Endowment funds provide financial flexibility for nonprofits

When you lead a nonprofit, funding is a top priority—and the most effective way you can serve your cause.

While general fundraising methods provide immediate money, you can also plan for future expenses by setting up an endowment.

How endowments work

An endowment fund is a pool of money an organization has raised to invest and provide a consistent stream of income. The principal, or a portion of the money, usually remains intact. Meanwhile, the organization can withdraw the earnings and use them for general operating costs or special purposes.

Generally, only public-serving entities can put endowment funds in place. This includes nonprofits, as well as universities, churches and hospitals.

There are four main types of endowments:

• Unrestricted: The nonprofit can use the funds in any way they choose.
• Restricted: These endowments are the most common. They limit use of funds to ways the donor specifies, such as to purchase a piece of property or to serve a certain part of the nonprofit's community.
• Term: The organization can only access the funds after a period of time set by the donor.
• Quasi: The nonprofit's governing board directs the funds, instead of donors controlling or restricting them.

Important parts of an endowment fund

All endowment funds have three important components in place. The first is the investment policy. This gives the fund manager guidelines about how they can invest the money. For example, the investment policy may stipulate that the fund can only be in certain types of securities.

The endowment also needs a withdrawal policy. This states how and when the nonprofit can take money from the fund. If the endowment is a term fund, it may specify the date and frequency with which the organization can access the money, such as monthly or quarterly.

The final component of an endowment is its usage policy. This part states how the institution can use the money. Some funds are only for scholarship purposes, while others may be for capital investments, such as building a new facility.

Launching your endowment fund

To start an endowment, the nonprofit needs to determine how much money it would like to request or build. Experts suggest that the minimum should be at least twice the annual operating budget. Cultivating endowment donors can be a big undertaking, and you'll want to consider this a long-term project.

The nonprofit board will need to set up rules for the endowment, such as its use and withdrawal guidelines. The organization can use its existing nonprofit corporation to set up the fund or a separate 501(c)(3) organization or foundation. While a nonprofit can set up a fund on its own, it's important to work with an accountant and attorney to ensure state compliance. An endowment fund consultant can help streamline the process.

Consider the costs

The amount of money available to the nonprofit each year will depend on how well the investments perform. Consider what will happen if the nonprofit's board of directors doesn't want the responsibility of overseeing the fund's market performance. The organization will likely need to hire a professional investment firm to provide support.

You'll need to consider how much money you're willing to spend on management and what tasks the board of directors is willing to take on themselves.

The benefits of an endowment

Setting up an endowment fund gives organizations a way to generate money over time. Nonprofits are often focused on serving the immediate needs of their cause. An endowment provides a pipeline of funds that the institution can stretch over a longer period of time to diversify sources of income.

Having another revenue stream also helps with sustainability. This can give nonprofit managers greater financial flexibility. For example, an endowment can cover regular operating costs, while fundraising drives generate money for other goals, such as expansion programs.

Creating an endowment fund also signals to donors that your nonprofit is well-managed and has a solid plan for future operation. It provides donors a way to give your nonprofit a gift that will outlive them, as well as the option to designate how you'll use their donation.

By taking time to explore this option, you can relieve the constant pressure to raise money—plus provide for the future of your organization and the people it serves.