Challenges of Managing an Endowment

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:

• Carefully evaluate the costs involved in managing an endowment before establishing one. This includes expenses such as investment management fees, bank charges, and additional staff time needed for reconciliation and tracking.
• Adopt formal policies for accepting gifts, managing endowments, and making investments. These policies should provide clear guidance on how funds are to be invested, spent, and used.
• Use standardized templates for gift and endowment agreements to ensure uniform language and prevent misunderstandings. Templates should be reviewed and approved by personnel from various areas of the organization, including legal, finance, operations, and the board.
• When in doubt, clarify the intent by contacting the donors or their representatives, particularly for atypical gifts received from trusts and bequests.
• Keep detailed documentation for all gifts, including key information like details on the donor, assets transferred, specified use, spend rate, investment policy, and any modifications.
• Regularly monitor endowment assets and compare them to donor agreements to ensure they are being managed in accordance with gift instruments and applicable laws.
  • Analyze investment returns, spending rates, and fund balances throughout the year to ensure proper management of funds.
  • Discuss any needed modifications with donors, seeking legal advice before making significant changes and obtaining written approval from donors.
  • Keep in mind the goal is to preserve the overall purchasing power of the endowment over time. Track deficient funds separately and monitor them more frequently. Elevate these to the board or investment committee for review and to develop a plan of action.
• Think about short- and long-term needs when accepting gifts. Overly large endowments may be viewed as hoarding and may not generate adequate income for operations. Consider more flexibility, such as term/quasi endowments or variance power language in their agreements, to redirect the use of assets and ensure the immediate needs of the organization are being met.
• Stay up to date with the latest accounting guidance by conducting research and receiving appropriate training.

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.