A Good Case for an Endowment

Image: © Rfischia | Dreamstime.com

Image: © Rfischia | Dreamstime.com

I recently heard the story of a donor’s gift to his daughter’s private school. Not, as one might expect, a shiny new fitness center or maker space – but a new set of much-needed storm windows, which would pay dividends in the form of energy savings for years to come. The condition of his gift?  The windows had to bear his family name. 

The story of the “Smith Family Storm Windows” is a compelling statement on the challenges that non-profits face in covering unglamorous expenses – like storm windows – that are nonetheless necessary to keep an organization running. By having the windows bear his name, this donor hoped to highlight the importance of supporting the general operations of the school to other donors.

It’s a story – and issue – that resonates with many of the non-profit managers that I work with at Wellspring. Donors are much more apt to support programs or fund new buildings than to provide unrestricted funds that keep the lights on (or the heat in). Often, this means that organizations must raise operational support through annual campaigns, special events, memberships, and so forth. These income streams can be unpredictable and there is an ever-present anxiety of missing the year’s targets.

For this very common dilemma, a solution we’re often asked about is building an endowment fund, an investment that is set aside for the long-term support of an organization. Only the income, or a portion of the income, is spent each year. An endowment represents the promise of a reliable income stream to cover operating expenses, fill occasional shortfalls, or even seed new work. Many eminent cultural, educational, and healthcare institutions have accumulated massive endowments – if Harvard University is doing it, many wonder why shouldn’t we too? Putting aside the question of whether Harvard actually needs $20 billion for a rainy day, is raising an endowment fund in fact a good fit for smaller non-profits?

I recently found myself pondering these questions while working with a mid-sized regional science center on their five year strategic plan. The center has thrived and grown over its brief ten year history, and has a very active board that’s committed to ensuring the institution’s long-term viability. Its campus, including its LEED certified building, cutting edge exhibits and extensive outdoor attractions, are beyond what you’d expect from a regional institution, particularly one that happens to be located in a fairly remote location. Less surprising is that these programs don’t come cheap – the operational expenses associated with maintaining this impressive infrastructure are a big part of the center’s budget.

The center’s leadership reached out to Wellspring Consulting to help them assess the institution’s long-term financial sustainability. In particular, they had concerns that finding ongoing support for the less “glamorous” aspects of museum operations, namely the maintenance and refreshment of their facilities, was getting more difficult over time, as donor fatigue set in. Some members of the board felt that the answer was the creation of a large endowment fund—the bigger the better, since a larger principal would mean more investment income, and therefore less pressure to raise other funds on a yearly basis. This makes perfect sense, right?

Up to a point, yes – a bigger endowment may be better, all else being equal, but in the world of fundraising that’s rarely the case. There are reasons why smaller organizations might wish to be modest in their endowment ambitions, or even avoid endowment fundraising altogether. The answer to whether a given organization should pursue this strategy needs careful analysis of its current financial and programmatic position, trajectory and goals.

Much ink has been spilled on often underestimated complications that come with building an endowment. Some potential downsides of these funds include:

  • Needing to be big. When it comes to the value of an endowment, size really does matter. To provide meaningful income, an organization’s endowment needs to be substantial relative to their yearly expenses. For example, if an organization has an annual budget of $10 million and it manages to raise $2 million in endowment funds (no small feat for many organizations of this size), that would only give them $100 000 dollars toward their expenses each year (assuming annual earnings of 5%), covering only 1% of the budget.
  • Robbing Peter to pay Paul. Raising enough money to cover current annual expenses poses a challenge to many non-profits, let alone trying to build a fund to cover future expenses. Donors may only be willing to give to one funding stream. Raising that $2 million for the endowment may reduce giving in other areas, including support for core programs.
  • Creating a need to feed the beast. A recent conversation with development staff at a private university highlighted another, less often noted, issue with endowments. Because the size of an endowment is easily quantified, it can become a measure of organizational success in and of itself. This can result in a focus on growing the endowment (to achieve ever greater success) rather than viewing the endowment as means to an end: that is, the creation of an important rainy day fund, or important revenue stream to cover overhead costs.

However, along with these challenges, there are potential upsides to building an endowment, even for smaller organization. Non-profits are understandably drawn to endowment building because, among other benefits, they may:

  • Attract large gifts. Individuals often prefer to make major gifts (including bequests) to support features or efforts that will remain in place long after they are gone. For example, universities and hospitals often receive major gifts that support new buildings, wings, or endowments from individual donors. Contributing to an endowment ensures that the gift lives on beyond the donor. (A corollary of this is that many organizations now require funders to cover future operating costs of buildings or programs they donate.)
  • Signal strength. The existence of an endowment can serve as a signal to donors that an organization will be around for the long-term. This may draw further support from those who wish to invest in an institution that has longevity.
  • Support operations and innovation. Because it comes in as unrestricted dollars, the income from an endowment can be used as needed in any given year—for example, to smooth out financial shortfalls in lean times, and can also be used to cover ongoing overhead costs (paying for those storm windows!), or even fund projects that are more experimental in nature and may put an organization on the cutting edge of its field.

In order to determine whether our client, the regional science center, should build an endowment, the Wellspring team collected and analyzed data from a variety of sources. We made our final recommendation after having engaged in the following activities:

  • Analyzed the center’s current financial status and built ten-year financial projections that accounted for multiple funding and expense scenarios.
  • Conducted interviews with existing and prospective donors to assess their willingness to support the center in the future.
  • Conducted interviews with Board members to ascertain their willingness to give to an endowment campaign and to elicit funds from those in their social networks.
  • Held in-depth conversations with the center’s leadership and development staff to gain a greater understanding of their capacity and support for conducting an endowment campaign.

After intensive analysis of our data, we concluded that this is an appropriate time in its planning trajectory for this science center to move forward with building an endowment. This decision is grounded in a deep understanding of the organization’s capacity, programs, and goals for its future. Key factors that led us to this recommendation include:

  • The source of the center’s future deficit is the maintenance of its impressive infrastructure. Covering this cost requires a reliable stream of operating funds, which is well-suited to the nature of endowment income.
  • The amount of investment income required to cover the center’s shortfalls does not require that they build a Harvard-sized endowment. The endowment goal is aligned with realistic levels of giving for this institution.
  • The center’s existing donor base is willing to contribute large sums in the form of bequests to an endowment.
  • The Board is committed to building a restricted endowment and is willing to actively engage in fundraising for this purpose.
  • The staff leadership of the center understand and are committed to making the investment needed to launch and implement a successful endowment campaign.

While the Wellspring team recommended that the science center pursue an endowment campaign, this should not be interpreted as a global endorsement of non-profit endowment fundraising. If anything, our research and analysis reinforced our belief that strategic and financial planning is not a one-size fits all endeavor. For example, if we had found that most of the center’s individual donors would redirect their support from the annual campaign toward the endowment campaign, we would have reached very different conclusions.

To return to the story of the Smith Family Windows, the school was clearly lucky to have a forward-looking donor willing to “invest” in mundane day-to-day expenditures. For some (but not all) organizations, an endowment fund can serve the same purpose.