Let’s rethink ‘forever’ and explore new, flexible ways to ensure your nonprofit organization’s longevity and effectiveness.
Endowments may seem like a secure financial harbor in theory, but in practice, are they really as beneficial as they seem?
“Perpetuity is a very long time.” — John D. Rockefeller
When the pandemic created a worldwide need for dollars for nearly everything (social services, universities, the arts, etc.), I took a hard look at this whole permanent endowment thing. I admit—I’ve never been a fan of permanent endowments. The entire idea of forever blows my mind: I picture these funds sitting there when humanity is long gone, and the world is inherited by cockroaches and Keith Richards. Throughout the pandemic, I found myself wondering why so many nonprofits—like our small nonprofit outdoor theater—had a hard time getting our hands on (and actually using) those endowments. Seriously, if this wasn’t the end of the world, then what is?
The Different Types of Endowments—and What Each Means for Your Organization
Let’s start with what endowments are NOT. First of all, most endowments are not one big wine barrel full of money. Instead, they are wine barrels full of coin-filled dixie cups, with each dixie cup (usually) tagged for a certain thing—perhaps “scholarships” or “the commission of new works.” Each tag is written by the hand of a donor, and it’s important to carry out that donor’s intent—in perpetuity. The money inside (including any interest earned therefrom) may only be used for what it says on the cup. Because these cups are already tagged for projects, they are neither rainy-day funds nor are they cash reserves.
Now, let’s get into some of the different kinds of endowments.
The True Endowment
True endowments are permanent, in perpetuity, forever, until the end of the world.
Let’s say you’re the ballet. You have a donor who gives you a million dollars. You take this million-buck barrel, and you ask an entity—usually a community foundation—to hold onto it for you. Now this barrel, like it or not, has become the permanent property of the community foundation—not the ballet—yet the ballet will receive (most of) the interest earned from the barrel. The community foundation charges the ballet a fee for the storage and supervision of this barrel, including all administrative costs and investment expenses. Any earnings from this barrel are first used to cover this fee, and then distributed to the ballet. If these earnings exceed a certain amount or percentage, however, the excess will often be put back into the barrel. This helps the barrel magically expand every year, earning more and more.
Another thing to keep in mind: although allegedly in perpetuity, the barrel is only dedicated to the ballet until the ballet ceases to exist. At this point, any earnings must be transferred to other nonprofits with similar missions. If none exists, the community foundation can take the entire barrel and use the money any way they want—and it’s no longer permanent or in perpetuity. No offense, but maybe the ballet wouldn’t have ceased to exist if they could have used the money any way they wanted.
The Term Endowment
Think of a term endowment as a Certificate of Deposit, which are offered by most banks and provide a higher interest rate if you commit to leaving the funds in for a fixed period.
For a term endowment, a nonprofit’s board agrees to keep the endowment money in the barrel for a specific amount of time—sometimes it’s a set number of years or perhaps it’s until the donor’s death. During this time, the board cannot touch this money, but once the term is up, the principal can be used to fund operations or any other appropriate organizational needs.
Imagine your ballet just dancing along and, suddenly, you get this lovely, big wine barrel out of nowhere. Your board might decide to put this into a reserve fund, which can be restricted (tagged) or unrestricted (untagged), but the wine is yours. This is a quasi-endowment.
You can use quasi-endowments however you like. And if circumstances change dramatically—if the world ends—you can tap into these funds. Of course, if they’re restricted, you can only use them as specified: the funds are still tagged, but they’re all yours. With unrestricted funds, you can reinvest them back into the endowment, into another account, or spend them out for ongoing operations. That’s cool, too!
The Non-Endowments: Donor Advised Funds (DAFs)
I haven’t discussed DAFs yet because they’re technically not organizational endowments. However, they are similar: DAFs are held by community foundations who legally control, and therefore own, the funds.
The process for DAFs is fairly simple: a donor gives the funds to a community foundation, writing off this contribution as a tax deduction: these funds now belong to the community foundation, not the donor. However, the donor will advise the foundation on how the funds can be distributed to nonprofits and sometimes even where they should be invested. Essentially, a DAF represents a donor’s promise of charitable contribution: when a donor finds a nonprofit or cause that they support, they can easily direct the holding community foundation to pay out any or all of these funds. A donor can add more money to their DAF any time they wish, and the donor will receive a tax deduction any time they contribute money.
Here’s the current problem, particularly in the United States: today, billions of dollars are sitting in DAFs that are not being distributed to nonprofits even though donors have already received their tax deductions. Which leads us to question: Who is advising these donors? Why isn’t the money being distributed?
But of course, this problem is not necessarily limited to DAFs: organizations with endowments suffer similarly from their inability to access their funds. So, we might understand this further, let’s take a look at some of the problems (and potentialities) of endowments.
The Good, the Bad, and the Ugly of Endowments
The Good: Many donors love to give to endowments. Donors and grantmaking foundations tend to trust organizations that have endowments because endowments help organizations look like they’re there to stay. It’s that permanence thing. And during trying times, the interest that comes from well-invested endowments can be a lifesaver for some organizations. During the pandemic, for example, those endowments often meant regular incomes for nonprofits—incomes they would not have had if they had depleted their principal or had no endowment at all.
