Managing Subrecipient Risk: Best Practices for Federal Grants
One of the most critical aspects of federal grants management is subrecipient risk assessments and monitoring. Such practices safeguard against funds...
Endowments are long-term investments that generate income to support nonprofit organizations' ongoing operations, programs, and services. These investments are typically managed by a professional investment manager or committee and are designed to provide a reliable source of income for the organization in perpetuity. Endowments can be funded by a variety of sources, including individuals, foundations, corporations, and even the organization itself. Donors contribute to endowments with the understanding that their gift will continue to generate income for the organization long after the initial gift is made.
Endowments can be categorized into three types: Perpetual (donor-restricted), Term (donor-restricted), and Board designated. Perpetual endowments preserve the principal (corpus) perpetually, while earnings may be spent according to the donor's stipulations. Term endowments preserve the principal for a specified period or until the occurrence of an event specified by the donor. Board-designated endowments usually retain the principal, while earnings may be spent, and the principal may be used with board approval.
Although endowments are a great strategy for long-term planning, organizations must carefully navigate the nuances and challenges associated with them.
Common Challenges
Understanding and Identifying Endowments
Nonprofits that are new to endowments may struggle to understand how to account for them and identify the appropriate keywords in governing documents. Endowments are governed by guiding documents that come in various forms such as trust instruments, written agreements from donors, or board resolutions.
Stipulations and Governing Laws
Endowment operations are not only governed by the gift instruments but also by state law. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) provides guidance on investment decisions and endowment expenditures for nonprofit and charitable organizations, but donor stipulations take precedence over UPMIFA in some cases, which can create confusion.
Unclear Donor Intent
Donor agreements may not clearly convey the intent and purpose of the gift. These documents can be written by various individuals who are not accountants, creating challenges when determining the appropriate financial statement classification and operating mechanics of the endowment. Nonprofits may face difficulty in understanding the donor's true intent and applying the correct accounting treatment.
Managing Endowments
Managing an endowment can be complex and time-consuming. Nonprofits must track endowment activity in detail, retain supporting documentation for all gifts and investment returns, and have various levels of expertise and strong internal controls. Funds are often commingled in investment pools, which can create allocation challenges.
Donor Changes
Donors may submit modifications to their original gift instruments that are not correctly applied on a prospective basis. Nonprofits need to retain support from donors who make modifications to their endowment agreements as a record for any changes made to the accounting and treatment of an endowment.
Balancing the Objectives
Under UPMIFA, the goal is to apply prudence to the fund to preserve its value, not just the initial corpus. Prudent investment and spending policies must be applied while considering donor stipulations for the fund's use. Funds with deficiencies require special considerations related to spending and estimating future recovery. These challenges also apply to a board-designated endowment fund. Nonprofits need to establish the purposes of the endowment fund and document them in board minutes.
Navigating the Challenges
Nonprofits must be proactive and meticulous to effectively manage endowments. They must be willing to invest the necessary resources to educate their team and establish appropriate processes and controls. Here are some tips to navigate the challenges discussed above:
In recent years, nonprofits have been faced with navigating a tumultuous economic and political environment due to the COVID-19 pandemic, inflation, and political unrest. Endowments and other reserves can help boost liquidity and support philanthropic goals. Nonprofits should carefully weigh the benefits and costs of establishing and running an endowment and be mindful of nuances to avoid financial statement errors and reputational risk.
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