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Is Your Nonprofit Organization Ready for an Endowment Fund?

Establishing an endowment fund is a big step forward for an organization. It demonstrates that the organization is serious about helping the community through its charitable work well into the future and is taking the necessary steps to ensure that future. An organization with an endowment fund is a beacon to potential donors that want to give lasting gifts that help their communities.

While an endowment fund has serious benefits for an organization, the organization itself may not be ready to take on the challenges associated with an endowment fund.

Management and the Board of Directors of the organization should think about the following considerations as they weigh the benefits and costs of establishing an endowment fund.

Donors & an Endowment Fund

An endowment fund is set up to provide a revenue stream on an annual basis through investment income that can help stabilize the future of the organization. An endowment fund will allow the organization to target a specific demographic of donors that were previously out of reach for the organization. These types of donors generally like to ensure that their donations have maximum impact and that the donation will provide for the organization on an annual basis. A donation to an endowment fund that will restrict the principle of the donation but allow the organization to benefit from the investment income is the perfect vehicle for these donors to use to leave a lasting legacy.

While an endowment fund can help the organization reach these types of donors, it may inadvertently discourage the organization’s donors that give annually for operations. An organization with a large endowment fund reflected on its statement of financial position may turn away the necessary and vital general donations that contribute the majority of the annual operating income of the organization. In today’s economic climate, donors want to see that their donations are being spent on the actual charitable work of the organization. Donors could view the large endowment fund as a sign that the organization has an abundance of cash and investments that are not being utilized for charitable work and decide that their donations are better gifted to another organization that does not have such a large surplus. Donors could similarly question the choice to restrict cash assets that could be used to provide immediate benefit to the community.

Managing an Endowment Fund

Other factors to consider are that the endowment fund will need to be invested and monitored on an ongoing basis to ensure healthy returns that grow the principle and provide annual investment income. Someone within the organization can monitor the investments or the organization can hire an investment manager that comes with monetary costs. Policies have to be written and adhered to in regards to investing, maintaining the principle, and utilization of the investment income. Time and resources will be devoted to the endowment fund that could otherwise go towards other efforts of the organization.  However, the organization could choose to have their endowment held at another entity, such as another nonprofit who specializes in endowments or a financial institution trust department but again should weigh the costs of those arrangements.

Timing of Establishing an Endowment Fund

As the organization weighs the benefits and costs of establishing an endowment fund it should ask, “When should we establish an endowment fund?” A good indicator that an organization is ready to establish an endowment fund is based on the annual revenue. Ideally, the annual donor revenue should be 110% or more of the annual operating budget to allow for organic growth. If revenue is around 110% of the annual operating budget, the organization should consider if it has adequate reserves. The general rule of thumb is that an organization should have a minimum of three to six months of the annual operating budget in a savings account or other liquid asset in order to withstand volatility in the market and the fluctuations of donations. If the organization has established this reserve, then it may begin to consider establishing an endowment fund with any additional excess funds.

Amount Needed to Establish an Endowment Fund

As the organization considers all of the issues laid out above, it comes to the question of, “How much do I need to establish an endowment fund?” An endowment fund can be established with any amount of money. There is no minimum, but an endowment fund of a few thousand dollars will not offer much in the way of investment income to stabilize the organization for the future. A goal for an investment into an endowment fund may be two times the organization’s annual operating budget, which the organization could choose to pursue once that savings level is reached or build up within the endowment over time.  However, an approach to establishing an initial endowment will vary for every organization depending upon their cash needs, cyclical nature of operations, opportunities for matching dollars, current reserve levels, and many other factors to consider.

Establishing an endowment fund does not make sense for every organization. Every organization has different needs and establishing an endowment fund may not fit within those needs. As an organization prepares for the future it should weigh the benefits and costs associated with establishing an endowment fund. For questions regarding endowment funds and your organization, contact your local Blue and Co. advisor.

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