When you hear the word endowment, what do you think of?
In simple terms, an endowment is a pool of donor money that is invested in the stock market. Every year, some or all of the investment income is pumped into the organization’s mission, while the principal remains intact.
Large institutions like colleges, hospitals, and some private K-12 schools have endowments that provide long-term financial security as well as prestige. There is something quite fancy about having piles of money generating income!
Harvard University has an endowment valued at more than $40 billion.
That’s right. Billion.
This is how large institutions sustain their work over time. It’s how they grow and thrive. Having a lot of money makes it easier to bring in more money. Everybody loves a winner.
Good for them, you might say. What does this have to do with someone who leads a small nonprofit?.
It matters because endowments aren’t just for large, wealthy institutions.
Some smaller nonprofits have endowments. And even if you cannot imagine an endowment in your near future, adopting an endowment mindset can put you on a path to financial security.
Adopting an Endowment Mindset
Most small nonprofits live in the moment, fundraising today for programs happening tomorrow. Small nonprofits are scrappy like that.
Institutions with endowments are not scrappy. They are fundraising today for future programs, new buildings, scholarships, and endowed positions. Their development teams work long hours to meet aggressive fundraising goals, but their sense of urgency is not about meeting payroll and paying for other immediate needs.
They are playing the long game. And when you fundraise with the future in mind, you spend your time differently.
You spend a lot of time on one-on-one stewardship. You focus on bequests or money your supporters leave your organization when they die. You encourage stock donations and you are even learning about cryptocurrency.
When you talk to donors, you talk about your organization’s present and you also talk about your organization’s future. What amazing work will your organization be doing in three years? In five? What is coming around the bend that is new and exciting?
Donors respond positively to nonprofit leaders who are building something that will have longevity.
As a small nonprofit, it’s important that you get beyond the day-to-day grind of bringing in enough money to fund your current programs. You need to direct some attention to your organization’s future and your strategic plan.
You don’t have to wait until your fundraising for this year’s operation budget is 100 percent covered to start conversations about what’s next.
Think about the personal finance advice professionals dole out. They never say wait until you have paid all your bills and covered all your expenses to start saving. They want you to start saving today, even if it’s just $5 a week. “Pay yourself first,” they say.
Your nonprofit should take that advice, too.
When you adopt an endowment mindset, you prioritize saving for the future. That way, when the future arrives, you are ready.
Start with Cash Reserves
The first step for getting into an endowment mindset is to start putting money aside for the future right now, even if it’s a very small amount. Even if you feel like you can’t afford to do so.
Start with $5 a week if you have to.
If you want to ensure your organization has a future, you have to save for that future.
At first, you won’t be saving toward an endowment, you will be saving for your cash reserves.
In personal finance, this is your emergency fund or rainy day fund.
For your nonprofit, this is separate from an endowment, because this is money you will keep liquid in a low-risk savings account. You need to be able to access your cash reserves on a moment’s notice in case of a rainy day.
Your organization should aim for four to six months of expenses in cash reserves. For an organization with an annual budget of $100,000, that’s from $33,000 to $50,000.
Some Boards want even more funds in cash reserves, up to 12 months’ worth of expenses. A larger cash reserve fund makes sense if your organization is dependent on a few large grants. If one of those grants disappears, you need cash to carry you until you replace that revenue.
If even a few months of cash reserves sounds insurmountable, take a breath. It’s a long-term goal. Commit to consistently putting a small amount of revenue toward cash reserves, and watch the fund grow over time.
Personal finance experts recommend individuals save at least 10 percent of their income. Could you make it your goal to designate 10 percent of funds raised for general operations toward your cash reserves? If that number sounds too steep, start with 5 percent or even 3 percent, with a plan to increase the percentage over time.
Get your Board on board with the idea of creating cash reserves. Without cash reserves, your nonprofit will scramble to survive economic downturns and unexpected expenses. With cash reserves, your Board will be tasked with managing financial challenges, not getting by on a wing and a prayer.
Ask your Board members to get you started on your cash reserves by making a special gift toward the organization’s future. That will get your cash reserves fund established.
When supporters ask what your most critical needs are, tell them about urgent needs. But then let your endowment mindset kick in. Tell them how important it is that the organization’s work be sustainable. Ask them to consider an additional gift toward cash reserves. Maybe they will be comfortable with you earmarking 10 percent of their gift toward cash reserves.
Donors respond positively when leaders think ahead and acknowledge that the economy is cyclical. Raising money during economic downturns is challenging, and donors know it. Also, donors like to know they are contributing to an organization that will be around for many years, making a significant impact in the community.
Incorporate this language into your talks with people who are already engaged and donating, and watch what happens.
When courting new donors, your best ask will always be an urgent, immediate need. But for supporters who are invested in your organization’s work, a request to designate a portion of their gift to your cash reserves will go over well. Even if some donors say no, they will respect you for thinking ahead.
As your cash reserves grow, so will your organization’s reputation among grantmakers. When applying for grants, a significant cash reserve fund on your balance sheet will show the funder that you are prudent, forward-thinking, and in it for the long haul. Funders do not like to support organizations with shaky balance sheets. Having money in the bank makes it easier to secure more money.
