofit not need keep its endowment's principle in perpetuity.  See the article's link, below.

To understand how acquiring an endowment fund goes, let's say, for example, that you and I work together, in their fundraising office, for St. Paul German Historic Stein Collectors Association (SGHSCA), a Minnesota nonprofit.  Our local organization is entirely volunteer run, has existed for over fifty years, and annually, the board and our executive director plan out SGHSCA's coming year's organizational operating budget; year long fundraising plan; and each individual fundraising event's plan, operations, and budget.  As such, the organization's leadership and volunteer staff know what our expected expenses are, how we will pay for those expenses in the coming year, how much we expect to raise from which types of fundraising events (and when those will occur over the year), and more.  Our leadership sees an opportunity to raise a bit more in the coming year and decides to begin an endowment fund (the organization has never had one).

To raise an endowment, like grant writing, annual appeal letters, special events, or any other form of fundraising the campaign requires all of the usual preparation, support, knowledge, and even experience necessary to successfully raise and put that money into place for the organization.  We put a committee into place at the SGHSCA, to learn about endowment campaigns, to research other area nonprofits who have them and talk to their staff responsible for raising them, to discuss what specific accounting is required with our organization's Certified Public Accountant, and to research whether St. Paul's community right now has enough interest in steins and our organization's mission's goal to raise an endowment (in addition to all of the other funds we plan to raise) in the new year and thereafter.  This committee's initial work, as described, is a feasibility study that will (without having the organization go through fully implementing, funding, and then discovering after launching an actual endowment campaign) whether the board's feeling that the nonprofit could raise an endowment fund is really and actually not just possible (within the nonprofit's community where it fundraises) but too, whether the campaign is likely to be successful (and what successful means for this organization's campaign's first year should be predetermined based on real, recent, quantifiable, financial, demographic, economic, etc. data from the community the funds will be raised from).  The best way to not waste an organization's money is to invest some money in prudent research that results in verifiable recent data.

Let's say that our Endowment Campaign Committee spends six months in their discovery phase or feasibility study that yes, St. Paul's local community will likely support funding the SGHSCA's new endowment fund and in the coming year.  Next, the Endowment Committee must move into a planning phase that will enable the nonprofit to launch the campaign and run it efficiently and effectively.  The Committee needs to create the campaign's: description, plan, goal (which will include how much is to be raised, total), timeline, staffing (including scouting of, recruitment of, and retention of desirable reputable and experienced endowment fundraisers (volunteers) with recent local experience usually with other organizations that the SGHSCA will ask to come to volunteer on this campaign), benchmarks, budget, sustainability plan (to be able to fund/manage the endowment for the following years after it's set up), etc.

The Endowment Committee during all of its work is disseminating its findings and sources for those findings to the board and the executive director.  It will make recommendations to the board, but it is the board that will determine all final decisions on what the actual game plan will be, and they will then put proposed plans to a vote and ultimately ratify them.

In actuality an endowment fundraising campaign winds up being a lot like a major donor campaign.  Larger increment donors (such as the organization's major donors but too, grant donors, corporate donors, etc.) will be solicited for large increments.  As in any fundraising, they should be viewed as investors in the organization's mission and its potential to carry out its mission's goal.  The donor should be seen as a partner in the organization's future and its potential for success.  They should be informed as to the campaign's progress, what the ultimate result is of the campaign, and thanked (probably several times).

Earlier, I referenced Greenfield's definition of an endowment which included the sentence, "Endowment funds are invested and generate income to to support the charity's mission."  No nonprofit needs to envision hiring a hedge funds manager (unless the board decides it would like to). 

The goal of having the larger sum asset (the endowment) is to grow interest on the principle (the endowment, ideally, is situated (perhaps in a money market account, perhaps in a portfolio of investments, etc.) to earn interest on the principle, and thereby grow the amount the nonprofit owns.  The finance committee is ultimately responsible for the endowment's placement and diversification in investment.  An endowment can generate income simply sitting in a savings account in the nonprofit's bank.  Whether that is the most effective way for the organization to make the most investment capital off its endowment fund, in a given year, is probably worth some serious (and perhaps even) professional consultation (with a nonprofit's Certified Public Accountant, an Endowment Fund investment adviser, or other reputable investment adviser familiar with nonprofit's unique specific needs and how endowment funds best earn money in the current economy and set of laws and best practices).

