🔒How to manage an endowment for a nonprofit

The term “endowment” often suggests larger nonprofits, such as hospitals and colleges. However, a nonprofit of any size may choose to create an endowment. In fact, most should! An endowment, after all, is simply a permanent fund. Most commonly, the funds are invested to produce a long-term income stream for the organization.

Endowments can be a smart way of diversifying an organization's income. The stability that comes from a long-term investment strategy and commitment to the nonprofit's mission can also be a comfort to donors who may wish to do more than contribute to the annual operating expenses of the organization.

In thinking about endowments, nonprofit executives should be aware of best practices. Executive directors and investment committees should develop policies for managing an endowment in order to meet their fiduciary obligations to the organization and to its donors, and to avoid liability.

Best practices include at least the following elements (keep in mind that there are additional rules that apply to “foundations,” as defined by the IRS):

• Develop an acceptance policy: What can be accepted? Wills and bequests are often an integral part of endowment fundraising. An acceptance policy allows the nonprofit and its board to determine the types of gifts it is prepared to accept. Aunt Florence's stamp collection may have real value beyond its sentimental value to the family, but should the nonprofit accept it? Or the parcel of real estate that is generously offered — what environmental or other risks does the organization run by accepting it?

• Establish a spending policy: How much can the organization spend or distribute annually (usually a percentage or dollar figure)? This depends in large measure on how the endowment is invested, which in turn depends on the nonprofit's investment policy. For example, if investments are limited to government issued notes and bonds, it is unlikely ever to be able to generate sufficient returns to permit a 4% annual payout. The spending policy should also establish rules for how much of the endowment's earnings may be spent annually, and whether it may be used should the organization face a financial crisis (which also should be defined). While an endowment should generally not be viewed as simply a rainy day fund for the nonprofit, the spending policy should provide guidance to the board and executives on how — or if — the endowment may be spent in extenuating circumstances.

• Develop an investment policy: What types of investments and in what proportions will the endowment hold? Typically, an investment policy states the classes of investments permitted, as well as asset allocation ranges for each investment sector and/or asset class.

• Consider hiring an investment manager: How (and how frequently) should the investment committee evaluate the performance of the investment adviser? Should there be an RFP process and what should it cover? As the endowment grows, the nonprofit should consider selecting an investment adviser or money manager to provide long-term investment guidance and oversight of the endowment. Additionally, there should be a specified process for evaluating on a periodic basis the investment adviser. Again, larger endowment investment policies may require the board (or investment committee) to undertake a periodic process to go to market to confirm that the status quo fulfills their fiduciary obligations in terms of both performance and cost.

Even a cursory review of these best practices demonstrates there is no cookie-cutter, one-size-fits-all solution. In the final analysis, it is always a matter of judgment, balancing legal and cost considerations with other values important to the nonprofit organization.

Barry L. Kohler, a certified financial planner, is a senior vice president and director of Trust and Wealth Management at Androscoggin Bank. He can be reached at bkohler@androscogginbank.com