Understanding and Implementing a Nonprofit Endowment Spending Policy

A nonprofit endowment spending policy is a crucial component of a well-managed endowment. It's designed to ensure the long-term sustainability of the endowment while also fulfilling the organization's mission.

The endowment spending rate, also known as the payout rate, is a key factor in determining how much of the endowment's assets can be used each year. A common rule of thumb is to use a spending rate of 4-5% of the endowment's value.

The spending rate should be set based on the endowment's overall investment strategy and goals. This will help ensure that the endowment's assets are being used effectively to support the organization's mission.

By implementing a well-designed spending policy, nonprofits can ensure that their endowment is working for them, rather than against them.

A nonprofit endowment is essentially a restricted gift that's invested to provide a steady income stream for a specific purpose. It's like a cash reserve that helps organizations like educational institutions, healthcare organizations, and cultural institutions fund their activities.

To establish an endowment, a nonprofit typically uses a large gift from a donor to create a trust, which is then managed according to specific policies and guidelines. These policies dictate how the endowment will be used, how funds can be withdrawn, and more. The principal investment is left untouched, and the fund is actively managed and grown over time.

There are several types of endowments, including restricted, unrestricted, permanent, term, and quasi-endowment. Restricted endowments can only be used for a specific purpose, while unrestricted endowments can be used for any purpose. Understanding these categories is crucial when creating an endowment that supports your goals.

A nonprofit endowment is essentially any restricted gift, but more commonly it's an investment fund created by nonprofits to hold and invest gifts for specific purposes, acting as a kind of cash reserve.

Income from an endowment is used for its restricted purpose or general unrestricted purposes, with the principal investment retained. The principal investment is left untouched, and the fund is actively managed and grown over time.

Endowments are most commonly used by educational, cultural, and healthcare organizations, but any organization—large or small—can create one.

The process of creating and managing an endowment needs to be prioritized properly. A donor gives a restricted (and usually large) gift with the express intent of establishing an endowment.

Here's a step-by-step overview of how endowments work:

A well-managed endowment serves as a sustained, reliable source of funding for programs, departments, scholarships, etc., or can cover unrestricted operating expenses.

This predictability of funding allows nonprofits to expand their capacity, focusing on big-picture strategy rather than just covering essential annual costs.

A well-managed endowment can also attract more and larger gifts over time, providing a steady stream of revenue for the organization.

When you're creating an endowment, you'll need to decide on the type of fund that will work best for your nonprofit. There are several key types to understand, including restricted endowments, which can only be used for a specific purpose.

A restricted endowment is a type of fund where withdrawals can only be used for a specific purpose designated by the donor or board. This means that the money is tied to a specific project or goal.

Unrestricted endowments, on the other hand, are funds from which withdrawals can be used for any purpose. This type of fund gives the nonprofit more flexibility and freedom to use the money as needed.

Permanent endowments are a catch-all term for any large gift intended to serve as a long-term source of funding. This type of fund is often used for major donations.

Term endowments are shorter-term endowments that allow the withdrawal of the fund's principal after a certain amount of time has passed. This type of fund is often used for a specific project or goal with a clear deadline.

Here are the main types of endowment funds:

As you can see, these terms can overlap, and a permanent endowment may be designated as restricted or unrestricted. This means that you'll need to carefully consider how you want to structure your endowment to best support your goals.

Creating a spending policy is a crucial step in managing your nonprofit's endowment. A spending policy should be carefully selected after evaluating key inputs such as the type of organization, time horizon, beneficiaries, and applicable donor restrictions.

Your organization's spending policy should be guided by a thorough understanding of the 7 Spending Factors, which include annual operating expenses and income, grant-making obligations, capital expenditures, risk tolerance, expected total return, investment-related costs, and inflation/deflation.

To create a spending policy, you should consider setting goals for spending success, including statements on the preservation of purchasing power, the extent to which investment income is needed to support the operating budget, and the possibility of exceptional spending.