We Have Cash Reserves … Now What?
When your cash reserves fund is fully funded … congratulations!
That is a huge milestone for a small nonprofit. Be sure to keep contributing to your cash reserves fund as your nonprofit grows and your annual budget increases.
What’s the next step? It may be time to talk to your Board about an endowment.
There are three types of endowments:
- True endowment: This type of endowment, also known as a permanent endowment, is for a gift received by a donor who specifies that the principal should not be spent. The income generated from investments can be spent, and sometimes this income is earmarked toward a special purpose. This type of restricted gift is more commonly received by large institutions, such as universities and hospitals. But any organization, including a small nonprofit, could receive a bequest with this type of restriction.
- Term endowment: This type of endowment is for a gift received by a donor who stipulates an amount of time before the principal can be spent. Typically, the donor wants to ensure their money is not quickly depleted, but the donor makes an allowance for the principal to eventually be spent, if the organization chooses to do so.
- Quasi-endowment: This is an endowment established by a nonprofit Board as a way of sustaining the organization’s work over time. The Board diverts unrestricted funds into the quasi-endowment, where the money is invested. Some of the proceeds are used to fund the nonprofit’s mission, while the principal remains intact until the Board decides to spend the principal. This is the most likely entry point into endowments for a small nonprofit.
With a true and a term endowment, the power rests with the donor. You may find it a farfetched notion that a donor would leave your organization a large sum of money designated as a true or term endowment. But it has happened! If your organization receives a gift intended as an endowment, seek guidance from a qualified investment advisor.
With a quasi-endowment, the Board has the authority to save and spend in accordance with the organization’s needs and goals.
You can launch a quasi-endowment with a small amount of money and grow the endowment over time. Your Board can decide to spend the interest and the principal at any time. In the early day, if you reinvest the interest and dividends, you can grow the endowment faster.
As with any endowment, even one that is starting very small, seek advice from a professional or even several professionals so you and your Board fully understand what you’re jumping into. Once the endowment is established, the Board may want to hire a professional to manage the investments. The Board can direct the professional regarding risk-tolerance and goals, and the professional would choose appropriate investments.
For a small endowment, a cheaper option would be a brokerage firm that automatically invests based on risk-tolerance. Research all options and make the best decision for your organization, knowing that you are not locked in and can change advisors or banks if your needs change.
Benefits of an Endowment
The primary goal of an endowment is to ensure your organization’s sustainability.
If you only focus on meeting today’s needs, you will always be at risk of not being able to meet those needs due to an economic downturn or other factors.
There are other benefits to share with your Board:
When talking to your Board about an endowment, emphasize your desire to see the organization grow and thrive, and that an endowment is just one way to build the foundation needed to do so.
Even if the timing is not quite right to start an endowment, talk to your Board members about adopting an endowment mindset, with a goal of setting the organization up for future success by consistently planning, saving, and pursuing gifts aimed at sustainability.
Downsides of an Endowment
Do not shy away from sharing the downsides of an endowment:
- Some Board members, staff, volunteers, and donors may view an endowment as wealth hoarding. They may see the pursuit of an endowment as sitting on resources that are urgently needed now.
Strike a balance. The vast majority of money raised will be spent on urgent, immediate needs. A smaller amount would be set aside first as cash reserves and later as an endowment.
Harvard has come under criticism for the outrageous size of its endowment, but your organization is not Harvard. You are recommending a cash reserves fund as a practical way of protecting the organization’s work and clients in case of an economic downturn and an endowment as a tool for securing the organization’s future.
- An endowment involves investing in the stock market. Some Board members might shudder at the idea of trusting the stock market with donor money. They might feel safer with all the money in a savings account.
A compromise solution is to keep significant funds in the bank as cash reserves while investing only endowment funds.
- An endowment requires expertise your organization might need to pay for. Boards are often loath to take on fees. They may say that you have gotten this far without paying for financial advice, why change.
This mindset is damaging. You need to be humble and acknowledge your lack of expertise. Paying for expertise will lead to a more stable organization and save you money in the long run.
- Not every organization plans to be around for many years. Many nonprofit leaders dream of the day they put themselves out of business. Money invested in the stock market is for long-term needs, at least five years out, most experts say. This long-term commitment is necessary to weather market downturns.
If your organization plans to sunset in less than five years, an endowment is not the right move. But you still need cash reserves and an endowment mindset!
The Bottom Line
An endowment may or may not be the right decision for your organization. But an endowment mindset is right for every organization. An endowment mindset plans for the future as well as the present and seeks ways to save, invest, and grow.
As you work toward an endowment mindset, you will feel less stressed about the future. You will know your organization has a solid foundation and will be okay no matter what challenges come your way.
With an investment mindset, you can lead your organization with confidence and grow your organization in ways that will change more lives.
Thank you, Sandy, for an outstanding overview of an important subject!
You’re so welcome!
Great article! I went to my board last year about this very thing and my board chairman shot me down really fast. This article gives me the tools I need to go back and intelligently discuss this topic.
Thank you, Sandy!
SO glad this was helpful Patti!