Starting an Endowment

For many nonprofits, sustaining a long-term mission requires more than meeting today’s fundraising goals. An endowment can help create a durable source of support, providing flexible funding that grows over time and can strengthen an organization’s ability to plan, respond and invest in future impact. Before establishing one, however, leaders should understand how an endowment fits within the organization’s broader financial picture, what responsibilities it creates and whether the organization is prepared to manage it effectively.

What is an endowment?

An endowment is a financial tool that can offer long-term sustainability by extending the impact of a large sum of money. The creation of an endowment involves an initial investment of assets, generally left intact, that grows over time while generating income from interest. For example, imagine your organization receives a gift of $100,000. You invest that $100,000 and commit to never spending the principal amount; however, every year you receive a distribution from the returns generated by your investment, creating a source of income that you could rely on in perpetuity.

Where do endowments fit in?

An endowment is one piece of a nonprofit organization’s overall capital structure, which refers to the distribution of an organization’s assets (what you own), liabilities (what you owe) and net assets (what you are worth after you subtract your liabilities from your assets).^[1] Building a strong financial safety net requires understanding the types of resources your organization needs over the long term to stabilize cash flow, cover unexpected expenses or take on new opportunities. When considering how an endowment fits into your organization’s financial picture, reflect on the four categories of long-term assets.

• Working capital: Covers planned expenses as needed, replenished on an ongoing basis
• Operating reserve: Used for rainy day savings, replenished after use
• Facilities and/or strategic reserve: Intended for strategic capital expenditures, replenished as needed
• Endowment: Long-term organizational support that generates income for the organization

Why create an endowment?

Establishing an endowment not only improves the overall financial sustainability of your nonprofit, but it also signals to the community that the organization has the desire, structure and stability to make a long-term impact. In addition to building public confidence, the income generated from an endowment advances the mission by supporting short- and long-term expenses, which can vary widely depending on the type of organization. In the higher education sphere, the largest percentage of endowment spending went to student financial aid, whereas community foundation endowment spending supported a wide range of activities including grants, capital projects and emergency responses to natural disasters.^[2] Furthermore, the steady interest earned on the initial investment provides protection from market volatility or economic uncertainty.

What are the different types of endowments?

For an organization considering establishing an endowment, there are three primary types (defined by the IRS) to consider:^[3]

Permanent endowments, also referred to as “true endowments,” are established by donor-restricted gifts and maintained to provide a permanent source of income, with the stipulation that principal must be invested and kept intact in perpetuity. Only income generated can be used by the organization and only for the purposes specified by the donor.

Quasi-endowments result from an internal designation from the board and are generally not donor- restricted. Instead, they are classified as net assets without donor restrictions. While the associated spending policy may place limits on how the income generated may be used, the governing board has the right to decide at any time how to expend quasi-endowments, including principal.

Term endowments are used less frequently and include funds established by donor-restricted gifts that are maintained to provide a source of income for either a specified period or time or until a specific event occurs.

Is my organization ready for an endowment?

Before creating an endowment, it is important to understand your current financial health and capacity to use an endowment effectively. Loading up on long-term assets can lead to miscapitalization, or a mismatch between your organization’s liquidity needs and its available resources. To evaluate the potential impact of an endowment, we recommend examining the role an endowment would play in sustaining (or straining) the following:

• Strategic objectives
• Business model performance
• Liquidity needs
• Development plan
• Staff and board capacity

Assess your organizational readiness by reviewing the worksheet at the end of this article.

What are the stages of creating an endowment?

1. Determine your “why”

When deciding to establish an endowment, your organization should begin with addressing the reasons for establishing a pool of assets dedicated to securing the long-term existence of your organization. What types of expenditures will it be used for? The board should be in agreement about the vision and purpose as endowments are, by design, difficult to change.

2. Recognize added responsibilities

In the early stages of the process, education is critical. Confirm the board understands the increased responsibility and cost that comes with establishing an endowment. When accepting a gift, the board legally commits to following the donor’s specific restrictions regarding how the income is spent, and they will also be held to their fiduciary responsibilities, including the duties or care and loyalty.

Another consideration is state law, nearly every state has enacted the Uniform Prudent Management of Institutional Funds Act (UPMIFA). The UPMIFA provides rules for how nonprofit and charitable organizations manage, invest and spend income from endowment funds. Learn more about the ways UPMIFA applies to endowment spending.

3. Decide between separate entity or separate account

Once key decision-makers have a common understanding around the purpose and responsibilities, and the board has passed a resolution to move forward with creating the endowment, it is time to consider such details as the type of structure. Will you create a separate entity for the endowment or a separate investment account? The decision of how to structure an endowment requires consideration of various factors, including legal and tax implications. Organizations should consult with their tax and legal advisors for advice.