Here are some key considerations to keep in mind when creating a spending policy:

Ultimately, the goal of a spending policy is to balance predictability and stability with the preservation of capital. By carefully considering these factors and setting clear goals, you can create a spending policy that supports your nonprofit's long-term sustainability and mission.

Your organization's spending policy should be carefully selected after a thorough evaluation of several key inputs, including the type of organization, time horizon, beneficiaries, purpose of the endowment, sources of funding, institutional resources, and applicable donor restrictions.

A qualitative review of these inputs should factor into a quantitative analysis that addresses annual operating expenses and income, grant-making obligations, capital expenditures, risk tolerance, expected total return from income or capital appreciation, investment-related costs, inflation/deflation, and general economic conditions.

To create a successful spending policy, you should set goals for spending success, which includes statements indicating your nonprofit's position on preserving purchasing power, the extent to which investment income is needed to support the operating budget, the possibility of exceptional spending, and the role of inflation and investment-related expenses.

A nonprofit's investment policy should govern how endowed assets will be invested and withdrawing money from the corpus is generally prohibited, absent specific authorization from the board to do so.

Here are the key factors to consider when setting up your spending policy:

Remember, the goal of a successful spending policy is to balance predictability and stability with the preservation of capital.

Implementing the policy requires careful consideration of several key factors. A thorough evaluation of your organization's spending policy should be done to ensure it aligns with your mission and goals.

Your organization's spending policy should be reviewed regularly to ensure it remains effective. This involves assessing your organization's annual operating expenses and income, as well as grant-making obligations and capital expenditures.

A quantitative analysis should be conducted to address factors such as risk tolerance, expected total return from income or capital appreciation, investment-related costs, inflation/deflation, and general economic conditions.

The investment committee should use the investment policy statement and spending policy together to balance current and future spending requirements. This ensures the long-term value of endowment assets is maintained.

By following a qualitative review of key inputs, you can create a spending policy that is tailored to your organization's needs. This involves considering factors such as the type of organization, time horizon, beneficiaries, purpose of the endowment, sources of funding, institutional resources, and applicable donor restrictions.

To implement the policy effectively, consider the following key inputs:

A nonprofit endowment's spending policy is a crucial aspect of its financial management. This policy should be carefully selected after evaluating several key inputs.

Your organization's type, time horizon, beneficiaries, purpose of the endowment, sources of funding, institutional resources, and applicable donor restrictions all play a role in determining the spending policy. A qualitative review of these factors should inform a quantitative analysis.

Annual operating expenses and income are essential considerations in this analysis. You'll need to account for any grant-making obligations, capital expenditures, and risk tolerance.

To determine the expected total return from income or capital appreciation, you'll need to consider investment-related costs, inflation/deflation, and general economic conditions. These factors can significantly impact your endowment's performance.

Here's a summary of the key factors to consider in a spending policy analysis:

Financial Management is a crucial aspect of any nonprofit organization, and it's essential to get it right before considering an endowment. A well-managed nonprofit is better equipped to handle the responsibilities that come with an endowment.

Reviewing your organization's financial management practices is a good starting point. Take stock of your current financial practices to determine if an endowment is the right choice for your nonprofit. Consider the types of funds you have in place, how they're being used, and whether they're replenished over time. This will help you understand your financial effectiveness and whether your current practices are serving your mission well.

Managing from income is the more responsible approach to nonprofit operations, as it allows for a more stable financial foundation. This approach involves setting budgets based on projected income, supplemented by cash reserves as needed. In contrast, managing from expenses can create more stress and limit growth. Many growing organizations manage from expenses out of perceived necessity, but this can lead to an endowment becoming a costly distraction.

It's essential to conduct an audit or further-reaching assessment of your financial practices and implement any changes as needed. If you're unsure about your financial operations, consider consulting with professionals to help you make improvements. This will give your organization a solid foundation for long-term growth, regardless of whether you create an endowment or not.

Nonprofits with endowments typically have an investment policy in place to govern how the endowed assets are invested. It's also important to understand that withdrawing money from the corpus is generally prohibited, unless there's specific authorization from the board to do so. This is often referred to as "invading the corpus."