MORE Good: Both endowments and DAFs help to connect donors to an organization. Endowments are often named for their donors, like DAFs, which can encourage a donor to continue to contribute to the organization. In addition, they provide a vehicle for this continued support, whereby a donor can add money on a regular basis or whenever the urge strikes them.
The Bad (potentially): Let’s talk about your organization’s tolerance for risk. Endowments are almost always invested in the stock market, which can be scary during a downturn. And for this nail-biting adventure, you’ll be paying for professional financial expertise from your endowment, eating into any returns your investment might make. At some point, you must wonder whether the juice is worth the squeeze.
The Ugly: Admittedly, a quasi- or term endowments usually doesn’t have this problem, but a permanent endowment is permanent. If it’s big enough to spit out a sizeable interest that can truly help your organization, then terrific. But if it doesn’t, then you’ve tied up all your wine in that barrel, and you can’t drink any of it. Ever. You can only drink the interest, and that can leave you quite thirsty indeed.
Enter the Pandemic
For many of us who might not be well-versed in nonprofit finances, it might seem unnecessary to donate to an organization with a large, permanent endowment. After all, they have all that money, right? But during the pandemic, several things happened.
Let’s take a look at universities as an example: during the pandemic, Ivy League universities received funds from the government in the form of CARES dollars. But once the public noticed that these universities had bajillions in endowments, the resultant public outcry led many of these universities to refuse the CARES dollars. In this case, the organizations lost the trust that their endowments should have earned them.
On the other hand, many wonderful and solid organizations (particularly those in the performing arts) were able to dip into their term and quasi-endowments to fund their operations. Many took literally millions from their very healthy endowments because their boards had the power to do so, which saved them from going out of business. But those with permanent endowments couldn’t access their money. Again, if this didn’t constitute the end of the world, then what did?
The big question: We don’t have the final numbers yet, but we do know that realistic estimates indicated 11 percent of nonprofits could go out of business due to the pandemic. I can’t help but wonder how many nonprofits might still be healthy if they had been given (otherwise unprecedented) access to some funds in those permanent endowments. But this would take the hard work of judges and lawyers who can see that the word “permanent” may not be a true legal concept.
What are some solutions to this whole endowment conundrum?
Ok, so they teach us not to complain unless we’ve got a solution. Sadly, there’s no solution for the billions of dollars in endowments that will still be there until the end of time. But if you’re a nonprofit who is thinking of cozying up to the idea of endowments—permanent or not—here are three things to consider before you go all in:
Make sure you’ve communicated with your board about what exactly a permanent endowment really is. This includes how you’re going to relate—and communicate—with the community foundation. Consider how the fund will look to the outside world and be transparent: make sure you let the public know how the earnings will be used.
2. The Contribution Amount
Don’t put your entire nest egg into a permanent endowment. Your organization needs cash on hand to run. And if the market dives and your donors stop giving, you will need enough to survive a crisis. Consider a term endowment or a quasi-endowment and be disciplined about both how much you contribute and how much you withdraw.
Another scenario: Let’s say a donor gives your organization a surprise gift, maybe as a legacy. It’s tempting to put all of that money into a permanent endowment in order to create a new project in honor of that donor. Don’t be tempted. Remember, new projects always require extra funding in the early stages, and you don’t want to be in a position where you’ve just tied up all your new cash in a permanent endowment without the funds to run your new program.
4. Long-Term Goals
Ask yourself, “how long do you plan to be around?” This might seem like an odd question, but when I was at the Social Justice Fund, we hoped we’d be out of business in 20 years—we were perhaps a tad optimistic. But this was what success looked like to us: the accomplishment of our mission to the point that our organization could dissolve.
For us, an endowment probably would not have enhanced our mission. Hopefully, not all systemic issues will continue until the end of time. So, if you’re one of those organizations providing services that you hope will become obsolete (at some point), maybe an endowment isn’t for you.
Nothing is permanent.
The reality is that, during the pandemic, a lot of nonprofits with smaller endowments survived, and ones with huge endowments suffered. Perpetuity sounds great if you’re a banking institution, but as we’ve recently seen, even banks can go out of business.
Turns out that many of the organizations that should have been shorn up by their permanent endowments were actually weakened by them. Maybe it’s time to rethink the end of the world, to reconsider what kinds of organizations should survive forever. And in doing so, it’s time to free up our dollars, so that we, ourselves, can define the end of the world.
Here’s my new favorite idea to consider: Let’s say a donor gives you a million-dollar gift. You can discuss with the donor how great it would be to have five years to spend that money. Every dime of it. It would collect interest until it’s gone, and you’d have five years to demonstrate your ability to use money wisely while you find another donor for the NEXT five years! Maybe it will be the same donor again! You never know! But now you’ve set yourself up with a goal to raise another million in five years, and your donor will like that. It shows long-term planning.
I do really hope that one institution is permanent: the Smithsonian. Otherwise, where will Keith Richards hang out to play some extraordinary guitars?
Articles on Blue Avocado do not provide legal representation or legal advice and should not be used as a substitute for advice or legal counsel. Blue Avocado provides space for the nonprofit sector to express new ideas. Views represented in Blue Avocado do not necessarily express the opinion of the publication or its publisher.