You know you’ve thought about it . . .
To endow or not to endow, that is the question. How much good could you do if you didn’t have to fundraise anymore?
Nearly every nonprofit leader has had the conversation: a board member confidently tells them they really should be building an endowment. Perhaps they even throw out some numbers that show a clear path to $20M in the bank.
At first blush, it sounds like a no-brainer. All the most prestigious institutions have endowments; many of your board members may be scolding you for not having one already.
In their telling, an endowment would solve all your money problems and provide income to support your mission in perpetuity, all with no downside. Sure, it’ll be hard work, but that just means it’s best to get started now.
However, napkin math and actual fundraising are very different things.
It’s easy for a board member or a consultant to confidently declare that you should have an endowment, but they aren’t the ones who will have to raise the money. You know the work required to increase fundraising numbers, and you also know how much good your organization could do with those funds right now. Every contribution to an endowment carries an opportunity cost.
You may decide to proceed with an endowment anyway, but before tilting at this multi-million-dollar windmill, I invite you to entertain the following considerations for an endowment. By the end, you may decide to undertake one anyway, but with a clear-eyed knowledge of the potential tradeoffs.
The Nature of an Endowment
First, let’s define our terms, because they are more slippery (slipperier?) than they appear.
The term “endowment” is simply another word for a gift, which gives organizations latitude when describing their endowments. Black’s Law Dictionary defines it thus:
A gift of money or property to an institution (such as a university) for a specific purpose, especially one in which the principal is kept intact and only the interest income from that principal is used.
This structure ensures that the donor’s gift provides for the organization in perpetuity according to their intent. The intent of the donor is enforced through gift agreements, which means that most endowments are composed of gift agreements with funds assigned for defined purposes.
Sometimes, endowed funds can be used for general expenses, but in such cases the principal, or “corpus,” will typically remain untouched.
Things to Consider Before Building an Endowment
Building an endowment is not a breezy decision. The required legal structure demands time, attention, and maintenance, not to mention cost. This can be a burden for many nonprofits.
More importantly, the board member or CEO who wants an endowment so that the org doesn’t have to fundraise as much probably isn’t considering that it takes fundraising—a lot of fundraising—to build an endowment.
According to the National Bureau of Economic Research, the average net investment return of endowments from 2008 to 2020 was 4.3% (let’s round that up to 5% for easier calculations). That means an organization would need to fundraise an additional $1M in order to generate $50,000 a year. If your organization is marveling at $50,000 “for free,” then you probably are not a multi-million-dollar fundraising operation, and raising the $1M is not going to be easy.
But even if we remove the problem of whether the effort is worth the payoff, building an endowment has a significant opportunity cost. Whenever an organization has extra funds to put into an endowment, they must consider the other ways those funds could be used. A simple scenario illustrates the point.
The leader of a $5M nonprofit is considering starting an endowment, but she’s done the math and doesn’t think it’s feasible for her org to allocate excess funds to an endowment. One day, a brand-new donor approaches her saying, “I want to give you $1M, and you can do whatever you want with it!”
We already know that the $1M could generate $50K every year in perpetuity if endowed. That means that over the next five years, the org would get $250K that could be directed towards programs. Not a terrible deal.
But what if that $1M were invested in growing the organization?
The organization could take half the gift, $500K, and commit it to programs over the next five years. Then, the organization could invest the other $500K to grow their fundraising. Many organizations see fundraising investment as a necessary evil, but as we’ve argued before, nonprofits shouldn’t be afraid to invest in fundraising.
Using conservative numbers (because the org in question is now in growth mode), this nonprofit could expect to spend 35 cents in order to raise a dollar. According to the Center on Nonprofits and Philanthropy at Indiana University, the average cost to raise a dollar is between 15 cents and 25 cents, so 35 cents is very conservative. That means, with a $500K investment over five years, the organization could expect to raise an additional $1,428,571!
Situation 1: Put $1M into an endowment and spend the resulting $250K on programs over the next five years.
Situation 2: Split $1M on programs and fundraising. Spend $500K on programs over the next five years and raise an additional $1.4M.
The latter situation is starting to look like a much better deal for the organization, and for the donor!
When Should You Build an Endowment?
There are three cases where it does make sense to build an endowment: 1) to respect donor intent, 2) to encourage planned gifts, and 3) when your organization is able to plan 25 years in the future.
1. To respect donor intent: Many donors who care deeply about your mission wish to leave a lasting legacy. These donors don’t like the idea of their gifts being spent right away, and they are drawn to the perpetuity of endowments. There are creative ways to help these donors leave legacies without the rigidity of an endowment, but organizations should have ways to respect the wishes of donors who desire to make gifts like this.
2. To encourage planned gifts: Every organization should be soliciting planned gifts, most of which are bequests. Given the considerations involved in such a gift, many donors are more comfortable leaving bequests to endowments to ensure their intent behind this most meaningful gift will be respected. Savvy nonprofits use endowments as a way to set donors more at ease with planned gifts, encouraging more generosity.
3. When your organization has a long-term plan: Certain organizations, such as large universities, have grown to the point where they serve almost as a public good rather than a private charity. These organization bear a responsibility, much like a city would, to plan for far in the future. Moreover, these organizations often have such robust funding that they are able to invest in the distant future. Endowments serve a role in these institutions.
Conclusion
So you see, endowments are not necessarily the solution to all your fundraising woes.
It may sound responsible to “invest in the future,” but we now know that the math isn’t so simple. As with any investment, an organization should consider the ROI. In the short term, you know it will take a lot of work to raise funds for an endowment, and you only get to see 5% of that money returned every year. Meanwhile, your organization could be using that money to serve more people and even raise more money! Even if a donor wishes to “secure the future” of your organization, it’s not immediately clear an endowment is the best way.
Nevertheless, there is certainly a place for an endowment as part of a larger development strategy. When donor intent, a planned giving program, and organizational stability are aligned, endowments can be a prudent use of funds to ensure your programs are able to serve your community for generations to come.
Next time a board member approaches you with the endowment suggestion, you’ll be better armed with questions and insights to ensure their vision is aligned with your organization’s best interests.