Considerations for Establishing an Endowment

In today's complex financial landscape, nonprofit organizations often seek ways to ensure the long-term sustainability of their philanthropic efforts. A common solution for these organizations is establishing an endowment fund, which can provide a level of financial stability while allowing the nonprofit to fulfill its mission.

Here are the benefits of establishing an endowment, key policies an endowment should have and the types of endowments available to help your organization achieve its goals.

What is an endowment?

An endowment is a fund that's generally created by a substantial donation of cash or other financial assets to a nonprofit. In the endowment fund, the donated principal is preserved while generating investment income to meet multi-year charitable goals. Donors can create an endowment to fulfill a stated purpose or to complete the organization's broader charitable objectives.

Managing an endowment requires disciplined preservation of the fund's principal and prudent investment decisions to generate income and growth. A successful endowment provides ongoing financial stability and control—key elements to the fund's longevity and the organization's ability to achieve its objectives and build donor confidence.

What are the benefits of establishing an endowment?

For nonprofits, a stable, income-producing, permanent endowment fund reduces the constant pressure to raise current operating dollars. Over the longer term, an endowment also lessens the impact of ever-changing business cycles. An endowment can also enhance a nonprofit's credibility by demonstrating fiscal strength and stability to its donors.

For donors, creating an endowment can help perpetuate the donor's charitable priorities and create an enduring legacy. Establishing an endowment can also provide great satisfaction to a donor, ensuring that a portion of their assets will go toward a cause they care about.

What policies do I need to establish for an endowment?

When setting up an endowment, there are generally three key policies you need to establish in order to govern how the funds can be invested, spent and used.

The investment policy governs the investment types and risk allocation the endowment fund manager can select. In many cases, the investment policy is built into the endowment fund's legal structure to ensure the money is managed for the long term.

The spending policy governs how much the organization is able to take out of the fund account in each installment period. While this policy should be developed to meet the organization's unique needs, including an annual spending limit is very common in these policies.

The usage policy governs how the funds from the endowment may be used to ensure those funds are effectively used for their intended purpose. This can also be referred to as the restrictions on the funds. These parameters may be set by either the organization or the donor who made the initial donor contribution.

What are the types of endowments?

There are a few types of endowments institutions and donors can leverage based on cash flow and gifting needs.

A restricted endowment is created when assets are permanently set aside for a restricted purpose. This purpose is generally defined by the donor in an endowment agreement. Specific guidelines for fund minimums, spending and use are required for a restricted endowment. With the principal held in perpetuity, related investment earnings support the donor's specific purpose.

A general or unrestricted endowment allows an organization to establish a fund that accepts contributions to support its overall mission and related projects. The principal is held in perpetuity, and the assets can be spent, saved, invested or distributed at the organization's discretion.

A quasi endowment—also called funds functioning as an endowment—allows an organization to invest its own unrestricted assets to support future operations. Because these are organizational funds, the resources may be used at its discretion.

One other type of endowment that exists is a term endowment, which allows the principal to be expended only after a certain period of time has passed or a certain event has occurred.

The Charitable Solutions Group at First Citizens works with restricted, unrestricted and quasi endowments and can guide clients through setting up, planning and investing an endowment.

Is an endowment right for my organization?

Here are some key questions we ask clients to determine if an endowment is the appropriate next step in their fundraising journey.

• Are you concerned about your ability to meet annual fund contribution goals if you start an endowment? Essentially, this question deals with the possible competition between starting an endowment and giving toward the annual fund. While an endowment can bolster the long-term financial stability of your organization, a lagging annual fund means the day-to-day operations may be impacted.
• Do you have dreams for new or expanded initiatives? If so, these aspirations can be a strong reason to establish an endowment. On the other hand, some nonprofits may not have the capacity to expand their current initiatives or launch new ones, in which case an endowment may not be necessary.
• Do you serve a purpose that's likely to exist on a long-term basis? Endowments can provide long-term financial stability. If the organization's purpose extends far into the future, an endowment may be the right tool. However, an endowment may not be the best option if the purpose involves short-term needs or goals.

How can I ensure success for my organization's endowment?

A strong start is key to the success of your organization's endowment fund. Often, organizations jump in head first without a game plan. Here are some actions to consider in the early stages of establishing an endowment to help your endowment start on the right foot.

• Research giving patterns. The over-60 age group is likely to be the most active group for considering endowed gifts. Existing donors who make consistent gifts on a monthly, quarterly or annual basis are good endowment prospects as well.
• Develop a case for an endowment. Explain how endowment income can provide support beyond the capacity of the annual budget, help support ongoing programs when ordinary sources of revenue may fluctuate and possibly make annual fund receipts available for one-time programs or program expansion.
• Create an endowment fund policy. Prior to receiving contributions, establish appropriate policies around restrictions, spending and investments related to each fund.
• Develop a marketing plan. Consider how your organization will spread the word about the endowment and ways to turn awareness into an ask. Consider a proactive outreach to your current donor list and any prospects in advance of launching your endowment.
• Look for sources of initial funding and leadership gifts. When meeting with a donor, suggest twice the amount of an annual gift and add a zero. For example, when approaching a donor who gives $1,000 annually to your organization, multiply $1,000 by two and add a zero to reach a suggested endowment gift of $20,000. With an annualized rate of return of 5%, the annual gift will continue in perpetuity.
• Develop some level of planned giving program. Educate staff, board and donor groups about your endowment and how it might fit into their legacy plans. An estimated 75% to 80% of all endowment gifts come from bequests. This is a great source of funds to help jump-start your endowment.

The bottom line

Establishing an endowment is a considerable commitment that can have a lasting impact on nonprofits and the generous donors who support them. They can provide financial stability for charitable organizations, alleviate some burden of constant fundraising and help weather economic cycles. In turn, donors can feel fulfilled knowing their gifts are going to a cause they cherish and will be used in a responsible manner based on the fund's policies.

To learn more about establishing an endowment and creating the necessary policies, get in touch with a member of our Institutional Trust team.