Too, Greenfield states in his definition, "Endowments establish quality and permanence for the charity.  The income can be used to offset funding shortfalls caused by unforeseen economic events."  What this means is three things.  Endowment funds, by nature, are not often touched by the nonprofit.  They are seen as assets.  Usually an endowment is a large single amount of money (i.e. $50,000 or $1 million).  By virtue of a nonprofit having that asset it has not just created a 'rainy day fund' or 'nest egg' for emergencies but it has provided the organization with a major asset which always raises a potential donor's confidence in the organization  (including grant donors and major donors) because the organization has ensured that it will be around tomorrow.  The endowment is earning income capital for the nonprofit.  It also demonstrates how well the organization is managed (or 'cared for' if you will) that the leadership has ensured the organization can make it through unforeseen (but expected) financial shortfalls.  Having said this, endowments should not be viewed as checking accounts or as a fund that will be dipped into once a month or even once every few months.  If an organization is doing this - they need to decrease their spending and increase how much they are raising, overall, immediately.  An endowment is truly meant to be a long term investment that is also available, if need be, on rare and few occasions (in order to ensure it is there over the organization's life and future, and to ensure, too, that it is earning investment money for the organization).

Finally, I end with part of Greenfield's definition,"Endowments can be board-designated funds set aside for future financial needs."  Endowments are board: created, overseen, and utilized.  What this means is that an endowment is the organization's and it's there for the goals of the mission.  As such, the organizaiton's (or even mission's) overseers manage it and the overseer of any nonprofit is its board.  In other words, while the executive director usually manages and oversees day to day spending and banking, via the organization's checking and savings accounts (if it has them), an endowment is not meant to be withdrawn from much if at all.  It can be deposited to regularly (as according to the laws and best practices that deal with endowments).  Endowments are not checking accounts but rather investments and as such come under the purview of the organization's own oversight, the board.

To bring this point home, consider a regular supporter of a given nonprofit who donates (probably a larger sum or even an asset) to the nonprofit and restricts that donation to the endowment fund (meaning the money, legally, can only be allocated to and spent from that account).  This is a donor who gives in good faith and is also being enabled by the law (allowing restricted donations which must be granted by the nonprofit that cashes the check).  But what about if a nonprofit accepts a donation to an endowment in good faith and then does not spend the money for the good of the mission but rather because the organization's been run poorly (in recent years) and is in danger of closing if the board does not take money from the endowment to save the nonprofit?  It is using the money for the organization's financial needs.  But, is the use of the endowment money (arguably the organization's largest or one of the nonprofit's largest assets on its books) to float the nonprofit so that it survives a good use of this particular asset?  How long with the amount used to float the organization allow it to continue operating?  Is this a step in a larger recovery plan for the nonprofit's operations (such as perhaps using a small portion of the endowment to float operations, while the board cuts expenses, increases immediate fundraising (maybe, for example, by talking with major donors), and considers new operational and leadership steps to improve operations)?  Or is using this money the actual recovery effort (which may not be enough and only prolong the organization's eventual closure)?  Is this the best use of the endowment?  Maybe.  Maybe not.  Let's consider the donor, again.  He or she gave the sum (probably a larger increment single gift restricted to the endowment) believing it would be principle used to earn interest for the organization, over the life of the nonprofit.  If the organization is operated and managed well, hopefully it never need be anything more to the nonprofit than an investment that earns interest.  To read a real-world example of this occurring, see "In Perpetuity"-Use or Misuse of an Endowment in the Face of Institutional Failure

What's interesting to note about this article is that the legal precedent set (at least in the State of New York) by the courts allowing the use of the hospital's endowment's principle as a revolving door of 'save the organization from closing money' (arguably because the nonprofit is not being run well enough to sustain its operations without regularly dipping into the endowment) - donors, especially larger increment (or major) donors might sit up and take notice of this precedent and be less inclined to give to nonprofits' endowments.  Remember, these contributions tend to be larger single donations or either capital or assets.  The vast majority of donors want the money they give to a nonprofit to be used for the nonprofit's mission (work) rather than to float a poorly run nonprofit that is perhaps only putting off its demise.  The money given by donors to the New York hospital, in the news item, is not assisting those in New York needing medical care.  This use of the money is getting the operating budget from red to black and often by pulling from the endowment's principle.  Donors will not take kindly to this, should it become a widely accepted legal use to allow nonprofits to use endowments' funds as they see fit (rather than in good faith).

Endowments stabilize, empower, and improve the organization, and they also strengthen the nonprofit's reputation and even how investment worthy a nonprofit is to its potential (and current) larger increment donors.

1 comment:

Nominal said...

This is good post.
Thanks for sharing.