Considerations for Endowment Setup

• Separate Account
  • Requires an addendum to the organization’s bylaws
  • More cost effective, but less dedicated focus
  • Requires the establishment of a new committee to govern the endowment
  • Drawback: direct legal and compliance risk due to mismanagement or failure to comply with reporting regulations
• Separate Entity
  • Requires the creation of a new legal entity and the creation of a new, separate board of directors, mission statement and internal policies.
  • More cumbersome, but has the potential to create better tax and legal impacts

4. Establish investment, spending and gift acceptance policies

Whichever option you choose, the next step will be to establish an investment policy statement (IPS) and a gift acceptance policy.

The IPS determines how your endowment should be invested to reach your financial goals. Within the IPS, the spending policy sets guidelines and parameters for withdrawing funds from the endowment.

A gift acceptance policy clarifies which gifts you will accept and provides a framework for managing risk and evaluating alignment with your goals.

5. Establish, fund and monitor an investment account

Once you have created guiding policies, establish an account to hold the endowment’s assets. This includes finding an investment manager who understands your goals and will walk you through your options and progress. Your board will determine how often the governing committee overseeing the endowment will meet to monitor the endowment. Revisit your IPS annually to confirm it still reflects your goals and make changes if needed.

Key takeaways

• With the right messaging, an endowment can attract new and larger gifts to your organization. While an endowment is a new opportunity for donors to support your mission, they may not be familiar with the benefits of contributing to a long-term asset pool. Explaining the purpose and policies governing the endowment can go a long way towards establishing transparency and building trust. As with your fundraising efforts, donors will be drawn to the purpose and impact of the endowment. Focus on creating a visual for your donors that demonstrates how their gift will benefit the community in perpetuity as a part of their legacy. You may even consider naming a fund after donors who make gifts at a meaningful level to solidify this legacy.
• Over time, endowments can strengthen your organization’s capacity to focus on long-range planning. Many of your programs are intended to serve your communities for years to come, but fundraising efforts often only cover a few years of expenses at most. An endowment is a long-term source of funds that matches the long-term needs of your organization. By relieving some of the pressure of fundraising to cover ongoing expenses, endowments can allow you to dedicate more of your time to your core mission.
• Endowments can advance your strategy, but they come with additional responsibilities for boards and staff members. Nonprofit organizations looking to start an endowment often find that they need additional capacity, particularly in fundraising and financial management. As outlined in this paper, there are five stages in establishing an endowment. At each step, it’s important to have a strong service provider who can provide feedback, best practices and tactical guidance to support your board and staff in making sound decisions.

How Can PNC help?

Forming an endowment can be a cumbersome process that requires expertise and dedicated resources. Larger endowments (such as universities and hospitals) often employ entire departments to manage the fund. For most nonprofits that do not have access to those same resources, hiring an investment manager can provide the expertise needed to handle those duties, leading to more cost-effective fund management and potentially greater investment returns.

With over 3,400 nonprofit clients^[4] , PNC has decades of experience creating and managing endowments. In addition to our highly qualified investment managers and financial advisors, PNC's Nonprofit Strategy & Solutions team is a dedicated specialty group that understands the unique challenges and opportunities faced by nonprofits and associations. This group is comprised of industry veterans who have built and managed endowments in previous nonprofit staff and board roles. With a robust list of solutions tailored for nonprofit entities and associations, we welcome the opportunity to engage nonprofit organizations and associations in planning, implementing and maintaining their endowment programs to help achieve long-term success. Please let us know how PNC can help you start, grow, preserve and maintain your endowment.

Determine Your Organization’s Readiness

Before establishing an endowment, your organization should take stock of its financial resources and expertise to determine whether it is well positioned to move forward. Below are a few topics that can serve as starting points for further evaluation:

Organizational Strategy	Yes	No	N/A
My organization has a strategic plan.
There is a process in place to measure progress against the strategic plan.
Progress against the strategic plan is shared with internal and external stakeholders.
Business Model Performance	Yes	No	N/A
We distinguish between our operating and non-operating financial results.
We evaluate the alignment of our program mix against our mission and impact goals.
Liquidity Needs	Yes	No	N/A
My organization has adequate reserve fund levels to respond to challenges or take advantage of new opportunities.
Development Plan	Yes	No	N/A
My staff and board can tell our financial story and articulate our impact goals.
We have fundraising infrastructure to support establishing and growing an endowment.
We have donors who would be willing to champion and contribute to an endowment.
Staff and Board Capacity	Yes	No	N/A
We understand the current level of investment acumen of our staff, board and broader network of stakeholders.
We have identified board members who would commit to sitting on a committee to oversee the endowment and pursue further training as needed.
We have identified tools and training our finance team has (and may need in the near future) to manage an endowment.