Setting up an endowment is not just for larger organizations. Even small organizations can benefit from these financial accounts. Endowments allow nonprofit organizations to prepare for future financial needs.
Understand Endowments
An endowment is a specific type of financial vehicle for nonprofit organizations. These funds are restricted, which means only the interest created by the fund can be spent. The principal investments remain in the account to ensure the fund remains in place for the long term. Most endowments also cap the amount of the earnings from the fund that can be spent. A common example is that only five percent may be spent while the remaining amount is put back into the endowment to add to the principal. The creators of the endowment have the goal of ensuring that most of the funds are used to help the organization fund its need long term.
A variety of financial professionals can manage this type of fund. Most often, nonprofit organizations can use money managers to oversee the management and invests in the fund. These professionals will invest the funds as the charter of the endowment dictates, if it does, in stocks, bonds and in other investment types.
Setting up an Endowment Fund
Anyone that runs a nonprofit organization can set up an endowment fund for that organization. Prior to actually opening the endowment, consider the goals of the endowment.
- How will the endowment be funded? What portion of fundraising efforts will the organization put towards the endowment as principal investment?
- How much does the organization need to make from the endowment on an annual basis?
Determine how much the organization needs to put into the endowment in order to reach its necessary spending goals. To do this, determine what percentage of the interest earned will be accessible to the organization each year, for example five percent. Then, determine how much money the endowment needs to have as principal in order to produce enough income for the organization's needs. If the endowment needs to product 20 percent of the organization's funding, for example, of the $1 million that the organization needs yearly, then the endowment needs a balance of at least $4 million to create the $200,000 necessary.
It is important to note that it is rare for an endowment to be the only source of funds for the organization. In most cases, the endowment will be one of several financial vehicles the organization uses, coupled with fundraising efforts, to support itself.
More Considerations
The board of the nonprofit organization will need to agree to various terms of the account. Then, the endowment can be initiated with the help of a money manager or other financial institution. While the funds to open the endowment may be any amount, the process of building a sizable endowment often takes time. The board must also set the terms of the endowment in a legally binding contract which should include:
- What to name the endowment (often after the largest contributor)
- What restrictions the endowment will have
- The guidelines of how much interest will be accessible to the organization yearly
- How the board can tap funds in an emergency situation
The endowment may be part of your current corporation but it can become its own nonprofit corporation as well, depending on the guidelines of the board. Discuss these options with an attorney or a nonprofit financial manager before making decisions.
Once the board of the nonprofit agrees to the terms of the endowment, legal steps can be taken to set up the endowment. This process simply involves opening the account with a financial institution who will properly manage the funds and the investing.
It is advisable that when setting up an endowment that a professional organization be utilized to manage the investing of the funds. This organization should be a third party organization not directly associated with the organization in any way. The organization's money manager will need to manage all aspects of the endowment including legal requirements, taxation and withdrawals and contributions.
